Flexible Forex Regime Takes Off, Faces US$4 Billion Demand

Nigerian foreign exchange operators will operate under new regulations from June 20, 2016. Photo: Reuters/Afolabi Sotunde

*Treasurers want ₦1tr mop-up for stability *Policy raises concern over write-offs, bad loans

As the flexible exchange rate policy takes off today, there is no less than US$4 billion worth of unmet demand, which has raised a new concern over its clearance within the targeted four weeks.

The Guardian Nigeria continues:

There is also anxiety within the banking industry over the implications of the expected exchange rate increase to between ₦275 and ₦300 on the existing Non-Performing Loans (NPLs).

While expectations are high that the more than US$4 billion backlog will be cleared, according to sources from the Central Bank of Nigeria (CBN) in the next three to four weeks once the policy takes off today, the significant exchange rate adjustment has raised new worries that the ability of customers to repay the existing dollar obligations would be constrained further.

A top bank chief, who is close to the group that is determining the appropriate value for which the naira will be traded today told The Guardian that there is the likelihood of further default, leading to increased impairment provision and outright write-off in the industry.

Already, the individual banks’ share of the backlog has been concentrated on 10 banks, while the composition of the demand ranges from maturing letters of credit, cash and profit repatriation and foreign investment outflows.

Further analysis showed that the pressure points are led by demands from the general commerce customers, given the limited scope they have to pass on this cost to their customers; power; manufacturing; real estate; and construction sectors.

“Given their relatively higher exposure to the general commerce sector, we are more concerned about the implications of this for the likes of Zenith Bank, 22%; Diamond Bank, 19%; Stanbic, 12%; FCMB, 9%; and Skye Bank, 8%,” the Sub Saharan Banking Analyst and Research, Nigeria, Adesoji Solanke, said.

Others are Access Bank, 10%; United Bank for Africa, 9%; Guaranty Trust Bank, 7%; First Bank, 5%; and Fidelity Bank, 5%.

However, for banks with net long positions in dollar, a revaluation gain may soon trickle in, but some of the gains could still be offset in collective impairments over the anticipated NPL risks.

“For NPLs, the reality is that many small businesses are already either starved of forex or accessing this at parallel market levels. Therefore, some adjustment to a weaker rate has already happened.

“Some banks tell us they’re holding Naira on behalf of customers at a weaker exchange rate but should the devaluation exceed this hold rate and the customer struggles to find the excess to liquidate its dollar obligation, that loss ultimately becomes the bank’s.

“Further, businesses struggle with a weaker exchange rate given the weaker consumer and macroeconomic backdrop, such that their ability to increase prices gets constrained, leading to weaker margins, cost cutting (layoffs) and in other cases the business shuts down.

“There’s a long downward spiral effect, which needs to play out and all this does not always materialize in one year. So, devaluation tends to be NPL negative for Nigerian banks,” Solanke added.

Meanwhile, banks’ treasurers have called for persistent follow-up in mopping up excess money in circulation, estimated around ₦1 trillion to foil speculative attack on the naira as the new policy begins.

While there is expectation of interest rate increase at the next meeting of the Monetary Policy Committee, the treasurers said CBN could wade in now with other measures, which include increased liquidity ratio, Cash Reserve Requirement, treasury and bond purchases.

At the weekend, CBN offered a ₦50 billion paper, but eventually made no sale. It also sold treasury bills at higher yields than in the secondary market in efforts to mop up Naira liquidity before the start of the new forex market, to curb speculation.

Specifically, it mopped up ₦205.9 billion worth of one-year bills at a price yielding 15.6 percent, the same level as inflation.

Still, Fitch Ratings has applauded Nigeria’s planned shift to a more flexible foreign-exchange regime, saying it could aid the sovereign’s adjustment to lower oil prices and support growth.

It, however, warned that the implementation may present challenges, adding that establishing the new framework’s credibility would be key to its effectiveness in attracting portfolio flows and Foreign Direct Investments (FDI)to make up for lower oil export receipts.

“Defending the naira has lowered reserves and increased external vulnerabilities, while a shortage of hard currency has weighed on the non-oil economy. The change of policy is consistent with our view that the CBN would struggle to defend the naira indefinitely.

“Allowing the market to determine the value of the naira could ease this, although we think much potential FDI may remain on the sidelines until a clearer picture emerges of how the new system is functioning,” the company said.

The Head of Africa Strategy at Standard Chartered Bank, Samir Gadio, corroborated the sentiment when he told Reuters that “foreign investors will need to be convinced that the new regime is sustainable in the medium term and will likely also require higher yields before resuming the purchase of local debt.”