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The Nigerian central bank looks set to win a showdown with the foreign
exchange market as it resists pressure for major depreciation of the naira
ahead of national elections.

Businesses and rich Nigerians are going long on dollars to hedge against the
risk of any prolonged political upheaval or security problems due to the April
9 presidential vote, in which President Goodluck Jonathan faces a determined
challenge from his main rival, ex-military ruler Muhammadu Buhari.

A downtrend in Nigeria’s foreign exchange reserves has added to the market’s
jitters. The International Monetary Fund warned last month that the naira could
become subject to “intense speculation” if the reserves continued to
fall, and recommended greater exchange rate flexibility.

But central bank governor Lamido Sanusi, who has won international praise
for his clean-up of Nigeria’s debt-ridden banking system, insists the naira is
flexible enough.

He has repeatedly said a stable exchange rate is key to maintaining investor
confidence, and told Reuters two weeks ago that devaluing the naira would increase
Nigeria’s import bill and fuel inflation.

Some clever maneouvering by the central bank in the market, and a recent
improvement in the foreign exchange reserves, now suggest it will probably
succeed in keeping the naira in a corridor of plus or minus 3 percent around
150 to the dollar, as it has been doing for over a year.

“We remain confident in the sustainability of the 150 level despite the
current naira weakness, notably given the country’s favourable external
fundamentals, the tightening in monetary conditions and, to a lesser
extent…the nearly flat spending outlook implied by this year’s budget,”
said Samir Gadio, emerging markets strategist at Standard Bank.

Weakness

The naira edged down to trade around 156.90 against the dollar on Thursday,
its lowest level in about 18 months, compared to 155.10 at the start of the
week and 153.40 around two weeks ago.

Dollar supplies from the central bank at its
bi-weekly auctions have slowed the decline but have not been large enough to
halt it. Traders say strong dollar demand from companies with unconfirmed
letters of credit, payments on foreign credit cards and large foreign exchange
purchases by bureaux de change are eating up dollar supplies in the interbank
market.

“I see the naira going up to 158 depending on whether the central bank
is willing to defend it,” said a treasury executive at a multinational
consumer goods firm.

The executive said a rate of 160 would affect his company’s operations.
“Anything above 155 naira would be a worry and anything above 160 naira,
we would have to put contingency measures in place like forward
contracts,” he said.

“Any increase in forex charges would be added to our bottom line and
reduce our profits, and it’s got the potential to increase our prices and
affect our operations.”

A senior commercial banker, noting the shallowness of the foreign exchange
market meant a single large deal could shift the rate significantly, said
Nigeria’s reserves were a concern. Their decline over the past year, despite
rising oil prices, has raised questions among some analysts about the quality
of the government’s economic management.

“Reserves of $37 billion would not anchor the currency in the event of
a concerted market drive against the naira,” the banker said.

Fiscal policy is another concern for investors. The Senate on Wednesday
passed a 4.972 trillion naira 2011 budget, increasing spending plans from
Jonathan’s initial proposal three months ago. Over half of the planned spending
is recurrent, meaning Nigeria is spending more on keeping government running
than on badly needed new infrastructure and development projects.

A Nigerian government bond auction on Thursday suggested some investor
disquiet about fiscal policy and the currency. Five-year paper was sold at a
marginal rate of 12 percent, up from 11 percent last month, and three-year
paper at 10.50 percent against 9.25 percent.

Support

Nevertheless, the treasury executive at the
multinational, and many analysts, said they expected the naira to recover to
normal levels after next month’s elections to the presidency, parliament and
state governorships.

Nigeria only emerged from military rule just over a decade ago, and all of
its elections since then have been marred by rigging and intimidation. But this
has not seriously threatened stability at a national level and Jonathan remains
the favourite to win, though the opposition is hoping to force a run-off vote.

Recently there has been good news on the foreign reserves; they rebounded to
$36.4 billion on March 8, up 10 percent from the end of February, though they
remained well down from $42 billion a year ago, according to the central bank.

The government has attributed reserves’ decline in the past year to
counter-cyclical spending during an economic downturn, the defence of the
naira, seed capital for a planned sovereign wealth fund, and financing for
infrastructure projects.

Those explanations do not fully satisfy everyone, but authorities insist
that with oil output and prices rising, reserves will build up once again.

And the central bank has taken some clever administrative steps to reduce
pressure on the naira. It has asked banks buying foreign exchange at its
auctions to submit lists of customers for which the purchases are occurring, to
verify the demand is for commerce rather than for speculation.

It also plans to start selling short-tenored forex forward contracts from
next Wednesday as part of efforts to smooth demand and help businesses hedge
their currency risk. This could reduce the threat of panicky sales of naira.

Razia Khan, economist for Africa at Standard Chartered Bank, said the
current naira corridor might conceivably be shifted, but only carefully and
gradually.

“We all believe that the mid-point is around 150 but there is nothing
to stop the central bank adjusting it up gradually in response to high
demand…and then maybe allowing it to go down again when conditions allow.

“Do we think that they are about to announce a big devaluation in the
naira? No. But do we think the recently announced spending plans are going to
create more pressure on the currency? Yes.”

REUTERS