We visited Nigeria for the first time since the currency was devalued in June 2016, when the naira moved from N199 to N280 to the US dollar. While the official exchange rate has since drifted up to around N315, at the airport we changed money at N410. So, clearly the foreign exchange market in Nigeria is not yet trading freely. After being unable to repatriate money from Nigeria since late 2015, we had hoped the devaluation would lead to business getting back to normal.

It came as no surprise that all our company meetings centred around the naira: where it is going, how much the company was previously being allocated, how much the company needs, and did they manage to source at the official rate or have they turned to the parallel market? The exchange rate is clearly a very sensitive issue and President Buhari seems to see it as a measure of his success as the leader of the country.

Responding to forex scarcity

In order to try and reduce corruption in the foreign exchange markets, Buhari has instructed the banks to publish all foreign exchange trades in the daily newspapers. Having said this, the foreign exchange market has created a new “get-rich-quick” scheme for the connected (replacing the oil import subsidy game!). Banks in Nigeria each gets allocated a small amount of US dollars to sell to its customers. While many are sharing their US dollar allocation fairly, we were told that some banks are allocating to friends and family. Apparently, friends buy these US dollars at N315 and then go and sell in the black market in excess of N400. Of course, this means getting rich in naira rather than US dollars. Chatting to people in Nigeria, they say that money is being “washed” through real estate investment. This may partly explain why, despite the economy going backwards, Dangote Cement volumes were up 38% in the six months to the end of June! (To be fair, I imagine that cement volumes were mostly up in response to the reduced prices.)

In order to eventually get a freely traded foreign exchange market, Nigeria needs to get somewhere near a balance between supply and demand for the naira. In the past, the higher oil prices meant that the oil exports balanced the demand for US dollars needed for imports and for taking money out the country. While some countries push up interest rates to try and attract inflows, Nigeria is trying a less conventional approach. The government has established something called FMDQ. For every US dollar brought into the country at the official rate of N315, FMDQ will award you with a free in-the-money foreign exchange option. The value of the option depends on the tenor you select. What it effectively means is that investors bringing in foreign exchange can get somewhere closer to parallel exchange rates in excess of N400.

Dollar shortage chokes industry

The shortage of US dollars is not only affecting investors, but more importantly, the listed companies. A couple of months back, many companies were still sourcing part of their foreign exchange needs through the official market. By September, even companies like Nestlé were having to source foreign exchange almost exclusively through the parallel market – at the higher rate. Given that most of the listed manufacturers require imports, we expect a sharp rise in costs. The manufacturers are finding it hard to pass on the rising costs, so margins are likely to come under pressure. The banks have actually benefited from the weak currency, as around 30% of loans and deposits are in US dollars. Many of these loans are to the oil and gas industry.

Our funds are underweight to Nigeria. Economic conditions remain tough − in fact, GDP growth is forecast to decline in 2016. While the banks are looking attractively priced (as they often are), the consumer stocks do not appear to be reflecting the difficult trading conditions. Before considering increasing exposure to Nigeria, we will need to see the currency market freeing up. If you cannot get money out, then you need to be very careful about putting it in.

MSCI was considering dropping Nigeria from its indices because of the foreign exchange controls, but has just announced that it will maintain it for now. Nigeria has, however, been added to the review list for June 2017. On a positive note, the hotel rates have fallen from around US$500 a night when we first travelled to Lagos, to $150 a night now. The weak economy also means that there is much less traffic and getting through passport control took about an hour as opposed to the usual four hours. Maybe I am getting stupid as I grow older, but for the first time I actually went for a run on the streets! I say “streets” because sidewalks are not big in Nigeria.

Cavan Osborne manages the Old Mutual African Frontiers Fund, and is the lead manager of the Old Mutual Pan African Fund. This piece was first published by Old Mutual.