Goldman Sachs Urges Higher Interest Rates, Clearing FX Backlog for Nigeria’s Unification to Work

One of the World’s largest investment banks, Goldman Sachs has welcomed the new foreign exchange rate regime of the government.

“We interpret the pace and content of recent policy announcements as significant positive surprises to our and market expectations and as being supportive of a constructive view on sovereign credit.”

In a report published on the 14th of June 2023, titled “CBN Devalues the Naira and Abolishes Official Exchange Rate Segmentation Policy” the investment bank welcomed the development but cast doubt about the true intent of the policy.

The investment bank also suggested interest rates needed to be increased to higher locally citing the negative real interest rates for local fixed-income instruments. It also stated that the rate is not enough to meet the $12 billion in pent-up demand.

On interest rates

Goldman Sachs pointed to Nigeria’s low fixed-income securities which banks still quote for about 8.5% for deposits of about N250 million and above.

“As we have argued previously, introducing currency flexibility and/or easing restrictions on access to FX would very likely need to be accompanied by higher local interest rates (with prevailing short-term market interest rates currently deeply negative in real terms.”

While Goldman Sachs welcomed the new exchange rate policy, it noted that there was no clarity on Nigeria’s current account.

“In addition to the devaluation, the CBN issued a communique specifying that it has collapsed all of its (multiple) official FX rates into the Investors and Exporters (I&E) window but did not provide any clarity on current/capital account FX restrictions that result in a parallel market exchange rate that is weaker than that offered at the official window(s).”

It also pointed out that while devaluation is important it was not enough to unify the official and parallel exchange rate which Nairametrics reported was still wide.

“In our view, devaluing the currency is a necessary but not sufficient condition for unifying the official and parallel-market exchange rates.”

Goldman Sachs also mentioned that the government will need to clear the forex pent-up demand of $12 billion which is necessary to unify the currency.

“We think that easing FX restrictions and clearing the FX backlog (that we estimate at US$12bn) would be required to achieve a unified Naira exchange rate.”

Finally, the Investment Bank indicated that the central bank directive did not provide guidance on whether it will lead to a flexible exchange rate or if the CBN will continue with its fixed exchange rate policy.

“In terms of the broader FX policy set-up, the CBN did not provide any guidance on whether the (historically heavily managed) currency regime would be maintained or if there might be any transition toward a more flexible exchange rate. In our view, any FX liberalization or easing of FX restrictions would entail the need for higher local interest rates to lean against currency depreciation pressure.”