Why it is risky to convert your naira to dollars or USD(T)

Why it is risky to convert your naira to dollars or USD(T)

Inflation data is out. 17%. The common interpretation is that the purchasing value of your money has declined by 17%. A quick comparison of inflation data with other countries – Saudi Arabia is at 0.4%, the United Kingdom is at 3.2%, and in the United States, it’s at a “transitory” 5.3%.

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The consequence of this is Nigerians are finding different means or investment vehicles to preserve their hard-earned naira from devaluation. They want their 100,000 naira to be 100,000 naira on a Month-on-Month basis.

The common trend now to achieve this is to “buy the dollar and preserve their naira earnings.” While in theory, this sounds like a well-thought-out plan or hedge as we call it in finance, there are certain flaws to it.

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Engaging in this form of hedging – inadvertently makes one a currency trader vulnerable to volatility. Foreign exchange rates can change rapidly in response to any real-time economic and political events. The tendency to always buy at whatever price will possibly lead you to buy at high prices and when it hits a negative inflection point – the purpose of “preserving value” is defeated.

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The fundamentals appear to be changing soon. There are signs the Nigerian economy would soon be supplied with dollars.

Nigeria has announced plans for another visit to the global market through the issuance of a $6.2 billion Eurobond in October. JP Morgan, Goldman Sachs, Citigroup, and Standard Chartered have already been selected as international book-runners for the Eurobond issue alongside local firm, Chapel Hill Denham.
Access Bank Plc’s recently oversubscribed $500 million Unsecured Eurobond that drew interest from top-grade investors globally should bring optimism that investors will rush the Federal Government Eurobonds.

The recent $3.35 billion Nigeria received from its share of the IMF’s SDR (special drawing rights) has boosted the country’s dollar liquidity.

President Buhari’s recent request for a $4 billion loan, which has been heavily contested, is likely to fly as it could get approval from the Senate, where his party is in the majority. Nairametrics reported yesterday that the Senate President, Ahmed Lawan gave the Senate Committee on Foreign and Local Debts one week to consider the President’s loan request and revert to the Senate next Tuesday.
Additionally, there have been indications that Indian refiners, Nigeria’s largest buyers of oil, are increasingly boosting run rates amid newfound confidence that there will be a revival in oil-products demand. The information in the market is that some refiners are planning to lift runs to 100% of their capacities for the rest of the year. With oil at $74-75, it’s a good time for Nigeria and Nigerians.

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With the possibility of liquidity support coming in and the Central Bank clampdown on speculative website “abokiFX” – artificial prices will soon flesh out and the intrinsic value of the Naira to the dollar will appear. Herein lies the need for introspection of the “currency conversion” practice.

Let’s break this down.

In investing, there are three principles to use as guidelines.

Investment objective
Risk appetite
Investment horizon

In this particular case, the investment objective of many Nigerians is to preserve their earnings in foreign currencies. They just want value – not profit necessarily. Any “profit” is just a bonus for their venture. Every year, Morgan Stanley picks the year’s best safe-haven currencies. The U.S. dollar was picked in 2020 as the best safe-haven currency. The Japanese yen and Swiss Franc are relatively mentioned as safe bets.

The risk appetite envisages the investor’s risk tolerance. Can Nigerians afford to handle the volatility of currency movements? Would they be perturbed when they realize they bought at the top as the naira appreciates?

A quick glance at the Central Bank’s Data on the monthly exchange rates over the last few years will corroborate the dangers of buying USD every time, especially in the height of speculation frenzy.

It involves a willing buyer searching for a willing seller on a P2P platform. The USD(T) seller sets a price at arbitrary rates which can vary and deviate from market rates. There are cases of people charging N800 for a dollar on these platforms.

Furthermore, there are stories of people getting duped on peer-to-peer platforms. Naira sellers are vulnerable to fraudulent peers who might not fulfil their part of the bargain. Buying “stable coins” in an unstable market has its valuation risk and the risk of being defrauded poses a significant threat to personal earnings.

So, what’s the way out?

Certainly not saving cash. As billionaire investor Ray Dalio puts it, “Cash is Trash.” Cash offers no real return or yield and is negatively impacted by inflation. The investment objective of Nigerians is valid, however, the real hack is earning in foreign currencies. Different ways to do that are by offering services on Upwork, Fiver, etc, partnering with relatives and friends in diaspora on how to channel their investments back home, and lump-sum investing in dollar-denominated assets with commercial banks and investment banks.

Another option is investing in assets and equities that offer returns higher than the inflation rate. Last year, the Nigerian All-Share index in Africa’s largest economy recorded its best return, rising 45.7% in 2020, the most among 93 equity indexes tracked by Bloomberg. This made it the world’s best-performing stock market. Some experts have advised the CBN to make treasury bills attractive for investors with a lower risk appetite.

The dollar has taken a beating since last year. Looking at the Dollar index, it’s far away from its highs. So Nigerians are paying a premium for cheap dollars.

Conclusively, it is advisable that if one does not have a need for dollars, engaging in precautionary and speculative demand for dollars can be counterproductive if the opportunity cost is a loss in earnings as a result of volatility. The truth is no British citizen is monitoring exchange rates daily although you would argue the British economy is more stable. The obsession with the exchange rate is partly responsible for why people refer to Nigeria as a “dollarized economy.” Aggregate speculative demand for dollars leads to pressure on the FX market and inadvertently affects the exchange rate.

Source: Nairametics