Nigeria Fixed Income Weekly

Greetings after a long hiatus. Apologies for the radio silence, I had to deal with some issues. Back to our regular weekly programming.

Catching up!

CBN clarifies position on the 1-yr: Coming into September, sentiment across domestic fixed income markets was how the CBN was going to deal with the liquidity deluge from large OMO bill maturities over the next 6-months. Specifically, markets were confused by the CBN’s dovish tones over July when the apex bank cut-back on OMO bill sales and trimmed clearing rates at these auctions to effective yield levels of around 12%. The CBN also reinforced this dovish posture with the issuance of a circular which imposed a minimum 60% loan-deposit ratio requirement for Nigerian banks as part of initiatives aimed at boosting lending activity. However, following the slump in oil prices over August to sub $60/bbl levels, the CBN had to re-think this dovish view in the aftermath of a foreign-led sell-off in the front end of the Naira yield curve which reignited pressures on the USDNGN and on FX reserves. Specifically, after allowing the effective yield on 1-yr T-bill fall to 11% levels, the CBN hiked rates at its OMO window to effective yields of 15.5% in Late August, a level it has maintained ever since. Indeed, the CBN governor would go on to reiterate that while it sought to support economic growth it would not let its eye off currency stability.

Figure 1: Naira yield curve

NGN curve 15.9.2019
Source: FMDQ, NBS

But bond yields remain flattish, as DMO maintains a market neutral stance: At the long end of the Naira yield curve, interest rates have remained largely flat after a mini-upward retracement. In effect, the yield curve inversion has returned as longer dated papers continue to trade at between 14-14.6%. This largely reflects lack of any stimulus in the form of desperation by the DMO at monthly bond auctions. Relying on a large swathe of non-competitive bids, the DMO has avoided giving any indications of a weaker fiscal position even though data over the H1 2019 shows that the FGN ran a fiscal deficit of NGN1.3trillion (2% of H1 2019 GDP). My thinking is that the absence of any clear direction from the finance minister, as Buhari only cleared his cabinet in August, created a do-nothing significant impetus. With the first FEC meeting in September, we are likely to see a different approach by the DMO at future auctions especially as the FGN commences execution of capital expenditure which did not occur over H1 2019. Given the return to quantitative easing measures across global central banks, one cannot rule out the temptation of a strong return by Nigeria to Eurobond markets even though the DMO has always insisted that any foreign loans would be largely concessionary vs commercial.

Figure 2: Average monthly primary and secondary bond yields

Primary and Secondary Bond yields

Source: DMO, FMDQ

2018 budget accounts reveal a broken fiscal balance sheet: The Budget office released the 2018 budget implementation report which showed that FG revenues rose 45% to NGN3.8trillion (3% of GDP) largely driven by higher oil receipts (+67%), while non-oil climbed 21% to NGN1.5trillion. On the expense side, the Nigerian government spent NGN7.5trillion (87% of the NGN8.6trillion budget) which translates to 5.9% of GDP. In all the fiscal imbalance printed (well wide of the budgeted NGN1.9trillion) at NGN3.6trillion (2017: NGN3.8trillion) or 2.9% of GDP just below the fiscal deficit rule of 3% of GDP. But more importantly as in 2017, the FGN was only able to finance a portion of the deficit with new borrowings of NGN1.7trillion leaving another NGN1.9trillion (2017: NGN1.3trillion) as unfinanced. For two years running Nigeria has racked up unfinanced fiscal losses which are likely to have been plugged by financing from the CBN.

Figure 3: Nigeria – Fiscal Accounts (% of GDP)
2018 fiscal accounts
Source: Budget Office, NBS

FG hikes VAT to 7.2% scratch that 7.5%: In testament to the sizable deterioration in Nigeria’s fiscal accounts, the Federal Executive Council, Nigeria’s cabinet, arose after its first meeting of President Muhammadu Buhari’s second term to announce a hike in VAT to 7.5%. Though actual gross VAT collections have expanded 9% on average between 2010 and 2018, as a share of the economy, the aggregate amount remains around 1% of GDP. While the measure will provide a temporary boost in revenues (especially at state level), more work is needed on coverage as clearly a large segment of the economy remains informal and away from the VAT net. Beyond fiscal balances, the projected rise combines with plans to hike electricity tariffs in July 2020 which suggests a build-up in inflationary pressures over 2020.

Figure 4: Annual Gross VAT collection

Source: Budget Office

The week ahead (September 16-20): Upside in oil plus lower inflation

In the week ahead, system maturities for the week are at NGN536billion split between OMO and NTB in the ratio 66:34. There will be an NTB auction on Wednesday where the CBN, on behalf of the FGN, would look to refinance NGN180billion split as follows: 3M (NGN3billion), 6M (NGN8.3billion) and 1YR (NGN168billion).

Attack on Saudi oil facilities presents upside to oil price outlook: Over the weekend, the world woke up to news that Saudi Arabia’s oil production facilities were hit by drone attacks claimed by Iranian backed Houthi-rebels from Yemen. Saudi Arabia would late affirm that this had resulted in the loss of around 5mbpd production capacity (nearly half of its production capacity). To put this in context, global oil markets have been dovish recently as markets priced in prospects of a bulging glut with estimates between 0.5m-1mbpd. The drop in Saudi output implies that global crude markets will swing to a steep deficit of 4-4.5mbpd which provides strong upside to oil prices over the near term. Though the Saudis have said they would draw down on huge stockpiles, markets are unlikely to take note at least over the near term. We are likely to see oil prices move higher towards USD80/bbl which is positive for oil exporting countries like Nigeria. That said, Nigeria’s subsidy regime implies we are unlikely to see sizable gains unless fuel prices are adjusted upwards.

Headline Inflation to slip below 11% in August: The National Bureau of Statistics (NBS) looks set to release inflation numbers for August 2019. At the start of early green season harvests, I’m looking for the headline reading to slide below 11% to 10.98% driven by a lower monthly inflation print of 0.95% (July 1.01%).

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