The New FX Regime in Nigeria: What’s in it for your portfolio?

A number of us spent the past couple of months wondering where all the dollar in the country was hiding, while some got down to making analysis and predictions about if and when the CBN will give in on it’s hard stance, however, majority where left perplexed, only imagining what a better FX Regime would mean for their investments.

Why don’t we start with a brief history, shall we? Now, remember the global commodity price crash of 2014? I’m sure you do. Well we can refer to this as the genesis of the whole devaluation story. And what am I trying to say? Well a good number of Oil exporting nations were hit hard and our dear country Nigeria wasn’t exempted.

Without overwhelming anyone with so many technical details, let’s review how a crash in oil prices became negative for the Nation. To begin with, Nigeria earned, and STILL EARNS over 75% of its revenue from oil exports. Therefore, since the primary currency with which oil is traded globally is the green back (a.k.a dollar), a fall in global oil prices translates to less dollar receipts in the Nation’s coffers.

Ideally, just like every business, lower revenues result in lower income or profits. The same goes if you consider Nigeria as a company in the business of selling crude oil to other nations. Lower oil prices mean less revenue, which in turn means fewer funds for Government spending. Since government spending spurs economic growth, a reduction of government’s funds can only gradually cause an overall slowdown in macroeconomic growth.

Permit me once again to use the company analogy. Now we know that if a company is recording lower revenues consistently, it can most likely be linked to the following factors:

·           there is less demand for its product

·           it is not operating efficiently enough to meet customers’ demands with its supplies

·           high competition amongst other market players have forced the price of the goods and services it produces to shrink.

For the leading oil exporting Nations especially Nigeria, factor 3 played a major role in the consistently sharp decline seen in government’s revenue for the past two years.

At this point, I feel the need to name our hypothetical company. Let’s settle for the name “ABC Corporation”. Now imagine the board of ABC Corp having realised a steady and critical decline in its revenues becomes very eager to salvage the situation. Siting the three factors previously stated, the board is restricted to pursuing one or all of the following solutions;

·        Revamp its agency and marketing department, overhaul its product design to boost attractiveness, and spend huge sums on advertising, all in a bid to achieve one thing – increase product demand.

·           Fix its internal operational issues to ensure it can supply at optimal efficient levels.

·          Now this is where it gets interesting; a third solution may be to form or join an existing ‘cartel’ amongst competing firms with the intent to drive market price upwards.

Okay, so now I have gotten the attention of most people, let me begin to paint the same picture in the Nigerian context.

Take Nigeria to be ABC Corporation, with the incumbent government as the ABC board, its paramount goal being to increase revenue. Now let’s review those three solutions again.

·         Demand: China, the United States, and the European Union are the largest crude oil importers in the world. In 2015, they consumed slightly over 30 mbpd (million barrels per day) of crude oil and liquid fuels. Now one may wonder why Nigeria being one of the top six global exporters of oil isn’t benefiting fully especially with the magnitude of demand from the above mentioned big buyers. The problem here is that while China and the EU have recently been experiencing setbacks in their economies which hampered demand for oil, US on the other hand (with the advent of a boom in its shale production), recently stopped importing oil from Nigeria. In any case, countries like Saudi Arabia, Russia and Kuwait, (topping the list of global exporters), all combined, export about 18 mbpd. All this goes to show that Nigeria has little influence of making the demand factor work in its favour, leaving us with just two other solutions.

·       Supply: Just as ABC Corp’s board fixes its internal operational issues to boost production and supply, recent efforts have been made by the government to fix old refineries and build new ones. While we saw steady progress in the achievement of the aforementioned, huge setbacks appeared in the form of sabotage, and very recently the outright destruction of oil installations by the much talked about ‘Avengers’. These hindrances undoubtedly impacted negatively on the nation’s volume of output. Now,  the combined effect of having a global oil market already awash with oil, weak demand for Nigeria’s oil, as well as its thinning supply can only mean one thing – decline in revenues. With two solutions out of the way, let us focus on a third.

·           Price: Unlike ABC Corp seeking to form or join a ‘cartel’, Nigeria already belongs to one called ‘OPEC’. Unfortunately, OPEC has displayed apparent anti-competitive cartel behaviour through the organization's agreements about oil production and price levels. What do I mean by this? Well, it’s simple, logically speaking, cartels work to fix prices in their favour, sometimes propping up prices by limiting supplies. However, for fear of losing its market share to U.S Shale producers, OPEC instead let prices decline enough (by not capping its supplies) to begin curbing investment in new shale wells. This technique ended up being counterproductive for both OPEC and Non-OPEC members, and countries like Venezuela, Brazil and Nigeria have suffered huge economic setbacks on account of it. So now, we see that Nigeria has no influence on the price factor as well.

With Nigeria running out of possible solutions on shoring up its dollar earnings from oil exports, the next best thing or should I say the inevitable last resort, was to consider devaluing its currency, and indeed, from 2014 to date, we saw the Nigerian Interbank Naira/Dollar rate fall from N156/$ to N199/$ to eventually settle recently at N281/$ levels.

While there have been many arguments for and against devaluing the naira, I will settle just for highlighting the effect of the naira devaluation on our dollar earnings and reserves. So, to put it simply, from a N156/$ rate to a N281/$ rate, the nation stands to get more naira (upon conversion) for each dollar earned. Technically speaking, with the devaluation, there is more naira for the government to spend against its shrinking dollar receipts.

Now let’s bring ourselves back to the main question - what’s in it for your portfolio? Without dwelling so much on the negative impacts of a valuation, one key concern for many is that devaluation in most cases may lead to a higher inflation rate, and if this is so, then the major objective for any investor will be to earn positive real returns on all investments. This means being able to earn returns above the inflation rate. Once this is not achieved, your disposable income shrinks (not in nominal terms) as you spend more naira per unit item purchased or consumed.

Research has recently proven that equity investors earn higher returns (in the long term) than Investors in other asset classes. The caveat here is that only those with moderate to high risk appetites end up telling a good story about their experiences in the equities space. In any case, the trick is to invest in fundamentally sound companies. If you are as psychic as I am, then you may agree that the next question for many will be “how do I tell what companies are fundamentally sound?” The answer lies in looking out for companies that exhibit the following qualities; sound corporate governance practices, transparency, quality, and timeliness of financial reporting, quality of earnings and cash flow, history of profit retention for funding future growth, and so on.

Having all these at the back of your mind, the next big thing is to choose your stocks, and if you still feel you are not ready, you can consult your financial planner or adviser for help. For those who however decide to grow their investments in equities, without going all out to make stock recommendations on this write up, I will nevertheless leave you with the following tips on sectors likely to benefit from the recent devaluation.

Like I mentioned earlier, there have been many arguments for and against the devaluation. This has also applied to companies. For companies that had huge dollar denominated debt before the devaluation, the devaluation can only mean an increase in its debt, putting further strains on its debt financing. In such cases, such an organisation may suffer a few setbacks in its business operations and most times will opt for a restructuring of its loans. The flip side will apply to companies that earned dollar denominated revenues (either because they have business operations abroad, or sales from local business transactions warrant earnings in foreign currency) before the devaluation. In this case, such organisations will see a nominal increase in revenues, and if they are able to manage their operations efficiently, such spikes in revenues may lead to better earnings for both companies falling into this category and investors in such companies.

It doesn’t really matter what side of the debate you are on – for or against – what matters at this point is your ability to utilise and make the best out of the opportunity herein. So go out there and make profitable investment decisions.

See you again.