Macro Analysis /

Nigeria: Exploding interest and exchange rates in 2 charts

  • 12-month T-bills yields have doubled since late-Sep, converging towards policy rate after 3 years of decoupling

  • Demonetisation drive has prompted panic dollar buying, pushing parallel exchange rate to 850/US$ (c90% premium)

  • Further interest and exchange rate increases likely amid rising inflation and resistance to FX liberalisation

Nigeria: Exploding interest and exchange rates in 2 charts
Janet Ogabi
Janet Ogabi

Senior Research Analyst

Tellimer Research
3 November 2022
Published byTellimer Research

Since the Central Bank of Nigeria (CBN) hiked its policy rate and Cash Reserve Ratio (CRR) in September, there has been a series of notable developments in interest and exchange rate realms (see related reading below). In this brief note, we unpack two of the key developments in these areas.

Sharp rise in interest rates

Firstly, we have highlighted how, since the bifurcation of the OMO and NTB markets in October 2019,  Nigeria’s broken monetary policy transmission mechanism has led to a sharp divergence between the CBN’s policy rate and prevailing yields in the primary and secondary markets. However, the yield on Nigeria’s 12-month T-bills has doubled to c17% from c8.5% in late September, as measured by the Nigerian Interbank Treasury Bills True Yield (NITTY), or 15.3% when measured by the T-bill maturing 26 October 2023, bringing market rates more or less in line with the CBN’s 15.5% policy rate.

Nigeria yields

The rate increase has been driven by a number of factors, including the recent policy rate and CRR hike, rising inflation (which hit a 17-year high of 20.8% yoy in September), the likelihood of greater domestic borrowing in the future (due to an expansionary budget and plans to end monetisation of the deficit), and rising global interest rates (with the Fed hiking by another 75bps yesterday and Chair Powell saying that it still has “some ways to go” in its fight against inflation and may have to push rates to a higher terminal rate than previously expected, albeit possibly at a slower pace).

In any case, after several years of artificially low yields due to weak monetary policy transmission and market distortions, Nigeria’s government debt yields have finally capitulated to fundamentals. The rise in yields is welcome, but further increases may still be needed with 12-month T-bills still yielding between -4% and -5.5% in real terms.

Exploding parallel market premium

On the exchange rate front, the naira has continued to sell off sharply in the parallel market. From 725/US$ at the end of September and 760/US$ just a week ago, the naira exploded to somewhere between 820-850/US$ on the parallel market yesterday. With the official exchange rate inching up to 443/US$, this represents a parallel premium of c85-90%, exceeding the previous high of 77% in May 2016.

NGN parallel

While we have previously outlined some of the key factors driving the naira’s parallel market depreciation, the more recent sell-off has been driven by the CBN’s demonetisation plans announced last week. As we predicted at the time, this has generated an environment of panic buying as holders of the soon-to-be-retired notes scramble to convert them to FX ahead of the 31 January 2023 deadline, echoing the large disruptions witnessed when India tried to implement a similar policy in 2016.

As we have emphasised numerous times (see related reading), the parallel naira will remain under pressure until the exchange rate regime is liberalised, which we do not see as likely before the February 2023 elections. Until then, the sky is the limit for the parallel exchange rate, which continues to set new records by the day and is on pace to break through the psychological threshold of 1000/US$ imminently if something is not done to arrest its fall, intensifying the vicious cycle of panic buying and depreciation.

Related reading

Nigeria: Demonitisation won’t salvage the naira – not a game-changer for banks, October 2022

Nigeria: Securitizing CBN loans may not signal the end of monetisation, October 2022

Nigeria’s budget is not the farewell Buhari intends, October 2022

Assessing the impact of Nigeria’s worst floods in a decade, October 2022

Nigeria: Confusion over debt restructuring plans drives eurobonds sell-off, October 2022

Nigeria webinar: Presidential hopefuls to inherit poisoned chalice, October 2022

Nigerian central bank strikes orthodox tone but larger policy overhaul is needed, September 2022

Nigeria: CBN’s elevated funding to the government increases risk to the naira, August 2022

Nigeria: The factors driving the Naira’s collapse on the parallel market, July 2022

Nigerian central bank surprises with another rate hike, July 2022

Nigeria: Upgrade to Buy after excessive sell-off, June 2022

Nigerian central bank surprises with symbolic 150bps rate hike, May 2022

Nigeria annual macro overview: The song remains the same, February 2022