By George Uchechukwu Iwuagwu
Foreign Exchange or FX is a tricky business, especially for investors who want to take advantage of the immediate value of one currency over another. A great deal of forex trade exists and accommodates speculation, which in turn impacts on currency value. Traders profit from the price movement of a particular pair of currencies. Some FX analysts believe that 75 percent of the value of any currency is merely speculation. Therefore, foreign exchange market is a space or platform where currencies are exchanged for another. This is so because currencies are required for purchase of goods and services locally and across borders. You would need, for instance, US dollars if you have to purchase a good or service from the US while in Nigeria.
The following example from Investopedia puts it simply: If you are living in the United States and want to buy cheese from France, then either you or the company from which you buy the cheese has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros.
The US Dollar is one of the safe haven currencies used globally. Some countries peg their currencies to the US dollars; however, it now becomes a challenge when too many people from a country require too many things from the US, the demand for the US dollar in that country becomes very high. The simple economic law of demand and supply follows. Let’s look at some of the items that take away dollars from Nigeria’s foreign reserve.
With a population of over 200 million, our consumption of imported goods more than anything else takes away billions of dollars from Nigeria’s foreign reserve. A report from Nairametrics estimates that more than 60 percent of the goods we consume locally are imported from the US – paid for in dollars (USD). Numbers from NBS show a trade deficit of N1.9 trillion in Q2 2021 alone, we can correctly guess that by the end of the year a wider trade deficit of about N3.8 trillion is expected.
Another channel that drains stock of dollars from our financial system is hospital tourism and education. Education alone saw an increase from $500 million in 2015 to $6 billion in 2021, and hospital tourism is also huge from unconfirmed reports. When put together year-on-year, it’s clearer what pressures foreign reserve and results to scarcity of dollars in the Nigerian economy and hence hike in dollar price, which profits a few and leaves others with a huge hole in their pockets
Its not hard to see that a lot of investors in Nigeria are dumping the Naira for USD, but the big question is should we dump naira assets for dollar ones irrespective of our investment objectives, risk appetites and investment horizon? I realized that part of the reason most people convert their naira to dollars isn’t really to make profit but to hedge against devaluation and fluctuation of the local tender, by converting their assets from naira to a more stable currency. Below are some of the reasons you should still hold the naira as an investor with little or no dollar liabilities. I see stability in the supply of dollars in the system soon:
The president’s recent request for additional borrowing of $4 billion will increase availability of dollars in the system. We expect this request to sail through as the president’s party has a majority in the Senate, the borrowing will likely be endorsed by the upper house, we believe.
2021 budget pegged oil price at $40 per barrel, though current Brent crude oil price is as high as $83 at production capacity of 1.86 mbpd; we expect increased export of crude and revenues in dollars to shore up Nigeria’s foreign reserve.
$3.35 billion draw down from the country’s share of IMF SDR will also boost dollar supply and surpass demand for dollar.
The country has also announced plans to raise $6.2 billion in the Eurobond market in October. Analysts expect this to be oversubscribed like Access Bank’s $500 million Eurobonds
Finally, the apex bank’s recent move against speculation and artificial pricing will see the naira begin to reflect true value. Hopefully, the huge gap between official and black-market rate will be bridged. The move will stifle, if not eliminate entirely, artificial pricing, which causes the hikes we observed in dollar. We hope to see the actual value of the naira against other currencies.
Therefore, it will be counter productive to have someone convert at say N560 and after a couple of months see price crash to N400 or even N360 because they didn’t have a clear investment objective, assess properly their risk exposure or maintain their peculiar investment horizon, before converting their assets from naira to USD!
These steps, when taken by both the federal government and the CBN, will see the naira strengthened. My worry is, I do not want investors with naira assets to be caught in the mix as they rush to convert their naira assets to dollars in a bid to hedge against depreciation.
My advice is hold naira if you have naira assets with little or no dollar liabilities, hedge against inflation by investing in some instruments with better returns. Pick from Real Estate Funds, Commercial Papers with good liquidity ratings and stocks of companies with strong fundamentals. Last year the equity market posted some pretty good performance and should be considered by investors with larger risk appetite as a hedge against inflation. See you again next week!
George Iwuagwu, passionate about financial literacy and development economics, is a seasoned investment analyst and wealth manager who has worked with some of the big names in the Asset Management industry, and currently Business Development Manager at UKdion Investment. He can be reached at firstname.lastname@example.org; +2348039104910 (text only)