I woke up on Monday to see the significant plunge in crude oil prices in the global market as prices crashed to about $36/barrel. The new price is significant below the $57/barrel used as the benchmark oil price in the Nigeria’s 2020 budget. The 2020 budget expects a third of the 9 trillion Naira (~$29 billion) budget revenue to come from crude oil proceeds. In one singular price plunge, Nigeria lost about 35% of its budgeted revenue for 2020. While the above price “incident” suggests that Nigeria’s destiny is probably not in its own hands, this incident will further put pressure on the Nigerian Naira. Let me explain why!
The President Muhammed Buhari administration has closely managed the value of the Naira using the foreign currency reserves – pooled from the country’s crude oil proceeds. The Central Bank of Nigeria (CBN) believes that this approach of defending the Naira helps to curtail inflation while also discouraging imports. Based on the weekend’s price plunge, the significantly depleted oil revenues would lead to a significant reduction in the foreign exchange reserves that the government has been using to defend the currency over the past few years.
The foreign exchange reserves depletion reduces the ability of the CBN to continue to defend the Naira. Although the CBN Governor, Godwin Emefiele, has recently denied any consideration of immediate devaluation of the Naira, the risk exists that the CBN might be left with no option if the downward trend of the crude prices should continue and the foreign currency reserves goes below $30 billion that seems to be the threshold set by the CBN for the country to consider a devaluation. Of course, there might be initial attempts by the CBN to tighten the FX liquidity in the interbank markets like it did in 2016/2017 period.
While we all wait for the above-mentioned possible outcomes to materialize, businesses and high net worth individuals in the country needs to consider different positions to either manage their foreign currency exposures or enhance their wealth management portfolio actions. I really pity those businesses with significant FX denominated loans and those whose product has significant import components, especially in those sectors where it is challenging to push the increased product costs out to the final consumers.
Businesses with a significant number of foreign clients may consider denominating their contracts with their foreign clients in foreign currency, even if the billings are going to be made in Naira at the applicable exchange rates on the billing dates. On the other hand, businesses with large foreign procurements may consider advance payments for their supplies, even if it requires utilizing Naira loans to fund such transactions. For high net worth individuals with free cash flows, it might be reasonable to build their foreign currency reserves or foreign assets ahead of the possible devaluation.
This is the time for businesses to be in close contact with their bankers, tax consultants, wealth and financial advisors, especially knowing that my views are strictly my personal views and should not be relied upon as an expert opinion without additional consultation. In addition, my views do not represent the views of any company or organization (including employers or clients) that I am associated with me – past, current or future.