Naira May Fall Further on Increased Government Spending

 Naira  notes

by: Obinna Chima

The possibility of an increase in government due to the emergency rule declared in Borno, Yobe and Adamawa states may result to further depreciation of the naira, a report has said.

The report also identified recent deterioration of Nigeria’s external position due to a drop in crude oil production and the slide in crude oil prices as factors that may hurt the naira this year.

Renaissance Capital Limited, an investment and financial advisory firm stated this in a report titled: “Sub-Saharan African Currencies -Weaker Prospects,” obtained Tuesday.

THISDAY checks showed that the local currency dipped further against the dollar at the interbank market yesterday as it closed at N159.50 to a dollar, from the N159.40 to a dollar it closed on Monday.

In fact, RenCap predicted that the naira might breach the upper band of the N150-160/$1 target range set by the Central Bank of Nigeria (CBN) by September this year.

As a result of these, the firm revealed that it would adjust its naira forecast, slightly weaker to N161.3/$1 for 2013 year end (YE13), from N160/$1.

“As our model suggests that this breach will not be temporary, we think there is a small risk that the central bank may be compelled to moderately adjust the target exchange rate band at YE13. Given the increased risks to the naira, we no longer expect a rate cut and amend our YE13 forecast to 12 per cent, from 11.5 per cent previously.

“Although the naira does respond to changes in domestic interest rates, fiscal dominance implies the appreciation effect of high interest rates may be undermined by an increase in fiscal borrowing to counter below-target oil revenue.

“One surprise from our model is that it indicates the naira has a weak and positive relationship with the oil price and oil output. That is, an increase in oil output or price results in a weaker naira. More export revenues often means more money kept offshore. We would expect this to alter over time, as more local money stays onshore to invest in fast-growing sectors of the economy,” it argued.

However, it pointed out that the naira had a negative correlation with the Current Account/Gross Domestic Product (CA/GDP), saying that a decline in the CA/GDP results in a weaker naira.

The report added: “The naira’s depreciation risks have increased in recent months, owing to increased negative risks to the CA/GDP surplus stemming from a softer oil price and below-target oil production due to rising oil theft. We think the biggest risk to the CA is a sustained fall in oil output.

“We downwardly adjusted our oil production assumption for 2013 to 2.2 million barrels per day. We believe an additional risk to the naira is a likely increase in government spending related to emergency rule in Nigeria’s three northeastern states.

“This implies monetary expansion and an accelerated drawdown of funds from the excess crude account (ECA), which implies downward pressure on foreign exchange reserves.”

RenCap argued that the slowdown in the build-up of forex reserves since February as well as the decline in May partially reflected a narrowing CA surplus.