Naira moves from overvalued to undervalued after foreign exchange reform

Following the long-awaited foreign exchange reform implemented by the Nigerian government, the Nigerian naira has undergone a significant transition from being overvalued to undervalued, as reported by Businessday.

Analysts from US-based Bank of America shared their insights in a note to clients on June 28.

“We now see a USDNGN fair value of 680 per USD (previously 580). However, USDNGN is likely to trade above this level, with year-end 700, and a return to 650-680 in early 2024,” the Bank of America said.

Since the floatation of the naira on June 14, the currency has experienced a considerable depreciation, weakening by over 60 percent in comparison to its pre-reform level of N460 per USD. As of the latest data from FMDQ, the currency closed at N780 per USD.

Bank of America’s fair value estimate of N680 suggests that the naira is currently undervalued by 12 percent. The analysts also cautioned that it might take some time for the market to adjust and unlock more USD into the formal market. Nevertheless, they expressed confidence that the value of the naira would strengthen and appreciate once the dust settles.

Bank of America further projected that higher oil exports, resulting in an additional $12 billion, coupled with a liberalized import regime, which could add $10 billion through increased non-oil imports, could lead to consistent current account surpluses in the medium term. This, in turn, would boost the dollar inflows required to support the naira.

The BOfA analysts state:, “An addition of $12-13 billion on export revenues from higher oil production is moderated by a liberalised imports regime that could add $10 billion as non-oil imports increase. Still a net gain of $2-3 billion that strengthens the current account surplus.”

Standard Chartered Bank also shares the view that the naira is undervalued after the float, and they expect the currency to strengthen to N685 per US dollar as Nigeria accelerates the pace of implementing foreign exchange market reforms.

“We now forecast USD-NGN at 685.00 at the end Q2-2023 (from 480 previously), rising to 720 in Q3-2023 (520 prior), before appreciating thereafter as the market stabilises,” stated Razia Khan, head of research, Africa & Middle East, and Samir Gadio, head of Africa strategy, both at Standard Chartered Bank, in a June 14 note to investors.

The decision to float the naira marked a significant departure from years of a currency peg system, which had deterred foreign investors and negatively impacted the economy. This move is part of a series of reforms by new President Bola Tinubu, who aims to achieve a unified exchange rate and has also eliminated a costly petrol subsidy program.

Despite drawing criticism from some economists, Nigeria remains committed to pursuing a more stable and efficient foreign exchange system.