Nigeria’s Foreign Reserve Crisis: A Second Take on JP Morgan’s Outlook
Is a half-filled glass of water half full or half empty? It depends. Perspective is a powerful tool for decision-making and reality interpretation. A man or woman who says Nigeria’s foreign reserves position is dire and a person who says it is manageable is correct. It depends on what the person has chosen to stare at. If Nigeria’s foreign position is compared to its balance sheet or assessment of its liabilities relative to resource assets, the word ‘dire’ could be considered expressive but inaccurate.
A recent JP Morgan report on Nigeria’s net foreign reserves and macroeconomic conditions has prompted prospective investors to scamper for safety. Short sellers have assumed that Nigeria’s naira-to-dollar exchange rate would slide south with relatively lean net foreign reserves (estimated by JP Morgan at US$3.7bn). The problem is that a few items back out of the financial service giant’s gross or total reserve position are contingent liabilities or future obligations yet to materialize. In addition, local analysts note that the lean reserve position could be improved within eighteen months if the federal government produces an asset register for designated federal government assets and/or companies, which it values and lists on an official traded equity exchange (like Saudi Arabia’s state-owned oil giant Saudi Aramco presently valued at 8.35trn Saudi Arabian dollars or US$2.22trn).
According to a Proshare analyst, ‘Nigeria’s foreign reserve has gone through a small trailer of challenges; the net position as of December 2022 was painfully low and delicately poised, but policymakers do have a way to improve the position through public asset financialization. Quickly selling off, leasing or licensing assets would send a fiscal policy fox after a foreign reserve rabbit.”
The financial statement of the Central Bank of Nigeria (CBN) for the fiscal year 2022 suggests a decline in foreign reserves, with the gross reserve reported at US$34.12bn, while the net reserve stands at US$18.04bn. An analysis by JP Morgan on the financials of the regulator suggests that the net foreign exchange (FX) reserves are around US$3.7bn in 2022, a fall off from the US$14.0bn recorded in 2021, based on assumed US$5bn in IMF special drawing rights with three key FX liabilities (FX forwards at US$6.84bn), securities lending (US$5.5bn) and currency swaps (US$21.3bn).
Nigeria’s Foreign Reserve Debates
A country’s foreign reserve size has bearing on imports, currency intervention, external debt settlement, and monetary stability; a low gross domestic product (GDP) to reserve ratio signals fiscal and monetary policy tightening, higher interest rates, and higher unemployment rates. Analysts’ helicopter view of the CBN’s 2022 financial statement puts into perspective the impact of the US$7.5bn loan obligation to JP Morgan and Goldman Sachs and the US$6.84 foreign forward contract payables in compressing the country’s net foreign reserve to US$18.04bn. The size of the net foreign reserve has recently become the subject of interpretation JP Morgan, in a recent report, suggested that Nigeria’s net foreign reserves were closer to US$3.7bn in 2022 or % lower than implied by the CBN’s year-end financial statement last year. The figure was assessed on the assumption of an additional US$5bn in IMF special drawing rights with three key FX liabilities (FX forwards at US$6.84bn), Securities lending (US$5.5bn) and currency swaps (US$21.3bn).
JP Morgan’s computation is hazy, but analysts spotted an additional liability under contingent liabilities and commitments valued at N14.945trn in the CBN financial statement, which was itemized in JP Morgan’s computation. The commitment covers intervention funds at N228.22bn, FX forward, OTC futures, and currency swap valued at N14.60trn, and capital commitments at N119.72bn. Meanwhile, the FX forward under the commitment excludes the FX forward quoted under other liabilities of N3.16bn in CBN’s 2022 financials.
All these obligations suggest that the net reserves might be hovering around estimated figures, which some analysts predict might be lower in 2023 given smaller oil production (1.1mpb), US$500m Eurobond redemption, external debt repayment, and currency intervention. Some analysts remain optimistic, arguing that currency swaps and FX forwards are not immediate deductions (they fall due between 13 and 60 months) and are partly relieved by the recent Nigerian National Petroleum Corporation Limited (NNPCL) US$3bn Afrexim bank loan that could help cushion external reserves pressure. Both arguments seem fair but point to addressing the worrying FX supply problem. One way to do this is unlocking new FX streams through asset financialization (selling equity and listing public assets on a trading floor) while improving semi-finished/ finished non-oil exports (see illustration 1 below).
Of FX Forwards and Securities Lending: A Lesson in IAS1 and IFRS 9
A review of the movement on foreign reserves data on the CBN’s website, Gross foreign reserves as of the end of July 2023 stood at US$33.95bn. However, the audited report of the Bank showed that the reserves were lower at US$32.4bn, a variance of US$1.55bn, which cannot be explained even by the 30-day moving average that the CBN carries out to arrive at its online statistic. Worse still, an analysis of the 2022 report showed that a US$7.5bn pledge to Goldman Sachs and JPMorgan and a US$6.8bn currency forward obligation resulted in a net reserve of US$18.1bn.
