Naira has fallen: The Lambs remain Silent
I was in the UK a few weeks. I bought bottled water from a store and I got a couple of coins as change. One of them was a £2 coin. And then it hit me. I stared at the coin for a couple of seconds while different kinds of thought ran through my head. That coin, I mean that £2 coin was equivalent to the highest Nigerian Naira denomination — the N1,000 note.
Yes, I have been aware for several months that the Nigerian economy was in a turmoil, but this coin really brought it home.
Some of us who believe that the currency should not be controlled, especially at a time like this when we do not have any reserve to defend it, have received a lot of bashing. I have even been called names. But the damage started when we did not face reality on time. We kept the Naira at ridiculous levels — N197 — while the world lost its head. Oil prices tanked. Oil production was wiped out. The difference between the official price and the parallel market was enough for people who had access to official prices to retire early. The CBN, reluctantly, instituted a “flexible regime”, which allowed the Naira to depreciate for a while and then slammed the breaks at around N280. After a lot of pressure, when people got to know that the so-called free market was rigged, CBN let go once again, and yet a gain slammed the breaks at just around N310.
The Nigerian Government has already fixed the dollar at N290 for the 2017 budget and fuel price is hinged around the N285 levels. They clearly believe that the local currency should not stray too far from that level. Right now, everyone is tired and CBN is winning the war. Nobody is saying anything about rigging the currency market again. The lambs have chosen to remain silent. But markets don’t lie… the Dollar is now trading at N412 at the parallel market, almost N100 premium from what is obtainable at the official market. We are gradually going back to where we came from, but at a more depressed and painful level.
Many people have asked me what the fair value of the Naira is, and my answer remains, “I don’t know”. But all I can say is, given all we are seeing around us, the Naira still has some way to go.
Last week, I took a closer look at the forex futures market, and I was amazed at what I saw. The July 19, 2017 contract was selling at N231/$. Meanwhile, the spot rate is at N315/$. Yes, I know that I have stepped into gibberish-land, but I am not the only person seeing this. Foreign investors are seeing this but no one is taking the plunge. Why? Okay, I know I am running ahead of myself. Let me take a deep breathe and explain what this means.
Let’s go back to that spot rate. N315/$. This is the current rate in the interbank market, but that spot rate is rigged. So, let me make it a little bit more realistic and place the spot rate at N330/$. Now this is really conservative, because the truth is if you bring in $1 million into Nigeria today, you can comfortably sell everything at N400/$ at the black market and do all the magic you want to do with it. But let us behave ourselves and act as patriotic Nigerians. Okay, so you bring $1 million into Nigeria and tell GTB you want to sell to them at N330/$ — trust me, they will buy it off you in a heartbeat. Now, that $1 million will land N330 million into your bank account. Straight.
Stay with me. This is where it becomes really interesting.
Remember that we were talking about the July 19, 2017 forex futures contract selling at N231/$, right? Right. Now, as you are selling your dollars to GTB, you also ask them to get you the July 13, 2017 Treasury Bills. That bill is currently trading at a discount of 16.27% — this is equivalent to a yield of about 18.95%. When you buy the treasury bills, you will get back exactly N384 million on July 13, 2017.
Now, at the point of executing this trade, you also go long on the July 19, 2017 forex future at the ongoing price of N231/$. What this means is that you lock in to sell the Naira at N231/$ to the person or whoever is at the other end of the trade — most likely CBN. (Only CBN will bet in favor of a strengthening Naira in this economy.) Because you know you are going to get N384 million back on July 13, 2017, you lock in the N231/$ price now. This will give you an equivalent of about $1.662 million in less than a year from you. I mean, who will see this kind of opportunity and not jump into it? One would expect foreign investors to scramble all over themselves to jump into this trade. This is 66% US Dollar return in less than a year without breaking a sweat!
But it is not that simple. It gets really complicated. If you do not have a head for mathematics, just skip the next paragraph so you don’t get a headache.
The futures are Naira settled, and they are benchmarked against the official US Dollar price, which the CBN controls. This means that CBN, or the counter party, will pay you the difference between the future price of N231/$ and whatever the official price of the dollar is as at July 13, 2017. And it will be paid in Naira. So if the dollar trades at interbank at say N350/$, then you will get N119 for every dollar. Remember our treasury bills that matured with the sum of N384 million? Yes. We bought the future at N231/$ and we purchased $1.662 million worth. Now the official dollar price is N350/$. That N119 difference per dollar (N350 — N231) is what you get in Naira, and this amounts to N193.018 million [N119 * 1.662 (millions of dollars)]. When you add your N197.778 million from the trade to your N384 million and then go to the official market to buy dollars at N350/$, you still end up with $1.622 million.
So it doesn’t matter where the official price is as at July 19, 2017, you will still get enough Naira to purchase your $1.622 million at official price. That one is guaranteed. What is not guaranteed is if there will be enough dollars in the official market to meet your needs when it is time for you to get out. The official price of the dollar is whatever the CBN says it is. What if you are desperate to get out, and parallel market is already N600/$ while official is N350/$? Now all of a sudden you are no longer looking at 66% return in dollar terms. I will not bore you with the mathematics, but now you are facing a loss. A big loss.
So, you see, the market looks very inviting theoretically, but in practice, it looks like a trap. This is one major reason foreign investors are not interested in coming into Nigeria. This is what you get when you mess with the markets.
So for everyone who is wondering why we have “devalued” or “floated” but those foreign investors have refused to come, it is because our official forex markets are still under the tight control of the CBN. We have a market, but the market is not free, and we do not have the war-chest to accommodate the potential outflows when the foreign investors are ready to go.
The Naira has fallen. But there is a silence of the lambs.