US-China dispute, South Africa’s recession… is the naira safe?

It has certainly been an explosively volatile trading quarter thus far as investors juggled with global trade tensions, dollar strength and chaos across emerging markets.

The simmering trade dispute between the world’s two largest economies fuelled global risk aversion while a brutal sell-off in the EM space rattled investor confidence.

Fears remain elevated over the turmoil in Turkey and Argentina spreading like a virus across developing and developed nations. With the South African economy already descending into a recession, will Nigeria be the next economy to take a hit?

Throughout the third quarter of 2018, Nigeria has kept afloat with GDP expanding 1.5% during Q2 and inflation easing 11.14%. Although the nation’s external reserve dropped to the lowest since March to $45 billion, it still remains at manageable levels.

With oil prices somewhat supported by geopolitics and the naira displaying a degree of stability against the dollar, the outlook looks somewhat encouraging.

However, external risks in the form of an appreciating dollar, prospects of higher interest rates and trade tensions could cripple Nigeria’s fragile recovery.

Contagion fears stemming from the EM selloff may force investors to scale back on investing in emerging markets, including Nigeria, while capital outflows could complicate the Central Bank of Nigeria (CBN)’s effort to defend the naira.

Although expectations were initially elevated over the CBN cutting interest rates in the second half of 2018 to stimulate growth, the current global and domestic economic landscape could force the central bank to maintain the status quo.

A CBN rate cut will widen the interest rate differential with the Federal Reserve, ultimately accelerating capital outflows and threating price stability. With inflation also expected to rebound thanks to election spending, some even feel the CBN may end up hiking rates instead.

Referring to price stability, the naira, like most other emerging market currencies, remains impacted by external forces. Although the local currency has barely budged against the dollar, this is based on the CBN’s repeated intervention in the FX markets.

While this strategy could ensure the local currency remains supported in the short term, Nigeria’s external reserves are already feeling the pressure. On the plus side, with Nigeria achieving a current account surplus, the naira’s punishment may not be as severe as those currencies belonging to markets with a high account deficit.

Although Nigeria’s economic prospects remain tied to oil prices, the upcoming presidential elections could play a leading role in determining if the nation is able to conclude this year on a firm footing.

The increased spending ahead of the February elections will most likely be a welcome development for economic growth. If oil prices remain at current levels and support both government revenue and consumption, this may stimulate the recovery further.

The largest economy in Africa still has the ability to shock the world stage this year. While it is widely known that the cure to Nigeria’s illness – oil dependency – can be found in economic diversification, the correct steps must be taken while the conditions are still accommodative.

As the third trading quarter of 2018 slowly comes to an end, global sentiment is likely to remain heavily influenced by US-China trade tensions and the emerging market rout.

With the US Federal Reserve expected to raise interest rates this month, the CBN’s effort to defend the Naira may be obstructed.