Nigeria Fixed Income Weekly

The week that was (July 19-30)

A lot has happened since my last update. First, the CBN discontinued sales to BDC operators which induced fresh weakness in the Naira at the parallel market though the exchange has pared back losses as banks commence FX sales for retail users. Post the July 2021 bond auction, interest rates have sung discordant tunes: declining trend on the front end while bonds have been weak due to an abundance of sellers. On the data front, money supply data suggests that CBN dialed back on its liquidity tightening in June while foreign capital inflows slumped over Q2 2021. I will look to catch-up in this post.  

Short term rates moderate as July 2021 bond maturities bolster system liquidity: Following the maturity of the July 2021 bond as well as coupons payments, banking system liquidity improved in July which resulted in a compression in money market rates to single digits 7.5-8% from 14% levels at the start of the month. For large institutions, the placement rate hovers between 10-12% levels down from the 14-16%. The robust liquidity position has seen banks become net depositors at the CBN discount window vs. net borrowers in the April-June period. In view of the as yet unclear outlook given currency issues and sizable borrowing needs, domestic investors continue to remain short which has pulled short term yields lower. 1-yr NTB yields have retraced lower under the weight of robust demand from money market funds striving to align with revised SEC requirements that mandate minimum exposure to FGN securities.   

FGN bonds remain offered post July 2021 auction: However, bonds remain weak as an abundance of sellers amid rate sensitive buyers continues to induce bearish trends. At the bond auction, where the DMO has NGN150billion on offer, demand was surprisingly weak with bid-cover at a six-month low of 1.9x (June 2.8x) despite a large injection of liquidity from the July 2021 maturities. As such the DMO sold only NGN138billion to the market at an average yield of 12.9% (June: 13.31%) while deploying NGN104billion of non-competitive bids on the 5-year. In terms of pricing, the DMO positioned the 2036 stop rate slightly above the weighted average bid at the auction while it kept the 2050s stop rate in line with the weighted average bid. Given the large NCBs the DMO could afford to place the stop rate well below the bids. In all, while the DMO tried to be neutral, it left enough hints that its appetite for borrowings remain. The July sale brings gross bond sales in 2021 to NGN1.65trillion (net sales: NGN1.1trillion). Post the bond sale, the long end of the FGN curve terminated the declining trend which began in June (when yields broadly declined 70bps) with 26bps uptick over July 2021.

Figure 1: Naira Yield Curve

Source: FMDQ

CBN changes the game for BDC operators, retains monetary policy parameters: At the July 2021 MPC, expectations were for the CBN to take solace in declining inflation and a robust growth outlook to leave interest rates unchanged. The CBN duly delivered and that was supposed to be the end of it. No sooner had he finished his announcement on interest rates, the CBN governor launched into a tirade about the unwholesome practices by BDC operators followed by an announcement that the CBN would no longer sell USD to the segment going forward. In lieu of BDC sales, the CBN would now disburse via commercial banks. In May, I had flagged that the CBN was selling dollars to BDC operators at NGN393-395/$ who were then selling those holdings at the parallel market rate (NGN480-500/$) vs. the regulated spread which would have put it at around the levels in the IE window (NGN410-411/$). Accordingly, the CBN action is the correct decision in my opinion as the continued sales made a mockery of any claims about credibility by the CBN.

Figure 2: CBN sale to BDC operators

Source: CBN

So, what happens? The last time the CBN ended dollar sales to BDC operators, the reasons were familiar: BDC’s illicit activities. However, in 2016, the move was more a cover for a reduction in USD supply across the larger FX market as the CBN was trying to conserve FX reserves following the plunge in oil prices. However, the current environment is different, oil prices have rallied thus far in 2021 to a USD70-75/bbl range which anchors the fundamental outlook for FX reserves over the rest of the year once the forward and swap outflows phase out. Over the last two days, outlook has been bolstered by the news of the potential IMF SDR allocation of USD3.3billion for Nigeria and the long-awaited plans to tap Eurobond markets armed with a USD6billion approval. Fundamentally, the CBN appears to be in a position of strength and with greater oversight over the banks can deploy more USD over the rest of 2021 at levels it prefers. While the CBN governor admitted the Naira is over-valued with CBN REER data placing the fair value at NGN463/$ it appears unlikely the apex bank will entertain fresh weakness over the near term. As such my view is the parallel market rate which appears over-valued now is due a correction. Where will it move towards? As economists one should not try to play God and I would not. That said, I would be willing to wager that the parallel market rate moves close to NGN420-430/$ levels.

