The continued decline in Nigeria’s external reserves despite high oil prices is adding fuel to investors’ fears as it threatens to exacerbate the scarcity of foreign exchange in Africa’s biggest economy.

When the incoming government of Bola Tinubu takes over next Monday, one of the most critical tasks it will face is the management of the country’s external reserves.

As at May 9, 2023, the nation’s external reserves declined to $35.23 billion, according to data from the Central Bank of Nigeria (CBN). In the last one year, the external reserves lost 10.52 percent ($4.15 billion) following declining foreign exchange (FX) inflows through oil sales and other sources.

In the first four months of 2023, the external reserves lost about $1.82 billion, further weakening the central bank’s firepower to defend the naira. This long-running downtrend in Nigeria’s external reserves is seen fuelling investors’ fears in Africa’s largest economy.

“The further depletion of the reserves will limit the CBN’s ability to intervene in the forex market, which could lead to naira depreciation. Also, the depletion of external reserves could douse investor confidence as investors become worried about the country’s ability to meet its obligations,” Financial Derivatives Company said in a recent note.

‘Major improvement unlikely’

Abiola Rasaq, an economist and former head of investor relations at United Bank for Africa Plc, said: “We are not likely to see any major improvement in the external reserves in the near term, except we change the policy management and rebuild market confidence.

“Notably, the current level of foreign reserve at over $35.6 billion is not bad when put in the perspective of Nigeria’s import cover, however, the concern lies in the loss of confidence of the market and consistent erosion to the reserve.”

According to him, the official market rate of the naira at N460/$1 is obviously a subsidised rate, which is costing the country a significant amount in both implicit and explicit cost.

He said: “At $85 per barrel price of crude oil, the country’s external reserves shrunk 5 percent or $1.8 billion, reinforcing the net outflows of foreign currency, as all autonomous sources of foreign currency earnings continue to wane.

“While the strong crude oil price has been supportive of the country’s FX earnings, official oil exports remain low for varying reasons, including low investments in the sector and prevailing theft issues.”

Rasaq said all other autonomous sources of foreign currency inflows have been weak, mainly due to loss of confidence in the current FX management in the country.

He added: “Notwithstanding incentives of the CBN to stimulate wilful repatriation of proceeds of non-oil exports, I am concerned that compliance levels may still not be encouraging given the notable spread between official and parallel market rates, which stands at N290/$, as the average parallel market rate of N750/$ stands at some 60 percent variance to the official rate of N460/$.

“It’s such a huge gap that provides incentives and recipes for round tripping and all forms of underground economics that policy decisions should naturally prevent.”

According to Rasaq, the market is neither convinced about nor confident in the CBN’s FX management approach and most Nigerians abroad would rather take advantage of unofficial remittances channels, including fintechs offering instant remittance from most developed countries at parallel market rates.

He said: “There is a major leakage of potential foreign currency inflows from this source as well, especially as I doubt most of the fintechs would repatriate the funds to Nigeria, rather sell to importers of items barred from assessing FX from the official window and perhaps in some extreme inadvertent situations they may even sell to those funding illicit transactions and money laundering.

“If Nigeria reforms the FX regime, we would have ticked one major box in attracting just foreign portfolio investments but also FDI. We would open the tap for the diaspora to have comfort and confidence to invest back home and perhaps redirect remittances through the official window.”

Falling reserves worsen currency risks

After hitting a record low recently, the naira on Monday strengthened across foreign exchange market segments as demand for dollars by the end-users moderated. At the parallel market, popularly called black market, naira appreciated by 0.26 percent as the dollar traded at the rate of N758 on Monday as against N760/$ on Friday. It also appreciated by 0.28 percent at the Investors and Exporters forex window as the dollar was quoted at N463.50, compared to N464.80/$ on Friday, data from the FMDQ showed.

Analysts expect the decline in the external reserves to worsen the country’s currency risks and delay the recovery of the economy.

The World Bank had in the Macro Poverty Outlook for Nigeria highlighted the deteriorating macroeconomic conditions such as declining oil production volume, high-priced oil subsidies, exchange rate fluctuations, declining external reserves as well as the surging inflation rate.

The downward trend in the country’s external reserves is attributed to reduced FX inflow into the economy and increased demand pressure on the gross official reserves.

Eben Joels, country leader for Stransact, RSM correspondent firm for Nigeria, said: “Our foreign reserves will continue being depleted as long as the central bank’s policy is to defend the naira at all cost without addressing the fundamental issues driving demand for forex.

“Investors’ confidence in Nigeria is already lower than it was a decade ago if you use the amount of foreign direct investment as an index. To make things worse, foreign investors have been complaining loudly about their difficulties in repatriating funds from Nigeria.”

He said the CBN should find the courage to allow the market to determine exchange rates. “The so-called black market rate is based on a willing buyer willing seller model without a regulator and is the closest to the true value of the Naira at any time.”

“The parallel market rate is driven by demand and supply and as more people are unable to assess forex at the official bank rates, they will indeed resort to the black market. There’s only one fix. Nigeria does not need multiple exchange rate regimes. Let the Naira float, and it will find its true value based on demand and supply,” Joels said.

Read also: External reserves lose $4.15bn in one year, naira down 10%

‘Inflows not good enough to grow reserves’

Muda Yusuf, chief executive officer of the Centre for the Promotion of Private Enterprise, said the external reserves are declining because inflows are not good enough.

He said: “We are not getting enough or a satisfactory level of inflows. Our inflows come from crude oil exports; we normally enjoy inflows from FDI that has dried up because of some issues, especially the FX policy. Foreign FPI is also another major source and because of FX policy, it has also dried up.

“Now you have export proceeds, again because of FX policy, many of the export proceeds are not coming through the right channel because many of the exporters are complaining that they are not ready to give their foreign exchange at N460 per dollar. So, the policy environment is not encouraging inflows. Basically, it is a policy problem and an oil production problem.”

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