Oil’s $30 price plunge this week has sharply increased strains on a number of pegged currencies in energy-exporting emerging markets, above all in Nigeria and Oman where currencies have come under pressure in forward markets.
The coronavirus threat to an already fragile global economy and an oil price war between Saudi Arabia and Russia have proved a toxic combination for developing countries, most of all for crude exporters which suddenly found giant holes blown in their budget plans.
Simon Quijano-Evans, chief economist at Gemcorp Capital said markets were “looking through a glass floor”.
“Against that backdrop, oil exporting sovereigns with a fixed peg to the U.S. dollar have quickly moved into the limelight again, with countries like Oman and Nigeria at the top of the focus list.”
Currency pegs – which fix the value of one currency relative to another and use central bank reserves to enforce that relationship – have become rarer in recent years. Instead policymakers allow economic adjustments to be channeled through exchange rates, enabling them to preserve hard currency.
A number of countries such as Egypt, Angola, Uzbekistan and Venezuela have all recently loosened their grip on currencies.
For those who prefer to cling to the pegs, it is critical to have strong-enough firepower to defend currency peg levels. But Nigeria – which relies on crude sales for 90% of its foreign exchange earnings – saw FX reserves slip by more than $1.6 billion to $36.38 billion, data in February showed.
Africa’s biggest oil exporter operates a multiple exchange rate regime. The official rate NGN= of 306.90 is supported by the central bank.
(Graphic: Nigeria’s External Reserves – here)
Non-residents held around $8 billion of Nigerian debt, JPMorgan estimates. If some of these investors pull out in the weeks to come, reserve levels could slump down to levels last seen in 2014, when the last oil shock forced the central bank to impose FX restrictions and tweak the exchange rate, JPM said.
“We expect at least a 10% exchange rate devaluation at the investors’ and exporters’ foreign exchange (IEFX) window by end 2Q20,” said JPMorgan’s Ayomide Mejabi, referring to the exchange rate window most commonly used by foreign investors which sees the naira just below 370 to the dollar.
The central bank said on Thursday market fundamentals did not support a devaluation of the naira currently. But markets tell a different tale – in a sign of rising pressure, Nigerian non-deliverable currency forwards raced higher this week with the one-year contract NGN1YNDFOR= showing a dollar-naira rate of 448 to the dollar.
The one-year NDF stood at 388 in mid-January.
Many oil exporters in the Gulf who have long shackled their currencies to the dollar have seen spikes in forward currency markets this week in the wake of the oil price plunge.
But not all Gulf pegs are alike and the petro-peg that’s feeling the heat most is Oman, which has maintained a peg of 0.3849 rial to the U.S. dollar since 1986 but lacks the deep pockets and abundant FX reserves the likes of Saudi Arabia or Kuwait can boast.
On Thursday, ratings agency Fitch cut Oman’s rating to BB from BB+, pushing it deeper into junk and keeping its outlook “negative”.
Fitch predicted Oman – which needed Brent future to trade above $80 a barrel in 2019 just to break even – would face further fiscal and external balance sheet erosion.
Weaker oil prices would accelerate the fall in its gross foreign currency reserves, already down 4% in 2019, Fitch said, noting that at $16.6 billion, Oman had enough reserves to cover four months of current external payments, below the median for ‘BB’ rated sovereigns.
Hasnain Malik, head of equity research at Tellimer, noted that flexible oil exporter currencies such as the Russian rouble, Kazakh tenge and Colombia peso had depreciated in response to the oil shock. That in turn makes their exports more competitive.
“Currency pegs in countries with relatively low foreign reserves and sovereign wealth funds, particularly Nigeria and, over a longer period, Oman, are without doubt vulnerable,” Malik added.