Flat trends in monetary aggregates over H1 2021, CBN eases up on CRR debits in June:  CBN updated data on money supply till the end of June 2021. By its broadest measure M3, money supply is running at a flattish pace (-0.82%) over the first six months of 2021. Looking at the sub-components, M2 has expanded at 5.6% (annualized) while the other component of M3, CBN bills is down 65% from the end of 2020. The CBN move to term out its OMO bills remains the biggest drag on monetary supply aggregates in 2021. M2 growth is driven by an expansion in savings deposits (+9.3% annualized) which ties to a theme I spoke about earlier about investors electing to stay liquid. M0 or monetary base remains in contraction mode (-11% annualized) reflecting the CRR debits deployed by the CBN to manage liquidity build-up in the banking system. Curiously CBN eased up on CRR debits in June with the aggregate sum down to NGN9.6billion in June from the NGN10trillion average in the first five months of 2021. Structurally, M3 weakness reflects contraction in net foreign assets (-1.75% annualized) amid softer growth in net domestic assets on account of lower loans to government.

Capital flows moderated in Q2 2021, FX reserves maintain uptrend: Despite higher oil prices and improving global growth as economies re-open, capital flows into Nigeria moderated in Q2 2021 to USD876million (down 32% y/y and 54% q/q). Though portfolio flows recovered (+43% y/y to USD551million) due to a higher money market flows, a 71% y/y drop in loans to USD210million and continued weakness in FDI inflows (-47% y/y to USD77million) continued to weigh on overall capital flows. Over H1 2021, capital flows are down 61% to USD2.8billion from 2020 levels. Elsewhere, Nigeria’s FX reserves maintained an upward trajectory, posting the first month of growth in July (+0.2% m/m to USD33.2billion) after two months of contraction. The declining trend likely reflects outflows from maturing forwards/swaps as well as to a lesser extent higher interventions by the CBN over Q2. With these events now behind us, the steady improvement suggests gains from higher oil prices are starting to feed through to external reserves. Should this trend remain intact the SDR announcements by the IMF as well as potential Eurobond sales of USD3-6billion speaks to an upbeat outlook for external reserves. Nigeria could end up with FX reserves over USD40billion by the end of Q3 2021 holding all things constant.

The week ahead (August 2-6)

System maturities are tight in the week ahead with only minute OMO bill maturities (NGN5billion). Elsewhere, the FEC gave executive approval for the DMO to sell up to USD6billion worth of Eurobonds following National Assembly approval.

August Outlook: Market focus is likely to be dominated by sentiments around the incoming SDR proceeds and Eurobond sale which alongside a declining inflation outlook should suggest a more accommodative CBN posture towards interest rates. Despite a clear pathway towards a Eurobond sale after much delay, it is important to note the Eurobond sale is only a portion of the deficit financing requirements in the 2021 budget. The 2021 budget calls for a fiscal deficit in the region of NGN5.2trillion to be financed via NGN2.3trillion in domestic and foreign borrowings each. The Eurobond sorts out the foreign leg while some NGN600-700billion is left on the domestic side excluding the recently signed supplementary budget which calls for NGN802billion debt financing. Thus, domestic supply prospect still appears robust though admittedly, the DMO could afford to adopt a market neutral stance as in July at the August bond sale. That said on the demand side, pension funds are likely to remain disinterested in yields at present levels given decent interbank rates of short-term duration. Pension funds have become more sensitive to entry levels for bonds given regulatory requirements which effectively curtail selling out of HTM buckets. My sense is bond yields remain range bound around 13-13.5% levels for the long end (>10years).  

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