Nigeria Fixed Income Weekly

The Week that Was (August 1-5)

Oil production slips, CBN Ways & Means rises to NGN20trillion, Rates maintain upward drift and Naira pares losses.

Oil production reverses recent gains in July, changing output mix highlights fiscal revenue and FX related headaches:  In a reverse from the pick-up recorded over June, data from the Nigerian Upstream Petroleum Regulatory Commission (NUPRC) showed that average oil production, inclusive of condensates, declined by 6% to 1.31mbpd (H1 2022 average: 1.47mbpd). The drop largely reflects pressures along three of the four major export terminals for onshore production: Forcados (-27% to 144kbpd), Brass (-60% to 12kbpd) and Bonny (-24% to 30kbpd). Reduction in output via these three pipelines continues remain central to Nigeria’s current oil production woes and reflects outages along key trunklines in the Western sector due to industrial scale theft. On the Eastern axis, output continues to stabilize along the Qua Iboe export terminal while the offshore fields of Bonga, Egina and Agbami continue to struggle to get back to pre-COVID-19 levels. To get a sense of the impact of the effect on government revenues and external reserves, I recast the production data from the various terminals/fields into joint-venture (JV), production sharing contracts (PSC) and others (largely output from smaller independents and marginal fields) in Figure 1 below. From the data, one can see why fiscal revenues are on the ropes, the production declines are concentrated in JV fields where government offtake is higher and this is feeding through to weaker NNPC remittance to Federation Account and by extension, FX reserves.

Figure 1: Nigeria’s oil production by fiscal regime

Source: NUPRC, Author’s Computation

Tight liquidity conditions continue to drive a pick-up in yields track higher across the curve:  Liquidity conditions remained tight across the financial system with interbank rates holding steady at 15% and placements for large institutions averaging 15.5-16%. In line with the pattern since the middle of June, Nigerian banks on aggregate remain net borrowers (daily average last week: NGN49billion) at the CBN discount window, though to lesser degree than the daily average of NGN79billion over the last two months. This liquidity squeeze continues to underpin an inversion in T-bill yields with short dated SPEB instruments (1-3m) offered at 12-13% (including the 29-Aug 2022 maturities!) while longer dated tenors remain anchored at 7-9% levels. The tightness is brought about by a mix of adhoc CRR debits and tightened access restrictions to FX and NTB auctions for banks exposed to the CBN via repo and discount window borrowings. This T-bill inversion and high ST interbank rates is now driving bearish sentiments in the longer dated bond space and sets things up nicely for the August 2022 bond auction.

Figure 2: Naira Yield Curve

Source: Bloomberg,

Nigerian Eurobonds extend gains, despite weaker oil prices: Last week, Nigerian Eurobonds rallied further (with yields down 73bps) despite an abundance of bearish factors. Firstly, oil prices dropped below USD100/bbl as crude oil markets grappled with OPEC plans to raise output and mounting concerns over demand destruction. In addition, Friday saw the release of strong US non-farm payrolls data which will likely provide more support for the US Federal Reserve to continue to hike interest rates. The US economy created 528k jobs relative to forecasts for 250k jobs which pushed the unemployment rate down to 3.5% (last: 3.6%). This positive surprise now means the Federal Reserve is more likely to raise interest rates by at least 75bps (or more) at the next meeting in September. In response to the release, Nigerian papers as with the wider SSA universe moved higher and will be interesting to see how this plays out in the coming week. In terms of valuations, Nigerian Eurobonds continue to trade at a premium to oil related SSA papers possibly reflecting limited gains to external reserves (down 3% YTD to USD39billion) despite soaring oil prices and, to a lesser extent, rising political premiums as the 2023 elections move into the horizon.  

Figure 3: Nigeria – Sovereign Eurobond Yield Curve

Source: DMO

CBN borrowings to FGN hit NGN20trillion in June: Updated CBN data through June 2022 indicates that lending to the FGN (the so called Ways & Means) hit a record NGN19.9trillion (11% of GDP) up from NGN17.4trillion (10.1% of GDP) at the end of 2021. Although these loans have attracted wide criticism, the central issue is that in the face of a large government expenditure program, there is no time sensitive legal mechanism for dealing with actual fiscal deficits in excess of the financing provisions contained in the approved budget. The only recourse is to come up with a supplementary budget which is not time sensitive (and may not be politically expedient/feasible) which leaves the CBN, as the banker to the FGN, as the last resort via an overdraft facility called the Ways & Means (W&M).

