How Nigeria is depleting its dollar reserves to boost naira

In recent weeks, Nigeria has witnessed a remarkable turnaround in its currency dynamics, with the naira rebounding from record lows against the dollar. However, this resurgence has come at a cost, as the country’s foreign exchange reserves experience a significant decline, raising concerns about the sustainability of this recovery.

Nigeria is burning through foreign exchange reserves at a rate not seen in four years, prompting worries that the central bank is depleting its dollar holdings to bolster the naira’s value. Since March 18, liquid reserves have dropped by 5.6%, reaching $31.7 billion as of April 12. This marks the most substantial decline since April 2020.

The naira’s recovery follows a 43% devaluation in January, prompting the Central Bank of Nigeria (CBN) to implement measures to enhance liquidity and attract capital inflows. As part of these reforms, the CBN pledged to address the backlog of pent-up dollar demand, aiming to establish a more flexible exchange rate regime.

Charles Robertson, head of macro strategy at FIM Partners, acknowledges the CBN’s efforts to clear the backlog using forex reserves. He suggests that this move aims to restore confidence among investors, both local and foreign, in the Nigerian currency and rejuvenate liquidity in the foreign exchange market.

Despite the decline in reserves, Nigeria maintains a sizable cushion buoyed by a rally in oil prices and inflows from multilateral loans. With gross reserves covering approximately six months’ worth of imports, the country demonstrates resilience in the face of external pressures.

The CBN recently announced the clearance of a backlog of overdue dollar purchase agreements estimated at $7 billion. This backlog, accumulated over years of currency pegging, had deterred foreign portfolio investment. However, the extent of remaining dollar obligations on the CBN’s balance sheet remains uncertain.

Recent financial statements from the central bank revealed securities lending agreements with JP Morgan Chase & Co. and Goldman Sachs Group Inc., raising questions about outstanding obligations. The CBN’s response to inquiries about these agreements remains pending.

Despite a surge in capital inflows following interest rate hikes in February and March, forex reserves continued to decline. While foreign portfolio inflows exceeded $1 billion in February alone, totaling at least $2.3 billion year-to-date, the outflow persists.

Analysts anticipate a potential stabilization or increase in reserves, driven by forthcoming inflows from institutions like Afreximbank and the World Bank, as well as the prospect of a new eurobond issuance. Additionally, higher oil prices and the anticipated return of remittances through official channels are expected to bolster Nigeria’s forex position.

Nigeria’s recent currency rebound, accompanied by a decline in forex reserves, underscores the delicate balance between short-term stabilization measures and long-term economic sustainability. While the CBN’s interventions have provided temporary relief, structural reforms are necessary to enhance forex liquidity and attract sustained investment inflows.