A lot of problems Africa’s technology is set up to solve are structural problems that have their root in bad policies and failed governance. Take Nigeria for example. In the last 8 years, the government has banned, increased import duties or denied foreign exchange for the import of a number of items including staple food products like rice, maize and poultry. Full list here.
The idea was that, by banning items, the country could save valuable forex and spur local supply to meet demand.
But the opposite happened. Local supply failed to come near anywhere close to matching demand, and as a result demand for imported food went up. The result of this (plus poor monetary policy) was a significant gap between official exchange rates and what was more freely obtainable in the parallel market. By the end of 2022, spreads between the official exchange rate of the naira and the dollar were as high as 61%.
Naira-USD spreads have narrowed dramatically following FX policy reforms and the removal of Nigeria’s unorthodox central bank governor, Godwin Emefiele. | Chart: Ayomide Agbaje — TechCabal Insights.
That is more than 50% of pure profit if you could somehow get $ at official rates and resell in the parallel market. Nigeria has a fairly large number of people who need $ for everyday things like purchasing items on Amazon, paying for subscriptions or running a business with dependencies on international vendors/products. But banks no longer allowed international payments from Naira cards to go through, so importers of food and users of digital services had to source for $ from anywhere they could.
As I said, a lot of problems being solved in Africa are structural problems with roots deeply resident in government policy. In the last three years, cross-border payment products have really been dollar-local currency arbitrage products. They solved an important problem and benefited from netting a smaller percentage of the arbitrage opportunity from meeting that need. And Nigeria made up the bulk or at least a significant propoertion of that market.
Before moving forward, let us establish one truth, or something as near the truth as possible.
All currency problems are policy and government problems. Therefore all cross-border payment problems are government problems.
The degree to which they are business-solvable problems is tied to the attention and approach of the government. If you are in many African countries and run a business that is too exposed to swings in government policy, you are either close to the managers of government problems, or very brave.
In my opinion, we had a lot of very brave businesses. In any case, governments change and there is not too much you can do to hedge against changing government policies if your business depends on bad policies to thrive. In this case, when things get better, your business suffers from it.
A few weeks after Nigeria switched from its tenuous fixed exchange rate policy to a managed rate, Bloomberg and other media reported the upward surge in the country’s stock exchange. Last week, Bloomberg reporter, Emele Onu, clarified that a lot of that upward momentum came from bank stocks. An index of bank shares gained 23% last month, the most since 2018. Clearly, the banks were “balling”.
To rub it in, last week, banks in Nigeria have launched a slew of products targeting remittances.
Access Bank, Nigeria’s largest bank by assets (2022), launched a product with remittance fintech, Remitly to capture remittance inflow. ALAT, the digital banking arm of Wema Bank will now allow naira cardholders to spend up to $500 without needing a dollar bank account. It was $0 previously. Guaranty Trust Bank has done the same, and United Bank for Africa (UBA) will allow customers will FX accounts to borrow in naira against the FX in their dollar or British pound accounts.
It has been an onslaught of products capitalising on the FX policy reform and threatening the market of cross-border/dollar virtual card fintechs. It exposed the vulnerability of building a currency-policy-dependent payment product in Africa that is only designed to capture arbitrage opportunities. But not use the short term painkiller as a foothold to explore deeper user engagement models beyond the occasional need for a USD virtual payment option.
And it showed that the banks are learning how to quickly turn on a dime (at least in launching new products that also capitalize on policy swings). Banks are better positioned to do these types of product launches, because they have deposits, serious cashflow, legacy positioning and their stock (thus available capital) is up!
But banks cannot celebrate yet…
They still carry a corporate and non-digital-first baggage with them.
UBA will only give the FX-backed loan I mentioned earlier, if you walk into the bank and fill a form. And GT Bank’s new app launch was disastrous as it locked customers away from making any transactions for hours, until the problem was resolved.
Interestingly these remittance products have been launched just as remittance inflow is tightening. Nigerians at home received $952 million in the first half of 2023 and will need $1.2 billion in remittances in the next half to only match what came in last year. Declining inflow from remittances is not exactly good news for the new remittance products everyone seems to be launching.