The half-year balances over H1 2022, imply that the FGN has borrowed NGN2.5trillion which is 40% of 2021 FGN revenues, well clear of the 5% legal requirement in the fiscal responsibility act. (A word of caution here in 2020 following the outbreak of the COVID-19 epidemic, President Buhari effected provisions of the 2003 Quarantine Act which allows for the suspension of certain legal requirements to allow the FGN to deal with the pandemic. So long as this declaration remains in effect the 5% limit on W&M borrowings can be ignored). Interestingly, from my analysis, W&M loans appear cheap running at 6.4% annualized rate (2021: 7%) which compares with double-digit levels assuming the deficit was financed via bonds. This might seem to explain the anchoring of NTBs around those levels at the primary market auction.

Figure 4: CBN Ways & Means

Source: CBN, NBS

Who gets the blame? The key architect of the current fiscal mess is none other than Finance Minister Mrs. Zainab Ahmed. In the 2015-2019 cabinet, the Finance function was unusually hived into two with the budget function handed to a lawyer and former Senator Udo-Udoma and the financing function to Mrs. Kemi Adeosun. In the 2019-2023 cabinet, the functions were unified under Mrs. Ahmed suggesting wide ambit to design the budget in a manner she deemed fit. Under her watch, in spite of a limited revenue profile, Mrs. Ahmed has continually prepared and justified fiscal expansionism when prudence would have suggested a more conservative budget proposal or that expenditures in excess of revenues and borrowing limits be financed using non-debt means. Better still, Mrs. Ahmed should have put forward a supplementary budget to roll-up the more persistent overdrafts within a budget cycle. These two initiatives would have kept the W&M balances within reasonable limits. Rather Mrs. Ahmed would consistently put aside these concerns and take solace in some ‘new initiative’ that would unlock mythical revenue numbers.   

However, ambitious fiscal expansionism with limited non-debt options implicitly means that the underlying government expenditure plan was always going to be financed via borrowings. Having served as Junior minister previously, the finance minister certainly had the benefit of hindsight. When the history books are written for this time, she is unlikely to get favourable reviews despite some successful administrative reforms: restoring the budget cycle to January-December norm, introducing finance acts and more recently work on tax expenditures to highlight the impact of waivers and tax concessions. These achievements now pale in the background relative to the fiscal crime scene the next finance minister looks set to inherit.

Naira recovers from recent cycle of losses at the parallel market:  Despite declines in gross external reserves over the week (-0.3% w/w to USD39billion), the Naira recovered across the stage managed IE window rate (0.2% gain w/w to NGN428.13/$) and the parallel market (7.6% gain w/w to NGN660/$). The quick-fire reversal suggests that the late July sell-off reflected one-off technical factors:  a large buyer or seasonal demand around the summer holidays and the school fees crowd and concerns over the CBN Governor’s speech. At its July 2022 MPC press conference, the CBN Governor, in response to a question stated that “For those taking money from banks to buy dollars, it is illegal to do so. If the security agencies hold you, you will know the implication of that”.  Though the Governor was referring to politicians, as the CBN clarified several days later, the sentence would assume a different connotation, one which awoke the animal spirits of the parallel market. Taking a step back, the volatile patterns in the exchange rate fit a pattern observed since the present CBN leadership radically changed the Nigerian FX market architecture: from one which had the semblance of a market system (admittedly largely managed) into one where the price at which Naira traded and who got allocated dollars were determined under a mix of adhoc, arbitrary and unreasonable administrative circulars.

The Week Ahead (Aug 8-12)

August is the month of tight system liquidity given limited maturities and given the current tightening conditions engineered by the CBN, there is scope for rates to inch up.

Inflation likely cleared 19% in July: Price pressures across non-regulated fuels (diesel and kerosene) and food prices likely continued to combine to push consumer prices higher. Though subsisting subsidies continue to contain petrol prices, currency weakness at the parallel market over July likely applied upward pressure on diesel prices – the key fuel for heavy-duty trucks involved in inter-city transport of goods and services. That said, food prices are likely to slacken as the lean season winds down and early grain harvests help alleviate supply pressures. My estimate for the July 2022 NBS release is for a print within the 19.5-19.6% region.

NTB Auction: Another CBN bridge financing the rescue? The CBN, on behalf of the DMO, will look to refinance NGN150billion in NTB instruments at this week’s primary market sale on Wednesday. Given the tight liquidity conditions with overnight rates at 15% and the inverted T-bill curve, demand is likely to be weak at the auction. As such, we are likely to see another ‘smooth’ auction with the 1yr closing at 7-8% which essentially is the CBN ‘bridging’ the shortfall. Otherwise, the only way is up to reflect the ongoing inversion process along the NTB segment where 1-3M bills are hovering between 12-13%.

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