JPMorgan’s recent Nigeria report, which puts the country’s net foreign reserves at US$3.7bn, has unsettled the foreign exchange market. Analysts have speculated that there may have been an error in presentation and disclosure in the CBN’s 2022 audited report, which stated that the foreign reserves were US$32.4bn (as against the website’s US$33.95bn). In its computation, JP Morgan added the country’s US$5bn IMF SDR loan and then deducted from the gross reserves of US$37.8bn (N15.55trn) FX forwards (US$6.84bn), securities lending (US$5.5bn) and currency swaps (US$21.3bn), which the regulator stated was part of the other liabilities contained in Note 29a of the 2022 financial statement.
Addressing the accounting rules- IFRS 9 (a major disruptor of deposit money bank (DMB) financial statements in 2019), analysts note that FX forward contracts, securities lendings and currency swaps were typically classified as financial assets or liabilities on the balance sheet, at fair value.
As there is no requirement that the Net reserves be presented as a line item, EY, and KPMG, who audited the report, cannot be accused of dereliction of reporting standards. Regardless of how the liabilities are recognized, they represent a cause for concern about the country’s reserves. Analysts highlight the importance of diversifying FX revenue sources by promoting non-oil exports, attracting foreign investments, sovereign wealth fund utilization, import substitution, and strategic bilateral and multilateral agreements, all of which present opportunities for enhancing and sustaining the reserves(see illustration 2 below).
Illustration 2:
Comparing Nigeria’s FX Reserve Against Giant Corporate Cash
In an unorthodox review, Proshare analysts observe that heavy-weight US companies currently have much larger corporate cash than Nigeria’s gross and net reserves. For instance, Nigeria’s gross reserve settled around US$30bn, Apple had a Q2 2023 cash-at-hand of US$166.54bn, Alphabet’s cash was US$118.33bn, while Microsoft kept US$111.26bn in the corporate cash till. Amidst a global liquidity glut, with huge profits and large cash holdings by multinationals, a low national foreign reserve highlights the country’s failure to capitalize on rising crude oil prices and high prices of non-oil commodities. The predicament is expected to worsen should global markets drop into recession, further hindering the country’s capacity to defend the naira in the face of market pressures.
Analysts observe that multinational corporations’ huge cash dollar positions viewed against Nigeria’s foreign exchange (FX) reserves not only mirror these companies’ dominant trading currencies but also indicate a huge deficiency in Nigeria’s global tradable product contributions. The dependence on foreign borrowings (as against earning in foreign currencies) and local borrowings (largely through Ways and Means) suggests low national productivity, narrow exportable products, and low foreign capital inflows, thereby weakening the capacity for stable reserves growth (see Chart 1 below).
Chart 1:
CBN’s JP Morgan Clap Back
In reacting to JP Morgan’s net reserve calculations, Nigeria’s Central Bank questioned the report’s intention and undesirable beckoning of unfavourable market sentiments. The Nigerian banking sector regulator further queried the matching of the total outstanding liabilities to reserves to estimate net balance, given that the reserve is not stagnant but flows as earnings from oil export or swap can accrue to reserves. It further disclosed that 80% of the country’s reserves are CBN funds, noting that the country’s oil export receipts come directly to the CBN, which monetises that to naira for the federal government to spend through its budget. The maturity of the obligations was an additional argument raised; most of the liabilities were for immediate settlement, thereby limiting outflows currently. The argument aligns with some analysts’ perspectives, especially the N14.59trn FX forwards, OTC and currency swaps highlighted by JP Morgan. However, the argument does not negate the urgent need to grow the country’s reserves to prevent a falling down the global external reserve pecking order, as would be the case with countries like Liberia, Somalia, and others.
Generally, those challenging the CBN’s deemphasis of the country’s net external reserves may need to understand that if the financial reporting framework of the CBN for previous years has not involved line-item recognition of net reserves, then it is not under any accounting obligation to make such disclosures. Technically, the Bank’s financial position or balance sheet statement is consistent with global best practices. Nevertheless, would a net reserve line item add further insight into managing Nigeria’s reserves? Certainly, however, the interpretation of the position is nuanced. It should be addressed within the framework of looking at the balance sheet as a ‘snapshot’ of the country’s external position rather than as a flow over time.
The lean reserve position must be addressed, but for now, the country has not gotten to the point of panic stations. The external reserve nuts can still be pulled from the fire. In an in-house analyst’s clipped but shrewd comment, ‘the country’s reserves are down but not out; getting up from the floor is more important than staring at the skyline. If we must go out, it will be with our gloves punching back at relatively low dollar inflows rather than policy indolence’.
