January 26, 2018 /2:25 PM /Investment One
Late yesterday, the Director General of the Debt Management Office announced that the Federal Government would be looking to issue a USD2.5billion Eurobond in Q1 2018 as part of the USD5.5billion fund raising programme approved by the National Assembly last year. The proceeds of the issuance are to be used to refinance short term local debt, specifically T-bills.
In addition, it was stated that Nigeria may open discussions with JP Morgan in Q2 2018 regarding the inclusion of Nigerian bonds in the investment bank’s Government Bond Index - Emerging Markets. We highlight that the potential discussions come almost three years after Nigeria was excluded from the index due to the CBN’s restrictive FX policy, which hindered the ability of investors to repatriate funds and consequently replicate Nigeria’s weight in the index. Prior to the exclusion, Nigeria’s weighting was c.1.8% of the index, which was tracked USD210billion worth of assets under management, as reported by Reuters.
We believe the refinancing, which should moderate yields in the fixed income space, should be a positive for the administration’s goal to alter the nation’s debt profile to 60:40 domestic to foreign split, from c.75:25 currently.
The USD2.5billion refinancing, in addition to the USD0.5billion worth of T-bills refinanced in Q4 2017, should save the government N92billion in debt servicing per annum, according to the minister of finance while also elongating the nation’s debt maturity profile.
This should be a supportive of lowering the administration’s debt service to revenue ratio from c.45% currently thereby improving the government’s spending capacity and potentially increasing allocations to capex over the medium to longer term.
The potential decline in yields in the fixed income space due to the refinancing reinforces the likelihood that we may be moving towards a more accommodative monetary policy (lower interest rate and yield environment) in 2018. With this said, we highlight that the slide in yields may be more prominent on short dated maturities with the yield on the one year T-bill currently c.15.70%.
Also, the re-inclusion in the JP Morgan Index could lead to a further moderation in yields in the fixed income space as funds tracking the index would have to rebalance their portfolio and buy Nigerian bonds in order to minimize tracking error.
We opine that the increase in FX liquidity as a result of the rise in Brent oil price (up c.+27% y/y to c.USD70/barrel); increasing oil production levels; and success in offshore borrowings (USD4.5billion raised in 2017), which led to the c.+44% y/y jump in FX reserves to c.USD40billion and the establishment of the Investors’ and Exporters’ FX (IEFX) window, has enhanced foreign investor participation in Naira denominated assets.
Since the establishment of the IEFX window, over c.USD30billion has been traded, with turnover rising to an average of USD1.4billion per week so far in January, from an average of c.USD1billion in Q4 2017. In our view, the improvements in FX liquidity and foreign investor inflows may be supportive of the inclusion of Nigeria in the index.
Overall, we believe that a lower interest rate and yield environment, which should be in line with the administration’s fiscal policy, could bode well for the funding and implementation of the proposed N8.6trillion 2018 budget.
Lower interest rates should also be supportive of lending to the real sector and may spur growth in the non-oil sector, which has been less than inspiring in recent times. Furthermore, a slide in yields should be a positive for the performance of the equities market.
Additionally, success in offshore borrowings and foreign investor inflows on the back of the inclusion in the JP Morgan index, should lead to a further increase in the nation’s FX reserves in the near term.
However, we highlight that the on-going delay in the passing of the budget remains a risk to economic activities while heightened political risk in H2 2018, as electioneering intensifies, could lead to a drawdown in the equities market.
Furthermore, we highlight that a further slide in yields in the fixed income space may be moderated by the US Fed’s hawkish stance, with three rate hikes forecast for 2018.