CBN Faces Liquidity Crisis as $20 Billion of Foreign Reserves Tied Up in Derivative Deals

The Central Bank of Nigeria (CBN) is grappling with a significant liquidity crisis as nearly $20 billion of its $33 billion in foreign reserves is locked up in various derivative deals, according to a report by the Economist Intelligence Unit (EIU). This poses a challenge to the bank’s ability to support the naira amidst rising inflation and policy decisions impacting the currency’s stability.

The EIU’s report highlights the precarious position of the naira, stating that it will likely be highly volatile for most of the year, leading to regulatory erraticism that could affect businesses, especially those holding foreign currency. The CBN’s lack of liquidity to support the naira itself is a concern, with a large share of its foreign reserves committed to derivative deals.

To address this challenge, the EIU suggests that foreign borrowing will be essential to rebuild the CBN’s reserves, clear backlogs of unmet foreign exchange orders, and restore confidence in the naira. The report anticipates that foreign borrowing may only be achievable towards the end of 2024.

Nigeria has already taken steps in this direction, securing loans from institutions like the African Export-Import Bank (Afrexim) and the African Development Bank, with additional funding sought from the World Bank. The CBN is also working with the International Monetary Fund (IMF) to create a framework to address excess volatility in the forex market.

Despite these efforts, the EIU projects a gradual recovery of foreign reserves between 2024 and 2028, with a cautious outlook on the naira’s valuation. The report predicts further depreciation of the naira due to persistently high inflation and negative real short-term interest rates. However, it holds a balanced forecast, predicting an end-2024 rate of N1,770/$ and N1,817/$ by the end of 2025.

The report also highlights the dilemma faced by the CBN, noting that President Bola Tinubu’s economic goals, including a notable aversion to high-interest rates and the ambition to double GDP by 2031, may hinder the necessary monetary tightening to attract foreign investors. This scenario is exacerbated by high inflation rates, eroding the real value of short-term interest rates and potentially leading to higher unemployment if aggressive monetary policies are adopted.

Despite these challenges, recent reforms by the CBN have renewed investors’ interest in Nigeria and attracted the needed foreign exchange. The surge in foreign exchange inflows in February 2024, attributed to adjustments in benchmark interest rates, has heightened investor interest in short-term sovereign debt, indicating a positive trend for the country’s economy.

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