Liquidity pressures force the DMO’s hand, CBN delivers another rate hike, subsidy headaches set the stage for a record fiscal deficit and Eurobond blues.
The Week that Was (July 18-22)
DMO wilts under pressure of tight banking system liquidity at the July bond auction: In the lead up to the July 2022 bond auction, money markets had become tight, a reflection of an increasingly less tolerant CBN posture towards Naira liquidity which is a shift from a largely neutral position for much of H1 2022. As a result, the banking sector was now on aggregate, net borrowing at the CBN discount window to the tune of NGN231billion on the preceding Friday ahead of the auction on Monday. The import of this strain on system liquidity was two-fold: firstly, it effectively curtailed bank participation at the auction and more importantly drove an uptick in placement rates from the 7-8% level over Q2 2022 towards the 14% ceiling imposed by the CBN. With the appearance of a positive differential between short-term placement rates at 14% and the yield on long-dated bonds (12-13.2%), demand for bonds plummeted at the auction with the volume of bids relative to the amount on offer at a miserly 0.6x (June: 2.5x). In terms of actual bids that showed up, pricing was generally higher than secondary market levels across the three papers: 2025 (11.22% vs 10.5%), 2032 (13.21% vs 12.6%) and 2042 (13.41% vs 13.3%). This left the DMO with no choice but to cave in with the 2025 rising to 11%, the 2032 to 13% and the 2042 to 13.75%, a dramatic reset in market expectations.
MPC delivers another rate hike, but policy remains muddled: In line with my out-of-consensus call for 100bps rate hike, the CBN raised its key policy rate by 100bps while leaving other parameters constant. Reading through the MPC statement and the press conference afterwards the sense is that the hike likely reflects a desire to keep pace with runaway inflation and to raise the rewards for holding Naira to ward off speculative pressures. This is consistent with the tightness across money markets. However, in electing to leave the asymmetric corridor (+100/-700bps) intact (vs. my view for a return to a 200 basis point symmetric corridor), my sense is the CBN is still sending mixed signals about the level of its hawkishness. By leaving the deposit rate ceiling at 7% with the asymmetric corridor, the CBN is only attacking one end of the currency speculative game. However, in leaving negative real returns for deposits which will impact the retail end, the fire to fuel speculative activities in the parallel market from the segment retains intact. Perhaps the CBN is still underpricing prospects for the reported CPI inflation numbers to clear 20% which could inform its less hawkish posture. When and if this happens as I suspect by September, the CBN will be forced to go to uncharted levels either at the next meeting or in November.
Figure 1: Nigeria Monetary Policy Parameters
Naira yield curve sells off in response to auction and CBN hike: In response to the negative developments at the bond sale and MPC meeting, the bears remained in ascendancy in the fixed income market with yields up 35-40bps. In line with the tight conditions along money markets, front end paper, in particular, the 1-2 month SPEBs are now trading above 11% with longer tenors holding at 7-8% levels. T-bill yields repriced over the week by around 66bps with the OMO papers up over 150bps. Further out, bonds repriced in line with the auction with the 3-year (+89bps) while the belly and long end moved higher to 13% and 13.7% levels respectively.
Figure 2: Naira Yield Curve
Nigerian Eurobond yields retrace from sell-off, but spreads remain wide: Nigeria’s Eurobond yields recovered last week with yields down around 150bps w/w across. This partial reflects improved sentiment around oil prices (which stabilized after the sell-down in the prior week) and some improvement in global risk sentiment. Fundamentally, external reserves have continued to recover with the last update (15th July) at USD39.4billion (6-7months of import cover). In its MPC communique, the CBN linked the increase to a pick-up in non-oil inflows which could suggest either a step-up in FX swap activity or increased remittances.
Figure 3: Nigeria – Eurobond Curve
Nigeria’s next major external repayment is USD500million in July 2023 and on current form, the reserve number suggests there is a limited risk of default. However, market pricing of Nigeria’s Eurobond yields suggests less confidence looking at the spreads over US risk free bonds for the widely watched 10-year tenor which sits at 1070bps. While this is below Ghana (1840bps), Egypt (1220bps) and Kenya (1140bps), the spread is above fellow SSA oil producers Angola (1020bps) and Gabon (1030bps) and well above the trend average over the last five years. This suggests that despite higher oil prices, offshore investors (the main holders of Nigeria’s Eurobonds) are less confident about Nigeria’s short run dynamics possibly as the large fuel subsidy continues to limit scope for strong accretion to external reserves. From a structural perspective, one can read into this as a sign that confidence in Nigeria has weakened owing to several factors: worsening insecurity issues in recent years and a less credible policy framework. It could also be a symptom of wider disenchantment with the post-covid economics of Sub-Saharan Africa in a world of higher USD rates.
Figure 4: Selected SSA Eurobonds 10-year yields and Spreads over US 10-year treasury
Source: DMO, Bloomberg
Preliminary fiscal data highlights revenue and subsidy headaches: At the budget presentation for the 2023-2025 medium term framework, the finance minister provided an update on fiscal accounts over the January-April period which showed a fiscal deficit of NGN3.1trillion (or 5.1% of GDP annualised, 2021: 4.1% of GDP). Despite stronger oil prices, fiscal receipts printed at NGN1.63trillion – 51% wide of the budget estimates largely on account of the huge subsidy over-hang at the Federation account level, below target oil production (Actual: 1.36mbpd vs 1.6mbpd in budget) as well as disappointments in customs collections and the non-oil non-tax revenue (NONT) segment. The NONT line, usually a ‘plug-in’ item, came in 63% off the mark which pours water on the usual misplaced optimism by the Finance Minister on the line item. The weak revenue line implied that even though the FGN cut back on spending relative to its target (by about 18%), Nigeria is on track to report a record fiscal deficit (NGN9trillion) from merely annualizing the four-month number. The widely watched debt-service to revenue ratio is now out of funk at 119%, cue widespread media commentary on the item.
Figure 5: Nigeria Fiscal Accounts
Source: CBN, Federal Ministry of Finance. 2022e is annualised for January-April numbers.
In terms of feedthrough to debt markets, the difficult revenue situation is likely to fuel more desperate onshore borrowing as the Eurobond market is effectively closed given double digit yields and Nigeria is unlikely to approach the IMF/WB for any loan with less than a year to go for the Buhari administration. Overall, the data is supportive of higher NGN yields over the rest of 2022 if the July 2022 auction is anything to go by.
The Week Ahead (July 25-29)
In the week ahead, system liquidity will receive support from FGN coupons (NGN51billion) and bills (NGN294billion) with the latter split across OMO and NTB papers. Market focus will be on the outcome of the NTB sale where the CBN, on behalf of the DMO, will look to refinance around NGN264billion of T-bill maturities. Given tight liquidity conditions and the up-move in the SLF rate, the DMO is likely to move the stop rate on the 1-yr rate to 10%. On the Eurobond front, focus will be on the US Federal Open Market Committee (FOMC) meeting over the week where markets expect an additional hike in the Fed Funds Rate could drive another round of turmoil in risk assets.
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