Nigeria’s first economic recession in 25 years, in the second quarter of 2016, caught several investors and consumers unprepared. The attendant foreign exchange (FX) crunch left many businesses gasping for breath.
“At times the only way to access FX was through the black market and this led to a tripling of costs in some cases,” a private equity investor told the Economist Intelligence Unit (EIU) in a new report on ‘FX and debt trends in five sub-Saharan Africa economies’ released Tuesday.
The report focused on Nigeria, Ethiopia, Kenya, Tanzania and Zambia.
The rising import prices in Nigeria reflected in higher costs to consumers and squeezed margins for local businesses.
Although there has been an improvement in the FX liquidity following the rising oil prices and the interventions by the Central Bank of Nigeria (CBN), the impact of the devaluation in 2016 and the consequent FX shortages on firms, banks and consumers is still being felt.
While some high-end consumers are forced to resort to the greenback as a hedge against inflation or currency devaluation, companies and investors on the other hand are trying to limit their risk exposure by diversifying their investment portfolio across sub-Saharan African regions.
Local businesses and investors spoken to by EIU gave insight into their risk-proofing strategies. They suggested developing conservative business plans, with ample levels of reserves. They also suggested that currency mismatches (for payments and revenue) should be avoided as far as possible, while mitigating risk by diversifying an investment portfolio geographically is worth considering.
Furthermore, interviewees pointed to the need to take opportunities for exits when they present themselves.
The interviews revealed that, facing FX restrictions, businesses resorted to unofficial channels. The situation also pushed for changes in business planning. Cash reserves became a necessity in such an environment.
“Companies can adjust to a devaluation by passing on some of the increase in costs to customers and accepting a squeeze on margins. But a lack of availability of FX makes life very difficult, even for a business like ours which is not particularly import-intensive,” said a private equity investor.
The foreign exchange turnover at the Nigerian Autonomous Foreign Exchange Fixing (NAFEX) stood at US$105.9 billion as of March 2019, with foreign portfolio investors (FPIs) accounting for over 60 percent.
The Central Bank of Nigeria (CBN) in April 2017 introduced the Investors’ and Exporters’ (I&E) window for portfolio investment flows, export earnings and trade-related payments such as loan repayments, dividends and interest payments.
“The retail sector has been badly hit. Consumer demand is taking time to recover from the downturn. Margins on imported goods have been squeezed as retailers have been unable to pass on fully to consumers increased costs from the devaluation. Also, some retailers’ rents, in malls, for example, are indexed to dollars,” a real estate investor told EIU.
Another private equity investor said Nigeria’s economy is extremely import-dependent. As a result, currency weakness has broad-based knock-on effects across the whole economy, as the increase in costs for imported staples, such as rice and sugar, squeeze the amount that households can spend on discretionary goods and services.
According to the National Bureau of Statistics (NBS), 5.32 billion litres of petrol were imported into the country in the fourth quarter of 2018.
The devaluation and shortages of FX highlighted the benefits from an operational point of view of matching currency costs with revenue.
Analysts suggest that wherever possible, firms and investors should borrow in the currency in which they earn.
The report, however, forecast that the managed float system introduced by the CBN will likely remain in place throughout 2019-22. It projected a likely devaluation later in 2019, particularly if oil prices fail to recover from the 20 percent decline suffered since the peak in September. If this happens, it would help to correct an overvaluation of the currency that has built up owing to persistently high inflation, the report said.
The CBN’s secondary market intervention sales (SMIS) amounted to US$4.2bn in Q1 2019. These sales are targeted at the real sector of the economy (including manufacturers, importers of raw materials and airlines), and totalled US$2.9bn in Q1.
The CBN recently introduced Chinese yuan interventions, which are mainly geared towards manufacturers and a total of CNY237.6m (US$34.9m) was injected into the market in Q1 2019, according to a recent report by FBNQuest.