The week that was (January 4-7)
Happy new year! Welcome to another year and I wish you and yours a great year with abundance and good health.
Looming liquidity deluge induces bullish open to the year: Debt markets opened 2022 on a bullish note with the S&P Nigeria bond index up 0.21% w/w. Market sentiment was dominated by the likely gravitational impact on interest rates of a sizable liquidity profile in January from the maturing Jan 2022 FGN bond (NGN606billion) and coupons (NGN218billion). Given the already robust system liquidity in the tail end of 2021, money market yields gradually declined towards 2-3% for most of the week before CRR debits on Friday stirred things up a bit. That said, the impact of the large system liquidity overhang is that bank placement rates for large institutions have declined from 12-13% in December towards 10-11% which is working to re-ignite non-bank institutional demand for bonds given the differential over placements. Over January, potential aggregate inflows of NGN1.3trillion dominated by FGN maturities will likely weigh on investor sentiment.
Figure 1: Naira Yield Curve
Tax and higher regulatory costs to drive wider spreads: 2022 also marks the start of the new regulatory fee regime by the Securities and Exchange Commission (SEC) on secondary market trading of bonds. As I noted in my year-end review, the Nigerian SEC is ramping up on fee arrangements across domestic capital markets to ward off an existential threat after it attracted legislative attention for running an unsustainable cost-income structure. In turning its attention to bond trading, the SEC introduced a 0.025% of the value of bond trades and interestingly announced that Exchanges (like FMDQ) can charge a fee not more than 0.025% of the value of bond trades. This potentially implies total regulatory charges of 0.05% of the total value of bond trades, assuming FMDQ goes at the ceiling (which it apparently has communicated to dealing members) alongside the usual charges which were historically negligible (0.0007%).
In addition, under the new Finance Act 2021 there is a slate of changes to the tax on fixed income securities. Specifically, corporate investors (ex-tax exempt pension funds) in non-FG debt instruments (corporate and state government bonds) are now liable to income tax on investment income from these instruments. While the Finance Act retains VAT exemptions on disposal of corporate bonds, all fees and commissions on bond transactions (including FGN securities) will now be VAT-able. I will like to put a disclaimer that these are my views which may be wrong (and not tax advice) and investors will need to reach out to their tax consultants for more clarity.
Overall, in my view, there are three possible outcomes from the increased transaction costs on bond trading: 1) the thresholds for bond trading by non-bank investors (who are not dealers) is now higher and we can say goodbye to the era of small trading gains of 5-10bps which will likely lead to wider spreads going forward. 2) Given the large fiscal deficit and associated large bond issuance, more activity will likely move to primary market auctions at the expense of secondary market trading in a bid to reduce the now non-negligible transaction costs. 3) Nigerian corporates are now faced with increased costs for bond issuance as investors will now price these issues to ensure that the tax-equivalent yield is a fair one.
CBN continues its FX pretense, reverses end-of-year devaluation: After a depreciation in the Naira over the last two-days of 2021 to NGN435/$, the currency swiftly appreciated to NGN416/$ at the IEW. This is a stunning replay of 2020 when the Naira fell to NGN410/$ before reversals in early 2021. Essentially, the move likely appears to be an end-of-year effort by the CBN to massage fiscal accounts via FX translation gains given the record budget deficit over 2021. More on this later. However, this attempt delivers one-off valuation gains to Nigerian banks who are positioned to be net-long USD on their balance sheet while helping to maintain a veneer of relative Naira stability. It is an ostrich-head-in-sand approach to exchange rate management designed to help the CBN maintain the semblance of respectability on the Naira, while leaving everyone else confused. In all of this, the CBN has continued to conduct interventions at NGN430/$ (with offshore sales at USD440-445/$) while the parallel market is quoted by some Nigerian newspapers remains around NGN570-575/$. This looks like a return to the 2015-17 era. What is that quote again: The more things change the more they stay the same!
