Nigeria Fixed Income Weekly

The Week that was (October 17-21)

CBN rule change on SLF access drives low subscription at the auction, yields return to 15-16%: In the lead up to the October 2022 bond auction, the CBN had released a circular reiterating its rule that access to its discount lending window would not be available to banks on settlement days for bond/T-bill auctions. This circular, which provides confirmation that the CBN appears set on a scorched earth liquidity tightening approach resulted in the introduction of a requirement by banks that clients intending to submit bids for the bond auction had to pre-fund those bids (which could not occur on the auction day). As a result, this led to soft demand at the bond auction with bids of only NGN119billion relative to the NGN225billion amount on offer. The low demand forced the DMO’s hand on yields, leading to a jump in average borrowing rates to 15.17% (September: 13.95%) which marks a return to the high-yield era before CBN’s dramatic shift to an unorthodox monetary policy posture in H2 2019. In terms of actual sales, the DMO sold NGN108billion (48% of target) which brings YTD net bond sales to NGN1.9trillion (gross: NGN2.5trillion).

Banking system liquidity remains tight, high ST rates: Liquidity conditions remained tight across Nigeria’s financial system with interbank rates holding steady at the elevated CBN imposed ceiling of 16.5%. Reminder: sometime in 2021, the CBN had directed banks that the standing lending facility (SLF) rate was to be the ceiling for interbank rates with the standing deposit facility (SDF) rate as the floor. This creates a condition wherein interbank rates are artificially pegged at a level that may not be available during episodes of tight liquidity conditions. Indeed, placement rate for large corporates is higher (17-21%) while aggregate daily net banking exposure to CBN’s discount window stood at over NGN200billion in October relative to NGN25billion daily average in September.

Figure 1: Naira Yield Curve

Source: Bloomberg

For the bond market, post-auction saw some buying activity in the secondary market likely reflecting a mix of short-covering but also players who could not go to the auction looking to pick-up bonds with an eye on improved end-of-month liquidity. The 15-yr tenor saw yields compress by 25bps to 15.75% from the 16% auction level before paring gains with a back-up to 15.8-15.85% levels.

September 2022 Inflation comes behind expectations, suggests normalization in food production but flood risks on the horizon: The NBS published CPI numbers for September which showed a rise in inflation from 20.55% to 20.77% y/y which tracks behind my expectations for a 21%+ print. This reflects a marked deceleration in the m/m run-rate which came in at a ten-month low of 1.36% (August: 1.77%). Looking deeper at the numbers, the moderation stemmed from food inflation (in particular the rural farm produce component) which declined to ten-month low of 1.43% from 1.98% in August. This would seem to suggest that the main harvest, which got underway in September, was strong as elevated food prices worked to incentivize strong crop cultivation. On the other hand, true ‘core’ inflation remained to rise, with the monthly figure at 1.64% from 1.61% (Sept y/y: 17.49%) which implies that inflationary expectations, likely a fall-out of currency weakness, are well entrenched.

Figure 2: Nigeria Inflation

Source: NBS

Ordinarily the improved harvest readings would suggest a slowdown in inflationary momentum, but the massive flooding experienced across the major parts of the Niger-Benue trough is likely to pose problems for food inflation given the damage to transport infrastructure and storage. Without any dramatic interventions, rural farm produce inflation could reverse course.  But what the September number does is that it lowers expectations for Q4 2022 which would likely see inflation trend between 21-22%.

CBN pretense continues at the official FX window, reserves head south:  Despite stronger oil prices, external reserves declined 0.1% w/w to USD37.7billion (YTD: -7%) likely reflecting limited oil inflows to CBN reserves on account of weaker oil production and the large petrol subsidy scheme. Though the CBN has now jettisoned the ‘heterodox’ approach to monetary policy, the loss of credibility and global financial market turmoil means there is limited prospects for portfolio inflows as a potential source of USD flows. As a consequence, the CBN is now following a more ‘controlled explosion’ approach to FX rate management with gradual softening of its Naira peg which has weakened to NGN441/$ at the official window. That said, with limited USD supply prospects over the near to medium term, the problem never goes away so the Naira freefall has widened at the parallel market where the rate fell to NGN751/$.

When will the CBN resume credible FX policy management? My sense is two things need to happen: firstly, oil production needs to recover to 2mbpd which is likely over the next 6months given the renewed focus on pipeline security. Secondly, petrol prices need to rise to a level that significantly reduces the loss of crude oil receipts to fund the subsidy scheme. This latter decision is likely going to happen once clarity emanates on Nigeria’s political leadership after the 2022 general elections. Pending this step, the CBN will adopt a piece-meal approach to Naira devaluation at the official window with the parallel rate left to test fresh lows.  

