Mounting Pressure on Naira Ahead of Potential Interest Rate Hike

Financial experts are raising alarms about the Central Bank of Nigeria’s (CBN) low net foreign exchange (FX) reserves and its struggle to defend the naira. This situation has sparked risk-off sentiments among foreign investors and limited inflows from Foreign Portfolio Investors (FPIs).

Analysts at Cordros Security highlighted these concerns in their pre-Monetary Policy Committee (MPC) notes ahead of the third meeting of the year, scheduled for May 20th and 21st. They noted a significant drop in FX inflows into the Nigerian Autonomous Foreign Exchange Market (NAFEM), which fell by 48.1% to USD 1.95 billion in April, down from USD 3.75 billion in March. Inflows from FPIs were particularly affected, plummeting by 68.9% to USD 478.10 million from USD 1.54 billion in March.

Financial analyst Esther Mayowa pointed out, “Despite weak inflows from FPIs, the CBN’s intervention in various market segments has remained frail and irregular, given its weak net FX reserves.” Total inflows from the CBN into the NAFEM market declined by 35.1% to USD 98.00 million in April, compared to USD 151.00 million in March. Although the CBN continued dollar sales to Bureau De Change (BDC) operators and commercial banks, the total FX supplied was insufficient to ease the market pressure.

This insufficiency has led to a significant weakening of the naira, which fell to NGN 1,533.99/USD in the NAFEM market on May 16, down from NGN 1,072.74/USD on April 17. Similarly, the naira depreciated by 34.0% to NGN 1,515.00/USD as of May 16 from NGN 1,000.00/USD as of April 16.

Experts urge the MPC to acknowledge the naira’s depreciation and attribute it to renewed demand pressure from capital outflows induced by external shocks. Mayowa emphasized the need for the CBN to sustain its FX supply to stabilize the naira while implementing reforms to reduce speculation and boost market confidence.

Anticipated Increase in Monetary Policy Rate

Despite a moderation in price increases evidenced by a decline in month-on-month inflation for April, Cordros Research expects further tightening of the monetary policy rate. Mayowa noted, “A one-month data release of a slowdown in prices is not sufficient for the MPC to conclude that inflation is under control. Inflation risks remain skewed to the upside due to currency pressures and the anticipated minimum wage review.”

However, the expected increase in the Monetary Policy Rate (MPR) is likely to be less aggressive, primarily due to the slowing pace of inflation and the Debt Management Office’s (DMO) reluctance to significantly raise interest rates in the fixed-income market. Cordros Research predicts the MPC will raise the MPR by 100 basis points to 25.75%, while keeping other parameters constant.

Naira’s Struggle with Price Discovery

The naira showed some recovery on the parallel segment of the FX market last Friday, appreciating by NGN 90 to close at NGN 1,450/USD, compared to the previous day’s rate of NGN 1,540/USD. The positive trend continued in the NAFEX window, where the naira appreciated by NGN 36.66, closing at NGN 1,497.33/USD, compared to NGN 1,533.99/USD the previous day.

Despite this, the data indicates a 2.1% depreciation week-to-date. However, it was a 2.5% gain from the previous day’s rate of NGN 1,593.9/USD, which was the weakest since March 20 this year. Daily turnover for the week also rose significantly, from USD 608.5 million to USD 991.9 million, representing a 63% increase week-on-week.