July - September 2016 •
The Lion King
• 11
at a low interest rate and investing
it in an asset that provides a higher
rate of return, usually across sover-
eign borders. Since the higher yielding
market is in another country/region,
currency conversion and its attendant
exchange risk must be duly factored
into the overall investment strategy.
The proceeds of conversion will be
either placed on deposit in the sec-
ond currency if it offers a higher rate of
interest, or deployed into high-yielding
financial assets such as securities, equi-
ty stocks or real estate denominated
in the second currency. Carry trade is
a strategy more commonly adopted
by deep-pocketed entities referred
to as Foreign Portfolio Investors (FPIs)
because of their deep knowledge of
financial markets and their ability to
manage two key risks:
1. The risk of a sharp decline in the
price of the invested assets.
2. The implicit exchange risk if the
second currency devalues signifi-
cantly against the original currency
to such an extent that could wipe
away all the gains from investing.
Giving the foregoing, why then are
the FPIs not taking advantage of the
Nigerian Opportunity as much as
anticipated even after the Central
Bank of Nigeria has proactively gone
ahead to create a hedge product,
the Non-deliverable Futures aimed at
addressing (2) above. The following
are some of the apparent reasons:
• Market liquidity: The most important
consideration for a foreign investor
is the security of his principal. Since
the re-opening of the Nigerian
inter-bank foreign exchange mar-
ket, the market has not displayed
sufficient liquidity to guarantee
investors that they would be able
to readily source dollars whenever
they choose to exit. This concern,
coupled with underlying expecta-
tion that the naira is not fairly priced
will continue to keep investors wary
of coming into the Nigerian finan-
cial market space.
• Market levels: Financial markets
are known to follow trends. These
markets have resistance and sup-
port levels. Overall, these factors
are controlled by market demand
and supply volumes. A cursory look
at the Nigerian foreign exchange
market based on the balance of
demand and supply places the
local currency at risk of further
decline. The currency is expected
to find psychological resistance at
levels circa N400/$ to $500/$. It
is expected that at these levels,
demand will wane or lack effec-
tiveness as consumers begin to run
out of purchasing power. These
levels would thus serve as the per-
fect levels for FPIs to enter the mar-
ket and thus minimise exchange
risk on the dollar capital they wish
to bring into Nigeria, whilst simulta-
neously buying NDFs to hedge for
exit.
• Inflation: Since January 2016,
Nigeria’s inflation rate has steadily
risen from 9.6% to 17.1% recorded
for the month of August. Where
inflation is higher than return
on investment, the incentive to
invest is eroded (at least locally).
However, some might argue that
foreign investors are immune from
the negative impact of local infla-
tion since their return on investment
ultimately gets externalised and
it would thus be sensible to com-
pare returns on their carry trade to
inflation in the country from which
the funds originated. Nonetheless,
a rapidly rising inflation with no
imminent cap in sight could further
discourage foreign investment.
• Risk criteria: Nigeria’s most recent
credit rating as at June 23, 2016
was released by Fitch as B+ with
a stable outlook. On March 18,
2016, the country received a B+
from Standard and Poors with a
negative outlook. Moody’s rating
as at March 4, 2016 was a Ba3
with a negative watch classifica-
tion. Foreign Portfolio investors are
highly sophisticated and consider
every possible risk factor in their
target countries. For Nigeria, secu-
rity challenge is a major risk factor
considering the on-going hostilities
in North-eastern Nigeria as well as
the Niger-delta basin. The activities
of the Niger-delta militants place a
threat on the country’s future earn-
ings capacity.
• Policy instability: It is very essential
for regulators to assess the impact
of their pronouncements on mar-
ket volatility as policy instability also
has adverse effects on the stabil-
ity and soundness of the finan-
cial system. The investor’s biggest
fear (even over loss of revenue)
is the fear of eroding or losing his
entire capital. Thus a country that
cannot provide an ideal financial
market with the characteristics of
free entry and exit, timeliness and
uniformity of information inter alia
will not attract enough external
investment flows.
In summary, it is hoped that the CBN
will borrow a leaf from the G3 Central
banks and seek to adopt a regime of
policy stability in a bid to gain the con-
fidence of the much anticipated for-
eign investors. That coupled with the
fiscal strategy of reforming Nigeria’s
consumption pattern and boosting
non-oil exports will eventually serve
as the needed recipe for rescuing a
nation struggling in troubled waters.
EXPLAINING NIGERIA’S MISSING DOLLAR INFLOWS
| BUSINESS
