Nigeria Macro Update: Fiscal Tightening and Foreign Investment into Nigeria

Another month passes with another 3%-5% depreciation in the Nigeria Parallel FX Market. While economic fundamentals may have influenced the rate to drift up to around 1750 since our last update, there are a number of factors at play in the background that cumulatively are starting to take effect. 

At a Glance

• Widening Parallel and Official markets combined with significant disruption from banking network downtime signals high fragility in the Naira market.

• Recent Eurobond issue announcement falls short of expectations as local Central Bank bills also fail to incite interest from foreign investors

• Proposed fiscal reforms continue to strain political capital. Any boost from the recent cabinet reshuffle fell flat as key ministers maintained a stay of execution.

• Commitment from Dangote to purchase domestic crude is a key step forward as the NNPC strikes deals with key IOCs. However, eyebrows were raised over the NNPC's sudden settlement of outstanding debts.

• Saudi Arabia Trade Deal will need to be seen to be believed, but questions remain on whether any USD cash injection can be disbursed efficiently into the economy.

• Market-wide impact of President-Elect Trump’s victory will take time to filter through to Nigeria, but any longstanding unwind of EM credit will negatively impact future bond issuance.

• In contrast to twelve months ago, any sparks of momentum of an appreciating NGN are becoming increasingly short-lived. Local corporates are highly inclined to buy any dip as they look to rebalance books into year-end.

Developments in NAFEM

For weeks we’ve seen the spread between Parallel and Official rates widen to nearly 100 NGN. This would usually indicate a distinct lack of USD supply in the official market, forcing buyers to resort to the parallel and wearing a premium. On the contrary, we’ve seen local corporates continuing to source sufficient USD in the NAFEM window via local banks at highly discounted rates versus parallel. 

NAFEM turnover hit a single-day high of $1.4bn on 9 November, resulting in an expected appreciation in the parallel market given the lower demand for USD. It’s not immediately clear where this swell in USD supply came from, either willing sellers or the Central Bank of Nigeria (CBN) themselves. The CBN recently published guidelines for a temporary window permitting hard currency deposits at local banks without penalty, taxation or investigation of origin. While a questionable decision from an illicit funds standpoint, it seems reasonable to assume this may have injected much-needed supply into the NAFEM window as local bank foreign reserves potentially increased. However, this is not a sustainable stream of funds to prop up the Official market over the medium to long term.

It’s worth noting that the bout of appreciation seen last week coincided with another episode of banking outages from GTBank (GTB) and Zenith Bank. This proved another reminder of the fragility of the FX market as a whole. When funds are brought out of circulation (artificially reducing NGN liquidity in-market), the resulting scramble for local currency among remittance players and other hard currency sellers can drive a sharp but temporary appreciation in-market. 

There’s no doubt that the CBN will have noticed the effect on this immediate drop in local liquidity but instilling this systematically to aid appreciation may come at too much of a cost politically.

Fiscal Reform & Liquidity Tightening

Traditional methods of steady local liquidity tightening are still in play, however Open Market Operations are in full swing, with decent appetite from offshore investors as well as onshore. A rumoured $1 billion private placement was made at the end of October directly into OMO’s (an isolated example but signals of enthusiasm from FPI cannot be taken for granted at this stage). 

Local bond issuance at 17%-18% may not have sparked a huge wave of investment from offshore institutionals given the extent of the inverted curve, but interest could shift in the short-term if we see any substantial drop in inflation (even if this is via transitory effects). Finance Minister, Wale Edun, has announced plans for a $1.7 billion Eurobond plus $500 million Sukuk which, while likely smaller than many anticipated, will act as an important barometer for investor appetite going into 2025.

Away from market operations, there’s been various developments in fiscal reforms that may have a further impact on local liquidity. With the fiscal deficit dropping some 200bps since the start of the year to around 4%-5% of GDP, there are nascent signs that the Government is regaining some control. 

Questions remain around the efficiency of tax collections in-country, which jeopardise the impact of President Tinubu’s hikes in VAT (up to 15% over the next six years) and higher earner income tax rates (from 20% to 25% next year). Furthermore, there will no doubt be some pushback from opposition parties and the public alike, particularly when corporation tax is slated to drop from around 30% to 25%. The National Economic Council has already called for President Tinubu to withdraw the new proposals to allow for further consultation and consensus building among the National Assembly.

Cabinet reshuffle

This will be a delicate tightrope for the Government, particularly in the wake of President Tinubu’s recent cabinet reshuffle. With critical posts such as Wale Edun surviving as Finance Minister, alongside incumbent ministers for Defence, National Planning and Energy, the majority of the reshuffle impacted less influential positions. While outwardly it’s perhaps not ideal for confidence in the Government from both the public and potential investors, there is some positivity that the number of ministers holding posts have reduced a touch from the somewhat bloated cabinet announced after the President’s inauguration. This may help quicker decision-making on important matters, but the needle is unlikely to move significantly.

Fuel Prices and Critical Industrial Agreements Trigger New Investment and Growth Opportunities

The incumbent Government’s popularity has also suffered following the pass through of refined oil prices to the fuel pumps. The Nigeria Labour Congress has responded to higher pump prices by stoking the possibility of an indefinite strike commencing on Dec 1st in states that have not adopted the July increase in minimum wages. While the blame somewhat lies between Dangote, the NNPC and Marketers who have been disputing over prices of domestically refined oil products using the nation’s own crude, there’s no doubt the public backlash is currently aimed at the Presidency. 