External reserves continued to decline, down 0.1% w/w to USD40.5billion and I expect this trend to continue over the near term as the subsidy bill trims pass-through from higher oil prices and there are no major inorganic transactions like SDR injections or Eurobond sales. In 2022, Nigeria has USD debt repayment obligations of USD342million split across the USD300m Diaspora Eurobond (June) and USD42million in Promissory maturities (September).
Nigeria’s external account swung positive in Q3 2021: Data from the CBN data shows that Nigeria’s external balances moved back into healthy territory in Q3 2021 with a current account surplus of USD1.8billion (or 0.6 percent of GDP) vs. a record deficit of USD16.4billion (4.6 percent of GDP) posted over 2020. The improvement reflected: a recovery in oil exports (+20% to USD33billion) largely thanks to the rebound in oil prices (+55%), FX linked non-oil import demand suppression (-21% to USD26billion) and a recovery in official and worker remittances (+20% to USD18billion). The financial account was weaker (-10% to USD7.6billion) reflecting higher financial liabilities given large foreign portfolio inflows to debt securities, some some swap activity, the USD3.3billion SDR allocation by the IMF and higher reserve outflows.
Figure 2: Nigeria Current Account Balance
Revenue misses and higher debt costs underpin a record fiscal deficit in 2021: The Finance Ministry provided details of Nigeria’s fiscal accounts over the Jan-Nov 2021 period at its budget presentation last week. Details showed that the FGN ran a record budget deficit of NGN7.1trillion (relative to a revised deficit target of NGN5.9trillion) over the January-November period. Total fiscal receipts came at NGN5.5trillion (26% behind projections) as disappointments in oil revenues (NGN1.1trillion, -47% underperformance) and non-oil nontax revenues (NGN2.8trillion, -31% underperformance) offset an outperformance in non-oil tax receipts (NGN1.6trillion, 18% outperformance). On the expenditure side, the FG spent NGN12.6trillion (6% as above budget) as higher than forecast debt service costs (+38% to NGN4.2trillion) and the earlier cited revenue disappointments forced cutbacks in capital spending (-26% to NGN3.6trillion) and non-debt recurrent expenditure (-15% to NGN4.5trillion). In particular, the FG scaled down on overheads and pension payments while the higher debt costs reflected over NGN1trillion in interest on Ways and Means. And how was the deficit funded? via large domestic borrowings of NGN5.1trillion (including NGN2.5trillion in Ways & Means from the CBN), foreign borrowings (NGN1.6trillion) and bi-lateral project tied loans of NGN369billion.
The week ahead (Jan 10-14)
In the week ahead system maturities around NGN138billion split across OMO (NGN60billion) and NTB (NGN78billion) which implies that there will be an NTB auction on Wednesday and an OMO auction thereafter. Markets are likely to focus on the outcome of the NTB auction and the DMO calendar.
DMO unlikely to surprise with Q1 2022 bond issuance calendar: In its usual form of releasing a market neutral bond calendar, the DMO is likely to release a Q1 calendar which will likely show monthly borrowings in the NGN150-180billion region. The NTB calendar as expected was market neutral with maturities exactly matching planned issuances. As with the norm, I expect the DMO to borrow more than this guidance given market conditions especially in January given the aforementioned robust liquidity profile. In terms of instruments, my suspicion is that the calendar will show continued tap of the 2026s and 2037s with the likely introduction of a new 30-year bond (2052s) in January. Over the year, I expect the DMO to bring forward either a new 10-year (2031 or 2032) or 15-year (2038) given the gap in the segment and as the near term maturity buckets have filled-out.
Inflation likely moderated in December 2021 on base effects: The NBS is likely to release its December 2021 inflation over the week which will show a continuation of the declining pattern on large base effects in food inflation. Nigeria’s food production remain seasonal due to reliance on rain-fall for water which means the main food harvest occurs in Q4 and improved market supplies applies a gravitational effect on prices. My guesstimate is for headline in the region of 14.7-14.8% driven by m/m readings of 1-1.05%.