On 15th March 2017, Solarplaza organized the webinar “Currency Risk and Convertibility Issues for Nigerian Solar/RE Projects”. Jos Kramer & Per van Swaay from TCX, Luz Leyva from MFX, Subha Nagarajan from OPIC, and Denesh Srishanker from GuarantCo joined the webinar as speakers and discussed the macroeconomic and monetary situation in Nigeria. The entire video recording of the webinar and the speakers’ slides can be freely accessed here.

  • The Nigerian economy, overwhelmingly reliant on crude oil exports, has been struggling as of late due to the low price of oil;

  • The Naira, Nigeria’s currency, has been under immense pressure due to the central bank’s inability to prop it up as their foreign currency reserves decline;

  • Currency risk and convertibility risk continue to plague foreign investors and present a daunting challenge to developing solar in Nigeria.

The backbone of the Nigerian economy is oil, which accounts for a stunning >70% of budget revenues and >90% of exports. Ever since 2014, however, when the price of oil began its momentous decline, the Nigerian economy has struggled to maintain itself.

The price of oil has still not recovered to its former heights, and until it does it is unlikely that Nigeria will fare any better. A further complication is the recent decline in Nigeria’s oil production. There has been an increase in militant attacks on oil infrastructure as of late, which has put additional strain on Nigeria’s already bleak budget.

Unsurprisingly, the Nigerian economy has been in recession since 2016. This is reflected in the value of Nigeria’s currency, the Naira. The government was able to prop up its currency at 200 Naira per USD up until July 2016, but eventually dwindling foreign currency reserves forced the central bank to float the currency.

At present, the value of the Naira has declined by over 50% and is currently sitting at a stable (thanks to further central bank intervention) 306 Naira per USD. The severe shortage of USD has led to the rise of currency black markets, which tap into the unmet demand at rates as high as 460 Naira per USD. It is generally accepted that the official rate will trend towards the black market rate when the Nigerian central bank stops its intervention.

Tight capital controls have been established on the import of 41 different categories of goods. The resulting delays in investment and high inflation constitute an unpredictable environment for foreign investors, both in the forms of currency risk and convertibility risk.

Hedging these risks is on the mind of every foreign investor in Nigeria. In the on-grid solar sector, USD denominated power purchase agreements (PPAs) are the most used model; they shift the currency risk to the utility, which must then negotiate with hedge providers to minimize risk.

The off-grid sector is the polar opposite. Mini-grids and solar home system providers sell directly to the consumer and thus must accept payment in local currency. This exposes the providers to direct currency risk, and the decision whether or not to hedge it is very important.

A frequent postulation by novice financiers is the idea that hedging local currency is expensive and that you should borrow unhedged USD instead. TCX, a hedging provider, proves that such claims are almost always false.

In the past, the equivalent 3-year rate provided by TCX has shown to be much lower than the total currency depreciation over the same period. In the case of the Naira, TCX’s ‘rate’ was only 10% compared to the expensive 30% depreciation suffered by the currency.

Click image to enlarge

Click image to enlarge

Hedging does indeed maintain the illusion of being expensive, especially since the hedge provider charges a premium for his services (in TCX’s case, the premium is usually 1%). The unhedged option’s true cost is concealed and thus often underestimated. Annual depreciation and the exposure to daily volatility, however, can wreck havoc on even the most planned-out and well-funded ventures.

Learn more about the macroeconomic and monetary situation in Nigeria and other important topics at the Solar Future Nigeria (25-26 April 2017, Lagos), the region’s leading solar event.