In addition, for banks, the new FX reforms have failed to drive a surge in investment from foreign inflow. Remember that 23% gain in bank stocks I mentioned earlier? Here’s where the surge came from according to Bloomberg:
So far, the stock-market gains have been largely been driven by local investors looking to protect their savings against searing inflation. Bank of America Corp. economists said the country will have to increase interest rates by at least 700 basis points before the end of the year to curb inflation that’s poised to accelerate to 30%.
In the longer run, there’s speculation that the reforms may eventually draw more international investors.
“People are positioning in banks ahead of the expected return of foreign portfolio investors, who will want to key in for the benefits,” said Segun Adams, an equity analyst at Lagos-based Afrivest West Africa Ltd.
Local investors, including Nigeria’s ‘big men’ are buying up local shares, but foreign investors are still staying away. Chart by Bloomberg.
Reread this part, “In the longer run, there’s speculation that the reforms may eventually draw more international investors.” But will it?
Nigeria’s bond market (and the government’s unwillingness to increase how much they’re willing to pay for medium-to-long-term bonds), give us a hint. Remember, when foreign investors buy naira bonds, they do so with foreign currency, which they have to change to naira. But so far, they’re staying away. One reason why is that, $1 today will buy fewer naira bonds than before if you sum it all up (including inflation). Here’s Premium Times, a Nigerian newspaper from last month.
At 22.4 per cent, price levels in Africa’s biggest economy increased to their highest levels in nearly two decades last month, outrunning the rates at which such securities are priced so much that returns on them will have been much eroded by the time they fall due.
That has made their real yields negative, and foreign investors want notes to be priced higher to make up for inflation’s adverse impact.
Bloomberg cited a London-based institutional investor on Thursday as saying only rates in the 15-20 per cent band could tempt it to plough money into naira-denominated securities. An analyst at another told the news outlet that treasury bills’ yields need to really reflect the monetary policy rate to encourage foreigners to invest in the local debt market.
So remittance inflow is slowing down. The dollar-to-naira rate is now more than 45% higher than it was two months ago, meaning that in summary, foreign investors need to pay more in $-terms today (relative to the interest they hope to earn by bond maturity dates) to lend Nigeria money than they would have paid two months ago. But inflation is not slowing down meaning any profits from buying naira bonds will evaporate. The result of this is that foreign investors are still staying away because the FX reform is not enough temptation to come back and lend money to Nigeria. What’s more? There are other options. Egypt, Kenya or even the US.
What does this all mean? And why is it relevant to the world of tech, specifically to fintech?
Simple. The longer foreign investment stays away, the harder it will be to justify the FX reforms. Especially if the government has a low threshold for the public pain the reforms and petroleum subsidy removal is causing. If this pain threshold is breached, we may see a small (or large?) reversal of the FX reforms. That is to say, the central bank might step in again and the parallel market spread may begin to rebuild itself.
We have already seen the central bank blinking in the past week. Here’s Bloomberg again emphasis mine:
Traders also said a parallel market in the currency that had vanished after the devaluation has resurfaced.
The interventions are fueling a debate on whether incoming President Bola Tinubu’s pledge to move toward a flexible interest rate meant a free float or just a one-off devaluation followed by a weaker peg. Given the inflation risks of a freer trading currency, traders are seeking further clarification from the central bank on the role of markets in setting naira’s value. Meanwhile, the demand for dollars remains strong, which may have influenced authorities’ decision to boost liquidity.
For cross-border/USD virtual card fintechs, this is a small sign of good news. It means they may not be completely dead yet. For the new bank products built on the new FX policies, it means some anxiety. For everyone else, it is a live case study of building in-fluctuating-demand solutions under broader economic uncertainty.
Nigerians are probably at the maximum pain they can take. In my opinion, FX reforms did little to add to inflation because a lot of things were already priced at parallel FX rates. But the subsidy removal is a particularly strong pain giver. And so far, it has been the Nigerian consumer bearing the brunt of the new policies. There is a lot the government can do to itself to help staunch the bleeding of Nigerian consumer pockets by inflation. Borrowing $800 million to line the pockets of legislators and share the leftovers to a few million Nigerian households is not one.
Predicting government policy when you are not sitting in government circles is difficult, but if anything is certain, it is that building a consumer payment currency product that is solely dependent on how the government is feeling about its FX policy is not the best place in the world.
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Senior Reporter, Business and Insights