The week that was: (March 2-6): Interest rates climb in response to softer oil prices
Bond yields sell-off in response to weaker oil price: System liquidity improved slightly after the CRR rebates of NGN200billion after the NGN700billion debits in the prior week. This helped push OBB/OVN rates lower to 11.7/12.9%. However, the NGN yield curve closed higher driven by a sell-off on the long end where bond yields expanded by 107bps.
Figure 1: Naira Yield Curve
Source: FMDQ, NBS
NGN remains under pressure: Nigeria’s FX reserves declined 0.2% w/w to USD36.2billion (5months of import cover). YTD, FX reserves are down about 6%. CBN maintained its interventions across the market. The Naira remained under pressure for most of the week (down 0.3% w/w to NGN366.25/$) at the I&E window including bouts of NGN367/$.
A more frightful global environment: On Tuesday, in an emergency move, the US Federal Reserve announced a cut in its key Fed Funds rates by 50bps; the first out-of-cycle rate cut since the 2008 financial crisis. The FOMC stated that the move was in response to concern over fallout from the coronavirus outbreak which poses a downside risk to global economic outlook. Then on Friday, the Organization of Petroleum Exporting Countries (OPEC) and its Russian led allies (OPEC+) failed to reach an agreement over plans for a new 1.5mbpd cut in oil production. The development resulted in a steep drop in Brent crude prices to a four-year low of USD45.27/bbl (YTD: -31%) which look set to go below USD40/bbl on Monday.
Given the breakdown in the OPEC+ alliance that has essentially helped rebalance crude oil markets since 2017, oil prices are likely to remain around present levels as the potential glut is likely north of 4mbpd (relative to less than 2mbpd that choked markets in 2014-16). Consequently, oil prices are likely to come under pressure from oil market shorts which will see prices reset to a USD30-40/bbl range over the next 6months. This means more pain for Nigeria over the rest of 2020 and will require radical policy adjustments to cope with the new environment.
The Week ahead (March 9-13): Oil price collapse to drive risk-off conditions
In the week ahead, system maturities are at NGN232billion made up of OMO bill maturities. Markets are likely to turn bearish instantly but as we have seen bid-offer spreads have widened as traders are trying to limit duration losses from knee-jerk sellers. OMO markets have witnessed an aggressive sell-off as offshore investors looked to exit Nigeria.
Nigeria’s external imbalances look set to widen, doubts over NGN valuation: In the event of no policy response either the form of devaluation (less likely) or via the imposition of demand management measures, Nigeria’s current account deficit is likely to blow past the USD20billion region over 2020 assuming the growth in services is unrestrained. Alongside the weak external picture, we are likely to see a pick-up in FPI outflows over the near term. It is important to note that FPI flows (not oil inflows) were the big driver of FX reserves inflows over 2019 and thus far in 2020, offshore investors have yet to respond positively to the elongation of hedging options to 5-years. This combination suggests that unless the CBN reinstates dollar restriction measures used in the 2014-16 FX crisis, Nigeria’s FX reserves are likely to move below USD30billion before June 2020 with serious impact on USD liquidity. The CBN governor would never have guessed that sub USD40/bbl is feasible well its here. Now we wait for USD30billion target.
Figure 2: Nigeria – Current Account (% of GDP)
Source: CBN, Authors computation
Bigger fiscal imbalances and more expensive Eurobond financing costs could lead to higher local borrowing: After a large deficit in 2019 (largely financed by the CBN), Nigeria’s fiscal imbalances should track higher in the absence of downward revisions to the budget. However, as the increases in the 2020 spending plan stemmed from recurrent increases, the finance ministry will likely resort to a combination of capex reductions and or increased borrowings to deal with the shortfall. Under a low oil price environment and concerns are likely to have heightened over EM debt following the Lebanon default, Nigeria might have to increase rates for the proposed Eurobond issuance to 9-10%. This erodes the cost-benefit of FX borrowings relative to NGN debt and lead to greater leaning on the local side of things. Furthermore, given its weak FX reserve and balance sheet position, the CBN might need to dial back on fiscal deficit monetization.