Moody’s delivers a free-hit ratings downgrade on Nigeria credit, cites ‘restructuring’ among excuses: Late on Friday, Moody’s announced that it had downgraded Nigeria’s credit rating from B2 to B3 citing a deterioration in Nigeria’s fiscal and external positions despite the pick-up in oil prices. On the face, these two points are not surprising given the impact of an outsized petrol subsidy scheme and the loss of 1mbpd in oil production. However, what is new is Moody’s reference to the recent ‘restructuring’ fiasco triggered by the Finance Minister’s comments on Bloomberg last week. In the press release, Moody’s notes that subsequent explanations potentially imply ‘a distressed exchange under Moody’s default definition’.

Table 1: Credit Rating Equivalence table

Source: Wikipedia

In summary, the minister’s comments provide cover for a free hit downgrade. In terms of impact, Moody’s downgrade brings Nigeria in line with S&P’s B- rating but lower than Fitch’s B rating which means any future Eurobond sales are likely to be more expensive if somehow global financing conditions ease up (unlikely anytime soon). It also provides a fait accompli for broad-based ratings downgrade that Moody’s guided to in the prior week. Fitch is likely to release its next Nigeria’s update in November and the chances are high that they will align with a Moody’s and S&P with a downgrade to B-.

Finance Ministry draws the line on CBN deficit financing with progress on Ways & Means securitization: The Finance Minister, Zainab Ahmed announced the receipt of presidential approval to convert monies owed to the CBN (August: NGN22trillion). These advances are the so-called Ways & Means (W&M) and have gained media attention since coming to light in the last few years. Specifically, Mrs Ahmed announced that the W&M loans would be converted to 40-year bonds at an interest rate of 9%. This ‘securitization’ as the process has been tagged has been in the works for some time and progress on the Executive front suggests the FGN is likely also draw the line on the practice. Up next, the Finance Ministry will now seek to get parliamentary approval to complete the conversion.

What does this mean? Firstly, Nigeria’s debt metrics are about to change, with debt-GDP ratio rising to 35% of GDP from the current 23.7% level using the June 2022 W&M number. While this remains below the recently upgraded parliamentary ceiling of 40% (from 25% previously) there is going to be limited headroom for Nigeria to keep pushing the low debt narrative. Secondly, in terms of debt service costs, the 9% rate (which favourably compares with the current 13.3% weighted average cost of debt on Nigeria’s NGN20.9trillion domestic debt) implies incremental debt service costs of NGN1.8trillion. For context in the FGN debt service costs in the 2022 budget are set at NGN3.9trillion. Thirdly, from a principal repayment perspective, the securitization will potentially add around NGN500billion in principal repayments assuming no repayment moratorium and equal amortization as I do not believe they FGN will look to repay NGN20trillion at once to the CBN in 2062. Importantly the move suggests the FGN is likely to end the era of unrestrained CBN deficit financing which could mean a potential step-up in domestic borrowings to plug an expansionary fiscal budget. Assuming the next Nigerian president does not embark on fiscal retrenchment, a prospect I believe is likely to occur in the 2024-2025 budget cycle.

From a structural perspective, the action creates some breathing space for the CBN to improve the rate on its Naira liquidity management operation which is currently a mix of zero cost CRR debits and 0.5% SPEB securities. The CBN can afford to raise the rate on SPEBs from 0.5% to some level below 9% to ensure balance sheet profitability.

Overall, the whole W&M debacle is a reflection of a largely reckless approach to budgeting over the last six years. Faced with a collapse in oil revenues, the present government took the gamble of maintaining expenditure growth levels while looking for mythical revenues. If anything, when one remembers the entire gambit of pushing the ‘Nigeria has a revenue not debt problem’ narrative, it becomes clear that the intent to conceal an irresponsible approach to fiscal policy based on imaginary fiscal revenue numbers. As Nobel laureate Milton Friedman once noted: Judge policy makers by their results and not their intentions. The expansionary approach to fiscal policy has left one major result scorecard: Nigeria is now more heavily indebted with limited fiscal space. A more responsible approach to fiscal policy would have called for simply spending within ones means. When the annals of Nigeria’s economic history are written, the 2016-2023 era will be characterized as one of excessive fiscal policy irresponsibility and the present administration and its fiscal policy chiefs should note that history will not be kind to them.

The Week Ahead (October 24-28)

In the new week, focus will be on T-bill auction on Wednesday where the CBN, on behalf of the DMO, would look to refinance NGN240billion worth of T-bill maturities. In terms of liquidity, inflows from FGN bond coupons (NGN179billion) and OMO maturities (NGN30billion) would likely provide some relief at the close of the month. FAAC inflows are likely to come through. The 1-yr T-bill auction rate is likely to inch up to 14%

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