How FX backlog is clogging new investments in Nigeria

On Tuesday, September 5, the then-acting head of the Central Bank of Nigeria (CBN), Folashodun Shonubi, announced that the apex bank was working with commercial banks to clear the massive backlog of Nigeria’s foreign exchange (FX) demands within two weeks.

That announcement came on the heels of the decision by President Bola Ahmed Tinubu to remove fuel subsidy and liberalise the country’s FX market.

The CBN announcement should have sparked some investor optimism as they’ve had funds trapped in Africa’s largest economy since its FX woes began in 2019. The recent addition to this group is those who subscribed to forward contracts.

In 2016, the CBN, through the Revised Guidelines for the Operation of the Nigerian Inter-Bank Foreign Exchange Market (2016 Guidelines), introduced the Naira-settled OTC FX Futures to the Nigerian derivatives market in its attempt to address similar foreign exchange risks plaguing the country.

CBN’s forex policy on rice triggers fear among rice farmers, processors in Kano

CBN Dep. Director emerges new Magajin Garin Zazzau

An FX forward contract is a bilateral agreement where one party (the seller), typically the CBN, agrees to sell an asset to another party (the buyer) at a predetermined settlement date in the future and at a strike price, which is fixed at the time of entering into the contract.

The contract value is the difference between the strike price and the market value at the settlement date. As a result of its bilateral nature, forward markets are done over-the-counter (OTC), and the market platform fixes the price of the financial asset for future delivery. It is also a binding contract in the FX market that locks in the exchange rate for the purchase or sale of a currency on a future date. A currency forward is essentially a customisable hedging tool.

However, the Nigerian currency has been under a lot of pressure in recent times owing to a decrease in export earnings due to crude oil theft as well as some policy missteps.

Nigeria gets over 90 per cent of its foreign exchange from oil and gas exports but has, in recent years, been starved of dollars as the Nigerian National Petroleum Company Limited (NNPC) is unable to pump enough crude for sale.

This has led to a significant reduction in the country’s FX earnings, with the CBN missing deadlines for delivery of its forward contracts.

The last time the apex bank delivered on its forward contract was in February this year. The development is negatively impacting the importation of equipment, which is needed for economic development, especially in the infrastructure space.

Analysts have argued that the current situation has a significant effect on long-term investments in any country and is the reason why policymakers make sure they avoid any step that would be seen as a disincentive to investors.

Unfortunately, it has also continued to discourage foreign investors as the central bank keeps moving the goalpost on when to deliver.

“Some investors had planned projects based on these FX forward contracts, believing that when it matures, they wouldn’t have difficulty in executing these projects, especially in the infrastructure space. Unfortunately, the backlog of FX hasn’t been cleared by the apex bank.

“So, the problem with this is that the missed deadlines would continue to affect project development and businesses, and these projects would suffer. Most importantly, because they are foreign investors, they are likely not to have confidence in the system and that keeps FDI drive away,” an investor who sought anonymity told Daily Trust.

Nigeria’s Finance Minister and Coordinating Minister of the Economy, Olawale Edun, recently disclosed that up to $6.8 billion of overdue forward payments in FX needed to be addressed before the naira can stabilise.

Edun noted that resolving the overdue contracts would allow the naira to strengthen and “pave the way for additional foreign exchange flows. The issue we have now is that the market is not liquid enough.”

He added: “We are committed to encouraging liquidity based on reforms that have been made at the moment, on the fiscal side and the monetary side. And together with the restoration of trust and confidence, we think the FX flows will return.”

The Managing Director of Financial Derivatives Company Limited, Mr Bismark Rewane, highlighted rising external imbalances and the country’s reduced exports relative to its imports, huge debt profile and unfavourable terms of trade as some of the factors hurting the economy.

Rewane stressed the need for credibility in the FX market, saying, “Once confidence has eroded, if you don’t come clean with the exact picture, then the people begin to have doubts and once there are doubts, you will have distortions from the equilibrium.”

He added: “We announced that our external reserves on a moving average basis is about $33 billion to $34 billion, but when JP Morgan came out and the audited statement was released to say that our unencumbered reserves are actually about $3.7 billion, it made people, especially investors in the country, gasp and started wondering what exactly the true position is.

“They are asking if we can support the currency at that level. The minister of finance gracefully announced that we have about $6.8 billion of backlog. So, these raised a lot of concerns and eyebrows, and international and domestic investors are concerned.

“I believe the currency would appreciate and that we would go back to equilibrium in almost all the indices, but we have to start by coming clean and letting people know the true position. That reduces the level of anxiety people have. That is the best thing to do,” he added.

Rewane stressed that a lack of confidence would discourage people from bringing their monies to invest in the country, “more importantly, people would take their monies out.”

Also, a former CBN deputy governor, Dr Tunde Lemo, urged the apex bank to clear FX backlogs. He said, “One other thing that they need to do is, the new team at the central bank needs to restore confidence in the currency market.

“All the while, they were issuing circulars, banning products and there was no clarity about the market dynamics. All of this means that the participants in that market will not be rational, and once confidence is lost, how do you bring it back?

“They have been defaulting. Most of the commitments have not been met. You know there is a backlog of about $6.8bn of swap deals, forward deals and commitments by airlines and so on that are not met. They need to clear all of these to bring confidence back to the market.”

However, the new CBN Governor, Mr. Olayemi Cardoso, has stressed the importance of credibility and transparency in implementing the central bank’s monetary policy.

He said the central bank would remain open to different views in its push for greater transparency. “We are aware that there are unsettled obligations by the CBN. Whether it is $4 billion, $5 billion or $7 billion, I don’t know, but definitely the immediate priority is to ascertain the extent. “We need to find a way to take care of that. It will be naive for us to be expecting to succeed if we are not able to handle that side of the foreign exchange market,” he added.

However, amid the free fall of the naira in the foreign exchange market, President Tinubu has again vowed to resolve all the challenges discouraging investors’ confidence in the country.

Speaking at the recent Nigeria Economic Summit #NES29 in Abuja, the president assured that Nigeria will honour all future foreign exchange contracts. He said his administration is committed to sustaining Nigeria’s economy.

“All foreign exchange future contracts will be honoured by this government. We have a line of sight to the foreign exchange we need to refloat this economy. And we will get it,” Tinubu said.

All eyes will be on the CBN governor to vitalise these assurances by the president and get confidence back to the FX market, especially for local companies seeking FX for equipment importation and FDI seeking to repatriate their matured investments.