Nigeria’s $35bn External Reserves Balance Overrated

Nigeria’s foreign reserves which printed at $35 billion as of Friday (May 5, 2023) according to data from the Central Bank (CBN) is estimated to include about 30% foreign currency that has been swapped with trading partners.

The estimated figure released by Fitch Ratings suggests external reserves include at least $10 billion that belongs to a counterparty and this also excludes FX backlog. In addition to other foreign currencies obligations, external reserves may be significantly low, analysts said.

With FX Swap, Nigeria is under obligation to make good the agreements. Analysts said the size of the FX swap contract is a potential FX outflow from the nation’s foreign reserves, with the possibility of bringing the balance below $30 billion.

Early in 2022, Nigeria experience a lower foreign currency buffer which reduced the apex bank’s ability to support the local currency in the FX market. The situation impacted the naira which fell rapidly against the onslaught of foreign currencies with strong economic productivity.

Accretion into Nigeria’s external reserves has weakened significantly the dearth of FX inflows from hydrocarbon sales. From non-oil export, Africa’s largest economy attracted lower income after years of overdependence on hydrocarbon sales.

In a report, the Organisation of Petroleum Exporting Countries affirmed that Nigeria’s output increased to 1.3 million barrels per day (mbpd) on average in the first quarter of 2023.

Oil production including condensates fell to a low of 1.1 mbpd in July 2022, averaging 1.5 mbpd for the full year, from 2.1 in 2019, due to oil theft, pipeline vandalism, ageing infrastructure and low investment, Fitch said in a note.

It noted that production recovered to 1.6 mbpd in March, helped by a resumption of the Forcardos terminal and Trans-Niger pipeline, and a stepping-up of onshore surveillance to tackle theft.

Fitch forecasts a further increase to 1.75 mbpd in 2024 amidst increased investment in oil infrastructure while the government kick-started more oil discovery for commercial extraction.

“There will be a marked increase in refining capacity in 2023 when the Dangote plant commences operations (with an eventual 0.65 mbpd capacity), reducing import costs”, Fitch said in a statement.

In a chat with MarketForces Africa, FSDH Capital Chief Executive, Tolu Osinibi, said CBN reduced the supply of FX to Invisibles, by about half, due to the low level of its reserves.

The continuous rationing of foreign currency has not helped the local currency either in the official window or parallel market. The exchange rate has worsened and has become a core factor in Nigerians’ emigration plans.

Gross external reserves would be lower after you factor in outstanding Forwards, Swaps, Eurobond redemption etc., FSDH Capital Limited Chief Executive said. Osinibi told MarketForces Africa that the apex bank has also been delaying the settlement of its foreign currency sales at the retail auctions.

“The sustainable solution is to adjust the FX rate -allow some depreciation- in order to be able to attract real FX flows into the system.

“There are still some credibility issues regarding whether foreign portfolio investors will trust any change in FX policy that’s introduced before the new Administration takes over at the end of May 2023”.

“Also, keep in mind that US$35 billion is gross external reserves. We have no idea what the net reserves position is, that is after adjusting for all binding commitments, including Forwards sold, Swaps that have to be unwound etc.”

In its rating note on Nigeria, Fitch estimated that FX swap commitment is about 30%.

“There remains extensive use of foreign exchange and import restrictions to manage external pressures, with multiple exchange-rate windows, and limited flexibility of the main investors and exporters rate.

This results in severe foreign-currency shortages for the private sector, large divergence with the parallel unofficial exchange rate and has contributed to weak foreign investment and sizeable private-sector capital outflows over the past year.

International reserves fell to USD35.3 billion in April, from USD39.2 billion in July 2022.

“Together with weak capital inflows, this underpins our forecast for FX reserves to fall to 4.0 months of current external payment at end-2024, from 4.9 at end-2022. This is still well above the projected ‘B’ median of 3.3 months, although Fitch estimates around 30% of Nigeria’s reserves are made up of FX swaps”.

Oil production (including condensates) fell to a low of 1.1 mbpd in July 2022, averaging 1.5 mbpd for the full year, from 2.1 in 2019, due to oil theft, pipeline vandalism, ageing infrastructure and low investment.

Production recovered to 1.6 mbpd in March, helped by the resumption of the Forcardos terminal and Trans-Niger pipeline, and a stepping-up of onshore surveillance to tackle theft.

Fitch forecasts a further increase to 1.75 mbpd in 2024. There will be a marked increase in refining capacity in 2023 when the Dangote plant commences operations (with an eventual 0.65 mbpd capacity), reducing import costs.

There remains extensive use of foreign exchange and import restrictions to manage external pressures, with multiple exchange-rate windows at the Central Bank of Nigeria (CBN), and limited flexibility of the main “I&E” rate.

Fitch projects the current account balance, which improved by 1pp in 2022 to a surplus of 0.2% of GDP, worsen to a deficit of 0.8% of GDP in 2024, on less favourable terms of trade.

According to analysts, a foreign currency swap is an agreement between two countries to swap interest rate payments on their respective loans in their different currencies. The agreement can also involve swapping principal amounts of loans.