Nigeria – Fixed Income Weekly

The Week that Was (July 25-29)

Nigeria exhausts ECA balances, another ‘smooth’ NTB auction, Nigerian Eurobonds rally

The end of the road for the Excess Crude Account: Nigeria’s finance minister Zainab Ahmed reported that the Excess Crude Account (ECA) balance had dropped from USD35million in January 2022 to USD337k at the end of June 2022 due to an outlay on naval defense expenditure. The announcement marks effectively amounts to an obituary of the ECA and as we shall see highlights a collective failing of Nigeria’s political leaders post 2008 to achieve an working consensus on fiscal savings.

Figure 1: ECA (end year balances USD’bn)

Source: Budget Office, IMF Article IV Consultation Reports

During the oil price boom of the mid-2000s, President Olusegun Obasanjo instituted a practice wherein crude oil receipts above the budgeted oil revenue estimates were retained in the Federation Account and tagged Excess Crude Account (ECA). These monies were not in a separate bank account or the sort but rather were not drawn down to finance budgetary expenditures or for allocations to sub-national governments. The ECA was child borne out of prudence: save during boom times and draw down during hard times. Easy enough right? Not quite as upon the exit of President Obasanjo, state governors sensing the weak constitutional footing of the ECA, placed withdrawal demands on successive Presidents (Yar’adua and Goodluck Jonathan) which resulted in a drop from a peak of USD20billion sometime in 2008 to USD2.7billion in 2010. Though stronger oil prices over 2011 helped restore some discipline with newfound accretion to USD11billion by the end of 2012, between withdrawals to fund petrol subsidies and augmentation of state and federal budgets, the battle for the ECA was lost. At USD2.2billion in 2015 when the Buhari administration came to office, the outlook for the ECA appeared bleak with the collapse in oil prices. Given that the Buhari government’s response to the oil collapse was to embark on fiscal expansionism and continual pressure from state governments, the ECA is now largely depleted.

A smooth NTB auction, another bridge finance? At the primary market auction on Wednesday, the CBN, on behalf of the Debt Management Office (DMO), offered to borrow NGN264billion worth of Nigerian Treasury Bills (NTB) as part of its refinancing operations. However, for the second consecutive auction, investor demand was soft with bid-offer at 1.2x (Last: 1.02x), a fallout of tight liquidity conditions within the financial system occasioned by CBN’s monetary tightening. Ordinarily, this should have forced a jump in stop rates and/or limited success in borrowings, however, the CBN allotted precisely what was offered at respective stop rates of 2.80% (previously 2.75%), 4.10% (previously 4.00%), and 7.00% (unchanged). Curiously, the 1-year rate closed at 7%, below the 8% obtainable in the standing deposit facility rate and well below the secondary market levels for 3M bank placements (14-16%), 1-3M SPEBs (11-12%) and near term NTB papers (9%) which suggests presence of irrational bidders. Overall, the relatively smooth allotment at the auction alongside the clear mispricing in the NTB auction following the ‘bridge finance fiasco’, it is very likely that the CBN stepped in to plug (bridge) the unmet borrowing at the 7% stop rate for the 1-year tenor.
As I noted after the July 2022 MPC meeting, in neglecting the normalize the corridor around the MPR, the CBN remains in a fix regarding interest rates. On the one hand, while it desires to rein in runaway USD demand, likely reflecting its continued financing of fiscal deficit the CBN is conflicted

Debt markets remain net bearish despite slight easing in liquidity pressures: Liquidity conditions across debt markets remained tight with overnight rates closing the week at 15%. Placement rates are now moving between 14-16% while the 1-3m SPEB bills are at 11%. The NTB curve remained inverted and average yield across the sector expanded by 48bps to 7.7%. The bifurcated OMO yields also sold off with yields up 68bps to ~10%. Longer dated bonds also so more modest selling with increases across board: short (+11bps), mid (+12bps), and long (+5bps) with selloffs in the FGN 2026 (+35bps), FGN 2029 (+17bps), and FGN 2050 (+34bps)

Figure 2: Naira Yield Curve

Source: Bloomberg

Nigeria Eurobond yields rally in line with post-FOMC risk-on: Nigeria’s Eurobond yields continued to rally with yields down 36bps on average with a strong rally along the front-end (-80bps w/w) relative to the belly (-30bps w/w) and long end (-10bps w/w). This rally sits well with a risk-on mode across global markets despite another large rate hike (+75bps) by the US Federal Reserve and continued hawkish commentary. However, markets seem conflicted with the onset of a technical recession in the US and yield curve inversion. This played nicely into supportive commodity price backdrop from Nigeria as an oil credit and the curve repriced lower. However, the entire curve (ex the July 2023s) remain in double-digit territory (11-13.1%) which will continue to militate against a potential Eurobond sale.

Figure 3: Nigeria Eurobond Curve

Source: DMO

Naira unravelling continues at the parallel market, reserves dip: Naira fortunes at the parallel market continued to dominate headlines over the week as the currency fell 14% w/w to fresh lows NGN718/$ at the segment. At the official segment, the CBN continued to play ostrich with the IE rate published by its associate FMDQ holding at NGN430/$. Though it’s the period of summer holidays and school fees which drives seasonal demand pressures, the current spiral cannot be separated from recent comments by the CBN governor which was interpreted to mean that dollars cannot be purchased with Naira from bank accounts. Though the CBN later clarified (as with several less careful utterances by the Governor) the sense is panic is fueling retail end dollarization and corporate front-loading of USD purchases to limit downside from potential devaluation. Dealing with this requires a restoration of confidence which could have come via interventions. However, the failure of the CBN to properly manage the exit of BDC operators and its creation of several windows is preventing a credible resolution of the issue. Though reserve levels seem adequate, limited pass-through of stronger oil prices due to the large subsidy burden and the effective closure of the Eurobond market means the only option to large USD issuance is via an approach to the IMF.

Waiting for the killer blow
Going into August, fixed income markets are grappling with the prospect of tight system liquidity being the norm as the CBN ramps up on liquidity tightening and the FGN looks to hit its 2022 borrowing target by relying on local liquidity. A challenged interbank liquidity position is likely to keep short term rates pressured and the ongoing Naira weakness is likely to harden CBN’s resolve to curb banking system liquidity. With bond markets already smelling blood, the August auction could make for an interesting one in the event that bond market bears could seek to push the DMO higher on the short tenors which could drive bearish sentiments should they prevail. Inflation likely cleared the 19% reading in July which will reinforce sentiments about additional rate hikes in September.

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