Friday, July 06, 2012 / ARM Research
Domestic financial managers recently outlined plans to raise $100mn in diaspora bonds by 2013 as part of a broader Eurobond issuance programme. This is broadly in line with our views that foreign markets might provide a viable alternative for the FG to raise funds and our rationale hinged on the potential impact of such inflows in ameliorating incessant currency battles while relieving pressure on domestic debt markets. The latter goal has recently assumed new urgency with renewed pressures on government revenues, and lack of progress in resolving the financing quandary posed by the quantum of maturities as from 2013-2014. We examine the proposed issuance’s potential for serving these ends.
Low impact proposed borrowing falls short of potential
The World Bank estimated that remittances by Nigerians in diaspora hit $10-$11 bn in 2011 and expects this figure to grow further in 2012. Similarly, reports credited to an association of Nigerians in diaspora highlight the possibility of $100bn in annual domestic remittance inflows by 2015. Considering the potential size of the market, the proposed issuance appears small even when it is taken into account that funding volumes from diaspora sources might be more fragmented than for typical investor pools. In addition, even modest success of actions by central banks globally to support domestic economies should increase liquidity conditions. The possible return of risk-on trades also suggests easier access to capital given the favoruable trends for frontier market bonds even through the tougher periods.
In addition, it is not clear what such a limited programme intends to achieve, the typical use of diaspora bonds involves but is not limited to, tackling specific infrastructure and developmental challenges. In this case, it is impossible to envisage $100mn having an appreciable impact on the massive infrastructure deficits that underpin domestic economic challenges. India, which has one of the best success stories with diaspora bonds, raised over $11bn in three different issuances in the decade comprising 1991-2000 and this was credited as helping to avoid financial system collapse. In any event, the proposed size is unlikely to relieve pressures on the domestic debt markets and perhaps even less so on the currency market. The $500millon Eurobond issuance in 2011 barely covered one week’s dollar supply at the WDAS at the time and though this consideration is not entirely relevant, it does highlight the fact that we see hardly any benefit in the proposed issue.
More ambitious programme required
Unlike with the first Eurobond issuance in 2011, we do not think that the argument that ‘the waters are being tested’ remains tenable. In our view, to capture the potential benefits to domestic debt and currency markets, it probably makes more sense for the FG to go for a bulkier issue with a proportionally larger allocation to diaspora bonds, as needed. For one, larger issue provides more liquidity for investors and elimination of that premium in pricing should be beneficial to the issuer, especially when underpinned by strong demand. Also, considering smaller economies have raised far greater amounts than Nigeria’s current Eurobond stock there can hardly be grounds for feeble market forays.
There is a sense in which recent global developments provide a favourable window. Structural shifts in global fixed income markets are tilting the scales in favour of EM debt, a trend that has withstood recent bouts of risk aversion and appears set to accelerate in coming years. There is growing conviction behind the evolution of global debt markets towards reaffirming the favourable risk reward characteristics of emerging market bonds driven by favourable yield differentials, diversification potential, faster economic growth as well as fundamental improvements in EM credit quality—the latter supported by ratings upgrades and better debt sustainability ratios compared to developed markets. For instance, the proportion of sovereign wealth funds’ annual income going into FDI in emerging markets has reportedly increased by 20ppts to 60% from 2009 and the most recent surveys indicate that SWF’s are channeling 70-80% of new FDI into EM.
Significantly, as with other EM/FM instruments, the existing Nigerian Eurobond has enjoyed positive performance YTD, in the face of global economic turmoil rising $3 in H1 2012 to close at $108, underscoring the appetite on this front and at much better pricing than currently available domestically. Furthermore, EM bonds may benefit from the increasingly favourable environment for carry trades in near term with the ECB’s recent decisions opening a new window to broadening trend towards easing across developed markets.
Figure 1: Eurobond yields
Source: Bloomberg, ARM Research
Tactically, a larger fund-raising should be more cost-effective than a piecemeal approach especially considering the persistent delays that characterized the previous issuance which reflect inefficiencies in the issuance processes. Considering the many possible changes in global investing sentiment as well the numerous hurdles before the domestic debt markets can achieve any reasonable measure of depth and self-sustenance, there appears to be a case for economic managers to make the most of current favourable dynamics either via diaspora bonds or conventional Eurobonds.
Importantly, with a much more robust debt management framework in place we see little additional risk arising from a switch into dollar debt—provided of course that the proceeds are properly utilized to serve infrastructural and other long term strategic needs—the larger proportion of government revenues being dollar denominated. Indeed we believe fiscal focus should turn towards relieving the heavy burden of government borrowing on domestic debt markets—which now threatens to jeopardize the aims of the DMO’s domestic debt market development efforts—and limiting the impact of monetization of dollar revenues on domestic liquidity in view of the abnormally high differentials between dollar and naira denominated debt.