Bola Tinubu has been inaugurated as Nigeria's 16th president, succeeding Muhammadu Buhari. Tinubu's appointment comes after the Supreme Court dismissed a lawsuit questioning his eligibility as a presidential candidate, causing significant ripples in the market.
The official exchange rate of the naira remains stronger compared to unofficial rates, indicating a potential currency devaluation. This devaluation will be a significant concern for the incoming administration. South African companies like MTN, MultiChoice, and Nampak, which operate in Nigeria, face risks to their assets, profits, and cash balances due to potential fluctuations in foreign exchange rates.
“The recent Nigerian currency crisis and ongoing devaluation of the naira have emphasised the need for local investors seeking listed market exposure to emerging and frontier economies to pay close attention to the earnings and revenue impact of potentially volatile domestic currencies on their investment,” says Cavan Osborne, Portfolio Manager at Old Mutual Investment Group (OMIG).
This risk is particularly relevant when considering listed opportunities in Africa, the Middle East, and South America due to the number of countries in those regions that top the tables of ‘most volatile’ or ‘worst performing’ currencies against the world’s reserve currency, the US dollar.
Nigeria’s recent currency crisis saw the Nigerian government’s chaotic implementation of a currency ‘redesign’, where it replaced old notes with newly designed and more secure notes in an effort to prevent counterfeiting and allow Nigeria to move to a more modern card and electronic payment-based economy, which was the official rationale for the decision. An attempt to clamp down on kidnapping for ransoms and vote buying is also suspected to be behind the move.
The decision sparked bedlam across the country, with not enough of the new notes in circulation in a country where a significant portion are unbanked. A flight to foreign currency also caused a shortage in foreign currency reserves.
Nigeria’s central bank has been implementing tight foreign currency controls for three years now as it seeks to ease pressure on its dwindling reserves.
Explains Osborne: “While there are some tactics that asset managers can employ to avoid getting caught in a currency quagmire such as in Nigeria – simply avoiding investing in repressive regimes that present currency risk and continually scanning the macroeconomic environment for potential threats to currency stability and reducing investment exposures appropriately – there are times when an asset manager cannot trade out of a currency pinch”.
External factors such as regulatory changes, sanctions, or war can cause a rapid devaluation in a currency, leading to a listed company becoming entrenched in a difficult foreign currency market and asset managers cannot adjust for the currency risk.
The naira is a managed rather than a ‘free float’ currency which means the Nigerian Central Bank determines its quoted rate. And this rate has edged up – or weakened against the US dollar – by some 25% over the last three years, from 360 naira/US dollar to the current rate of 460 naira/US dollar.
Despite this devaluation, the naira is still considered expensive relative to the dollar. Thus, anyone holding dollars is unlikely to exchange (or sell) their dollars at the official rate.
Offshore companies that generate billions in revenue from their Nigerian operations end up being unable (or find it challenging) to repatriate their dividends and/or dividend – and investors who receive dividends in the local market end up getting a ‘raw’ deal’ when trying to get the money out of the country.
To put matters in perspective for local investors, JSE-listed telecommunications giant, MTN Group, is heavily exposed to the Nigerian economy, deriving about a third of its total revenue, or ZAR67 billion, from that market.
Using the official exchange rate of around 460 naira/ US dollar we calculate that MTN’s 80% stake in its Nigerian operation represents roughly 60% of its JSE market capitalisation, or ZAR140 billion.
There are other South African businesses generating revenue in Nigeria, including banking groups Nedbank and Standard Bank and the likes of AB InBev, British American Tobacco, and Nampak, though none of these come close to MTN’s exposure to the country.
Osborne says that in order to get the FX market working, the exchange rate will need to move to a level where supply and demand match and this rate will need to be substantially higher than where it is currently ‘fixed’.
In tandem with weakening the Naira exchange rate, Nigeria will also likely need to push up interest rates to somewhere around 20% to attract foreign investors. The new president, once he is officially installed, can make this happen, but in Nigeria, there are always many vested interests.
Attempts by the country to devalue its currency by another 15-20% against the dollar, as well as hike central bank interest rates to somewhere near 20%, are likely to be met by resistance from those who benefit from access to the dollar at the current official rate.
“We remain hopeful that the new president makes the tough decision to devalue the official exchange rate to a level where the market clears. The parallel exchange rate is currently sitting at around 750 NGN/USD and given that this is a well-established market, it provides a good indication of where this clearing level might lie. However, based on this parallel rate, the status quo could cut 15% from MTN Group’s reported earnings for the current year, though the impact on the dividend will be more muted, as MTN is already using a weaker rate to repatriate money,” warns Osborne.
Nigeria does not typically operate in a predictable way, and while we can continue to hope that the necessary changes will be implemented, hope is not a strategy and the path back to normal is complicated, uncertain, and potentially costly for affected investors.
There is a blue-sky scenario, being that the incoming president addresses the fuel subsidy, the new Dangote oil refinery comes online, and the FX market is liberated. However, the changes and reforms are unlikely to be implemented quickly, or in a comprehensive way. If they do happen, they will be slow and most likely insufficient to clear the foreign exchange backlog. Investors need to position their portfolios to factor in this scenario.
“We are watching for further signs of these developments, but in the meantime, foreign investors considering the growth prospects in Nigeria will do well to steer clear,” Osborne concludes.
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