S&P forecasts further naira depreciation in 2024  amid economic headwinds

Onome Amuge

As the New year dawns, Standard and Poor’s (S&P) Global Ratings have issued a bleak outlook for the naira, warning that a depreciation in the Nigerian currency is on the horizon.

S&P, in its Nigerian Banking Outlook 2024, noted that the dismal forecast is driven by the country’s stagnant foreign exchange (FX) reserves, which are at risk of being depleted further as the demand for hard currency remains high. With the Naira already facing devaluation pressures, this new development threatens to plunge the currency into even deeper turmoil, creating additional economic headwinds for the country in the months ahead.

The agency’s analysis noted that a number of factors are conspiring to restrict the country’s foreign exchange reserves, including rising import costs, outstanding FX obligations, and dwindling oil revenues. With each of these factors putting downward pressure on FX reserves, it is becoming increasingly difficult for the country to maintain its current exchange rate and meet its foreign exchange needs.

“We forecast usable FX reserves of $28 billion in 2024,” S&P stated.

S&P acknowledged the Central Bank of Nigeria’s (CBN) attempts to clear outstanding FX transactions, but noted that these efforts have not been sufficient to address the market’s supply constraints. This view is echoed by Fitch Ratings, which also recently commented on the dire state of Nigeria’s FX reserves. In an effort to shore up FX reserves, President Bola Tinubu secured a pledge of FX support from Saudi Arabia, but it is unclear how significant this would be in offsetting the country’s massive FX needs.

S&P warned that the Naira is likely to face further depreciation, driven by the structural weaknesses of the country’s foreign exchange market. These structural weaknesses, combined with rising import costs and anemic oil revenues, are creating a significant imbalance between Nigeria’s FX supply and demand. 

While the CBN has attempted to shore up its reserves through various initiatives, reports show that these efforts have not been enough to address the fundamental issues with the country’s FX market. With structural challenges persisting and oil revenues unlikely to keep pace with rising import costs, the outlook for the Naira remains bleak.

“We expect the current account to record a small surplus averaging below 1 per cent through 2025 as the import bill increases faster than oil exports due to high prices.

“While the Naira trades closer to a managed float rather than being a fully free-floating currency, the exchange rate is now significantly more in line with market demand and weak supply fundamentals,” S&P stated.

S&P further warned that currency depreciation and inflation will create additional pressure on the asset quality of Nigerian banks. The firm projects that credit losses for the sector will increase by 3.5 per cent in 2023, driven by currency depreciation, high interest rates, and elevated inflation. While the NPL ratio for the sector is expected to moderate in 2024, it is likely to remain below the regulatory limit of 5 per cent due to the continued impact of currency depreciation on outstanding loans. 

The agency predicted that the CBN will continue to raise interest rates in an effort to curb inflation and strengthen the Naira. However, the gap between inflation and the CBN’s benchmark rate is still significant, which could lead to further rate hikes. S&P explained that this in turn, will put pressure on borrowers, as banks will pass on the full rate increase to them. This dynamic could create additional challenges for the Nigerian economy, as higher borrowing costs could further dampen economic activity. However, S&P noted that there is a possibility of a rate cut if inflation and currency depreciation improve faster than expected

In addition to the credit risks posed by currency depreciation and inflation, S&P noted that the transition to cleaner energy sources also poses a significant risk to the Nigerian banking sector. The firm estimated that loans to the hydrocarbon sector account for about 30 per cent of the total loan portfolio of Nigerian banks, making the sector vulnerable to the gradual transition to cleaner energy sources. Moreover, S&P estimated that foreign currency loans will increase to 55 per cent of total loans due to the naira depreciation in June 2023.