September 11, 2019
By CSL Research
According to Bloomberg, conversations are ongoing between the FMDQ and the Central Bank (CBN) about extending the FX futures curve to 10 years, as the country constantly explores means to manage its foreign exchange risk. In recent times, pressure has been mounting on the country’s reserves as oil prices have been oscillating around the government’s US$60/bbl benchmark, causing outflow of foreign investment from the capital market. The external reserves peaked at US$45.12bn in May 2019 but have since declined by c.4.37% to US$43.10bn as at 6 September. The continued decline in the reserves could limit the ability of the Central Bank to keep up with its interventionist policy in the foreign exchange market, underpinning the rationale behind exploring new ways of managing foreign exchange risk.
The foreign-currency futures contracts was introduced by the Central Bank in 2017, and was recently extended to a maximum duration of 13 months. The introduction of the futures contracts helped to attract investment to the treasury bills market as investors are able to hedge against fluctuations in the Naira for the duration of their investment. However, the availability of only short-term contracts limits the inflow of non-resident capital to markets with long-term maturites. This has resulted in a concentration of short-term maturities which the Central Bank is constantly trying to manage, being the main supplier of FX to the foreign exchange market.
In our opinion, longer-tenor futures will help to drive capital into Nigeria’s economy. If the FX curve is extended, bonds with maturities of up to 10 years will become more liquid than they currently are, as they will become more accessible to foreign portfolio investors. Also, an extension of the FX futures curve could result in an increase in foreign direct investments because investors will take advantage of the futures to guard against exchange rate volatility. Additionally, an extension of the curve provides opportunities for Nigerians in diaspora to bring their money home and would also be beneficial to long-term borrowers in foreign currency (corporates and non-corporates) as it reduces the fear of an unexpected erosion in the value of the Naira.