Green shoots appeared this week as Dangote and Marketers came to an agreement to buy and sell fuel bilaterally (away from the NNPC who has also ceased purchasing offshore refined products in a bid to source from Dangote solely) that both sides promise should lead to a drop in pump prices and a significant reduction in price volatility. Whether influenced by President Tinubu or not, this has allowed for some political breathing room.

Doubling down on natural resources, a landmark deal has been struck between the NNPC, Shell, TotalEnergies and Agip to commence a $3.3bn project to tap into Nigeria’s largely unexploited gas reserves. Not only will this help reduce the reliance on refined products from crude, but also brings some much-needed Foreign Direct Investment from global enterprises with the gravitas to instill confidence in other offshore businesses to invest in the future.

This deal came at somewhat of a surprise after the Naira market was rocked in September when outstanding unpaid debts were disclosed by the NNPC to the aforementioned global oil companies as part of various joint venture agreements, reportedly to the tune of $6bn. The NNPC, however, has since announced clearing their claimed $4.68bn cash call debt, alleging using funds generated since the fuel subsidy removal from 2023. Delays in repayment are frustrating the likes of Shell and other International Oil Companies (IOCs). If all obligations have been truly settled, this paves a promising path for new investment going forward.

Offshore Investment and New Trade Deals Need Time to Achieve Positive Change

This future investment on the horizon may not come soon enough, as President Tinubu has once again made efforts to incite Saudi Arabia to accord a new trade agreement that will include a $5 billion loan to shore up reserves in Nigeria and “support economic reforms”. We’ve heard musings around a similar Memory of Understanding (MoU) between the two nations over the last twelve months, so it would be prudent to wait to see a material agreement and funds flowing before placing any expectations on economic improvements and currency appreciation. Furthermore, the Government sorely needs a clear strategy in how to disburse any hard currency injections into the economy to ensure maximum impact.  If the tried and tested strategy of dumping USD into the NAFEM window is implemented, returning to square one could quickly be on the horizon. 

CBN & Monetary Policy Aims to Curb Inflation

Inflation needs to be tackled first and foremost, and relying on transitory effects will not be sufficient in the long term. In a bid to tackle food inflation, President Tinubu should be commended for his efforts to enforce a six-month duty-free window for food imports. However, the take-up of this fell short of expectations, while local food producers pushed back on the prospect of increased competition with no support to reduce their fixed costs. If pump prices do drop in the short-term, the pass through to reduced transportation costs, leading to lower food prices could potentially materialize but this may take time. 

While the Government has been in the headlines for much of the last month, Governor Cardoso and the CBN has been in the background. Following endorsement from the World Bank on recent monetary policy, Governor Cardoso reiterated his intention to employ the CBN’s inflation targeting strategy with heavy hints toward further tightening and stopping Central Bank loans to cover Government spending. 

We still believe that the eroding of political capital is beginning to outweigh the positive impact on inflation from hiking interest rates, but to meet the World Bank’s inflation forecast of 14.3% in 2027 (from over 32% currently), Governor Cardoso may have no choice but to keep hiking in a bid to encourage a perpetual positive real interest rate environment.

US Election Result Impacts Emerging Markets

Finally, we cannot ignore the elephant in the room across the Atlantic. President Trump’s USA-first policies can only be seen as a negative for Emerging Markets as a whole, as seen with the USD rally and sell-off in Emerging Market (EM) credit across the market. 

Nigeria is likely to suffer less than other EM economies in the wake of Trump’s economic agenda. However, if crude prices drop to sub $40 levels as seen during Trump’s previous term in office, this will indirectly impact Nigeria greatly when it comes to both refined and unrefined exports. This was during a pre-COVID period so negative moves in crude prices are not necessarily guaranteed, but any impact of a Republican sweep in the US election can only be seen as a medium to long-term negative for Nigeria. 

A clear signal may come from JP Morgan CEO Jamie Dimon who announced his intentions to expand operations across Africa earlier this month, with positive remarks on the future of Nigeria specifically. However, if the US’s biggest banking institution pivots away from this Africa-centric strategy on the back of the US election result, it feels likely that other institutions and investors may look to follow suit.

In Conclusion

Focusing on the short term, with both Official and Parallel markets near all-time highs, there’s no doubt that hope is low among corporates for Naira appreciation this side of New Year’s Eve. Last year we saw huge volatility as any spark in momentum caused a huge rush for local currency as domestic FX participants held their nerve and waited patiently for the rate to drop further to buy hard currency. However, evidence over the last month shows that any drop in the NGN rate has been seen as an immediate opportunity to buy the dip, with Naira appreciation being eradicated as quickly as it materialized. Concerns around local currency backlogs for international companies have lessened in 2024, but there will still be a seasonal demand for USD as these enterprises look to consolidate balance sheets into year-end. For the time being, local banks are able to offer USD in sufficient quantities to quell the demand, but the market feels fragile. The Official to Parallel FX spread is wider than we’ve seen in many months, so if USD supply dries up and corporates are forced to source away from the Official market, the 5%-10% premium will sting and we could see a renewed bid for hard currency in the Parallel Market, inciting significant pressure for the remainder of 2024.