Copying Venezuela’s exchange rate policy and China’s failed equity market strategy might seen the height of foolishness.
But, at least in the opinion of John Ashbourne, Africa economist at Capital Economics, that is precisely what Nigeria, the continent’s largest economy, has just done.
“Low oil prices are battering Nigeria’s export-dependent economy, but it’s the government’s market-distorting response that risks pushing the country into a Venezuela-style crisis,” Mr Ashbourne says.
“Nigeria is sliding towards a Venezuela-style FX regime and adopting a Chinese-style stock market circuit breaker. Neither will reassure foreign investors, many of whom seem to be eyeing the exits.”
Both measures were announced after markets closed on Friday, January 15.
The circuit breaker on the Nigerian stock exchange, one of the worst performing in the world this year with a fall of 17.7 per cent, will pause trading for 30 minutes if stock prices fall 5 per cent. Trading will cease for the day if it is triggered twice in a session, or after 1.45pm.
This month, Beijing abandoned a similar policy after just four days, concluding that in a falling market the existence of the circuit breaker encouraged more selling as traders rushed to exit while they could.
“The effect is akin to calling last orders at a crowded bar,” Mr Ashbourne says. “It is hardly confidence-inspiring that Nigeria is copying a Chinese policy that is widely seen to have failed.”
He accepts that Nigeria’s circuit breaker may not be as badly designed as the Chinese version. Whereas the NSE All Share index rarely falls by 5 per cent a day, the Shanghai Composite did so a dozen times in 2015. The NSE’s version has not yet been called into action.
Nevertheless, Mr Ashbourne says that using a circuit breaker to shore up the market, rather than to avoid volatility, is “deeply flawed”.
Simultaneously, the central bank has said it will stop selling US dollars into the interbank FX market.
Nigeria has operated a de facto twin currency system for the naira since February 2015, when the bank held the official interbank rate at N199 to the dollar to avoid a spike in inflation. The unofficial rate, available at bureaux de change, has plunged to N300/$, as the first chart shows.
However Mr Ashbourne argues the latest move takes Nigeria a step along the road to a Venezuela-style scenario, where the dollar now buys 913 bolívars on the black market, according to dolartoday.com, compared with an unofficial rate of 6.28/$.
“Suspending US dollar sales to the interbank market will force consumers and firms to source dollars at bureaux de change,” he says, while providing an implicit subsidy for companies and individuals with the connections needed to access the official rate.
As the second chart shows, Nigeria’s reluctance to let the naira’s official exchange rate weaken means it has borne the brunt of the sharp fall in oil prices since the middle of 2014.
In naira terms, the oil price has fallen from $115 a barrel to around $35, with the modicum of weakening permitted so far doing little to take the edge off the fall in oil prices to $28 in dollar terms.
In contrast, Russia, which has allowed the rouble to fall sharply, is still seeing oil prices of around $65 in local currency terms, with many other oil exporters such as Brazil and Azerbaijan also seeing more cushioning of the blow than Nigeria.
Charles Robertson, chief global economist at Renaissance Capital, who drew up the second chart, expects Nigeria to bow to the seemingly inevitable and devalue the naira, given that his calculation of fair value is N305/$, very close to the current black market rate.
He notes that frontier market funds are now underweight Nigerian equities, and believes that international investors “are likely to remain on the sidelines,” barring an obvious catalyst for change.
Nevertheless he believes a devaluation to N250/$, “while no longer sufficient to ease all dollar shortages … would be good enough to warrant investors taking a fresh look at Nigeria, especially if they expect a rebound in the oil price”.
Daniel Salter, global equity strategist at RenCap, has been busy analysing just when equity market investors should consider returning to a freshly devalued Nigeria, if history is anything to go by.
Mr Salter analysed 13 emerging market currency devaluations since 1994 in countries ranging from Mexico and Turkey to Egypt and South Korea.
His conclusions are that it is rarely worth buying in anticipation of a currency devaluation and that, on average, equity markets do not hit their low point (in dollar terms) until 99 days after the start of the currency devaluation.
This delay can vary significantly, though, as the final chart shows. In the case of South Korea in 1997 the stock market troughed the day before the won started to fall. In Nigeria itself, in 2009, this point was reached after 35 days.
However in the cases of Thailand (1997), the Philippines (1998) and Egypt (2001), it would have paid equity market investors to stay out for at least six months.
Mr Salter believes the lag is due to two factors: the initial devaluation is often insufficient to stabilise the currency; and that devaluations frequently coincide with banking crises.
Unfortunately, this analysis probably tells us little about how Nigeria’s equity market is likely to behave in the year after any devaluation.
In the 13 previous episodes, the stock market typically fell 3 per cent in dollar terms in the three months after the start of the devaluation. However, as the above chart shows, there has been huge variability in this figure, from -56 per cent in Mexico in 1994-1995 to +100 per cent in South Korea in 1997-98.
Likewise, on average the typical stock market gained 4 per cent in dollar terms in the year after the devaluation, but once again this is the average of a widely dispersed data set, with the returns ranging from -86 per cent (Indonesia, 1997-98) to +172 per cent (South Korea).
The sector breakdown perhaps delivers a clearer message. RenCap found that consumer staples stocks have tended to outperform in the 12 months after the start of a devaluation, while consumer discretionary companies and industrials tend to pick up once the currency has bottomed.
Financial stocks, in contrast, tend to be the worst sector in the year after a devaluation, probably due to declining credit quality.
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