Nigeria Fixed Income Weekly

The week that was (September 23-27): Rates down but concern over mounting fiscal and external imbalances

  • Fairly robust system liquidity keeps Naira yields in check: Money markets were fairly robust over the week with interbank rates holding steady at single digit levels over the week. The OBB and OVN rates closed at 8.43% and 9.29% respectively. Against this backdrop, a bullish pattern was observed across the NTB segment as yields contracted across mid-to-long dated maturities. On Thursday, CBN sold NGN351billion in OMO bills with the bulk of sales occurring at the 1yr tenor (N350bn). Stop rates declined modestly to 13.48% amid sizable demand (>NGN600billion). In my view, CBN’s position can be interpreted as trying to strike a balance between the need to keeping the interest rate level supportive for foreign investors to rollover Naira maturities on the one hand, and the desire to curb the growing interest expense costs of the OMO sales.

Figure 1: Naira yield curve


Source: FMDQ, NBS

  • LDR policy increasingly looks like a zero-cost pseudo liquidity tightening: In a surprise move, the CBN announced that in a bid to sustain the boost to credit growth (+5% to NGN16.3trn in September) observed following its imposition of its minimum LDR policy in July, it would now raise this metric to 65% with a December 2019 target. As to the outcome of its three-month LDR experiment, the CBN noted that 13 banks failed the exercise which triggered a NGN500billion debit of these banks. Interestingly, the CBN used a more expansive definition of LDR to include other sources of funding which resulted in all Tier I banks (with the exception of Access) failing to clear the 60% threshold. While the CBN might mask a pro-growth drive as the underpin for this policy move, in my opinion, this LDR is providing a convenient avenue for the CBN to embark on liquidity tightening at zero cost. With no real justification for embarking on a hike in the cash-reserve ratio which would have been the appropriate tool to deal with the sizable maturity profile in Q4 2019, the CBN is now resorting to backdoor liquidity tightening moves to deal with this headache. In the aftermath of the adverse squeeze on system liquidity following the debits, the CBN avoided undertaking an OMO auction.
  • DMO continues to rely on non-competitive bids to remain market neutral at bond auctions: Consistent with the pattern observed lately, the DMO has continued to remain market neutral at bond auctions: with a marked reliance on non-competitive bids to fill up its monthly borrowing quotas. At the September bond auction, where it offered NGN150billion, the DMO called up non-competitive bids of NGN46billion and thereafter elected to match only NGN100billion of the bids which turned up. However, as demand for FGN bonds has waned (with debt market focus now on the 1-yr OMO bill where effective yields are above 15%), the DMO had to pay a slightly higher average clearing rate for the September bond auction – 49% – 10bps higher than the August 2019 bond sale.  So, what are these non-competitive bids? Historically, these were bids by some government agencies, most notably the Nigerian Deposit Insurance Corporation (NDIC) but my suspicion is that increasingly some of these bids are from the CBN as it converts some of the debt unpaid financing to the FGN into bond instruments.
  • CBN data provides further evidence of the fiscal carnage: As I noted recently, Nigeria’s fiscal accounts are in much worse shape than feared. Specifically, the 2018 budget accounts showed an unfinanced deficit of NG1.9trillion (2017: NGN1.3trillion) which I noted was being plugged via borrowings from the CBN. Recent data releases by the CBN show that at the end of August 2019, CBN loans to the FGN hit a record NGN10.7trillion which translates to 2.7x fiscal revenues in 2018. Adjusting these loans for FGN deposits of NGN6.2trillion parked with the apex bank places the net CBN financing to the FGN at NGN4.4trillion which if annualized translates to 4.9% of GDP. Whichever way one looks at it, Nigeria is in the midst of an ongoing fiscal crisis and this would seem to account for increasing attraction of the previously pro-poor Buhari administration towards what is shaping up to be a revenue drive. Instructively in his Independence Day speech, President Buhari seemed to hint at it’s the adoption of tough policies in the coming year.

Figure 2: CBN financing to the FGN

CBN financing of FGN

Source: CBN

  • FX reserves maintain downward momentum: Nigeria’s FX reserves declined 4.1% over the month of September to USD41.8billion. Alongside fundamental headwinds from a CA deficit likely amplified by fresh downside in oil prices to sub $60/bbl levels, increased portfolio outflows from large maturities and maturing FX forwards is exerting downward pressure on FX reserves.

Figure 3: FX reserves


Source: CBN, Authors computation 2019 is September end

The week ahead (September 30-October 4): Are we at an inflection point in economic policy?

  • Looking ahead, it increasingly looks like Nigeria’s fiscal and monetary authorities are now longer looking to externalize their respective revenue and FX reserve problems via the debt markets, at least in the near term. On the fiscal front, the plan to raise VAT and re-introduce tolls on federal roads alongside some hints at potential privatization suggests the FGN is paying some attention to its debt headache. On the FX side, the deterioration in the current account is pushing the CBN towards adoption of demand management tactics as against pushing interest rates higher. While oil prices continue to weaken the current account, the increased dominance of negative interest rate policies across major central banks is providing some avenue for the CBN to manage the exchange rate.
  • However deep structural imbalances remain across both fronts where painful adjustments are required such as fixing the mispricing issue on fuel prices which will decisively address the growing under-recovery by the NNPC on fuel imports (projected to hit NGN1trillion in 2019). Here, a fuel price increment in the event of a convergence which unlocks fiscal revenue increases is likely to occur at some point. In addition, the nominal exchange rate has remained at NGN360/$ for three years, which suggests some movement over the next 6-12months could yet occur. In all, with the appointment of an economic advisory council suggests the political side is starting to come to grasp with the need for some policy adjustment lead by the fiscal side.

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