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Tuesday, December 22, 2020 / 7:54 AM / By Coronation
Research / Header Image Credit: Dave Ramsey
Nigerian market interest rates are on the rise. This
marks the end of the long - over a year - march south. But what next? In our
view the key determinants are how the 2021 budget deficit will be financed and
how normal (given that the present interest rate/inflation mix is not normal)
the Central Bank of Nigeria (CBN) wants interest rates to be.
FX
Last week the exchange rate in the NAFEX market (also
known as the I&E Window and the interbank market) weakened by 0.05% to
N391.74/US$1. In the parallel, or street market, the Naira slid by 0.42% to
close at N477.00/US$1. Going by the recent data from the Central Bank of
Nigeria (CBN), FX reserves dropped to $34.8bn on Tuesday, 15 December from
$35.4bn as of Friday, 27 November indicating a loss of $1.7 billion since May
29, 2020. The downward trend could continue due to increased dollar sales by
the CBN coupled with depressed foreign exchange earnings from oil and non-oil
receipts. However, with oil surpassing the $50.00/bbl mark, it is possible that
oil receipts will be much better in the coming year. In addition, the approval
of a US$1.5 bn loan facility from the World Bank constitutes a significant FX
inflow that will assist to shove up reserves.
Bonds & T-bills
Last week, the secondary market yield for an FGN Naira
bond with 10 years to maturity rose by 99 basis points (bps) to 6.31% and at 7
years rose by 52bps to 4.86% while at 3 years the yield rose by 83bps to 2.77%.
The annualized yield on a 314-day T-bill rose by 14bps to 0.65%, while the
yield on a 312-day OMO bill rose by 17bps to 0.69%. The Nigerian Treasury Bills
(NTB) market started the week on a quiet note and during the week CBN auctioned
an NTB offering N7.00 billion ($14.43 million) worth of notes. The 91-day note
was allotted at a 0.05%, while 182-day and 364-day tenor were allotted 0.5% and
1.14% respectively. The NTB average yield closed the week at 0.41%. The CBN
also conducted an OMO auction offering N60.00billion ($123.7 million) worth of
notes. 91- day, 180-day, and 362-day were allotted 1.65%, 4.50%, and 6.44%
respectively. The NTB average yield closed the week at 0.47%. Given the rise in
yields, increased investor participation is likely. In the bond market, the
Debt Management Office conducted a bond auction offering N60bn worth of bonds,
however, what was allotted at the end of the auction was N30bn worth of bonds.
The 15- year and 25-year papers were allotted at 6.95% and 7.05% respectively.
Oil
The price of Brent crude rose by 4.58% last week to
US$52.26/bbl. The average price, year-to-date, is US$42.96 /bbl, 32.97% lower
than the average of US$64.10 /bbl in 2019. Oil closed last week at over $50/bbl
as the United States began vaccinating its frontline workers, but prices are on
the decline again as worry about excessive supply outweighs the positive news
about the vaccines and challenges come to the surface in terms of availability
and distribution. OPEC revised down its forecast for oil demand for the rest of
2020 and 2021 although oil inventories are also declining thanks to strengthening
demand from Asia, adding to the general optimism about oil prices next year.
Equities
Last week, the Nigerian Stock Exchange All-Share Index
(NSE-ASI) rose by 7.46% with a gain of 37.12% year-to-date to close at
36,804.75. Airtel Africa (+21.00%), Dangote Cement (+14.48%) and Guinness
Nigeria (+11.24%) closed positive while International Breweries (-12.67%) and
Stanbic IBTC (-0.11%) closed negative. The Model Equity Portfolio will be back
next week.
Interest rates on the
rise
Two weeks ago, we asked whether the Central Bank of
Nigeria (CBN) wanted to put a floor under market interest rates (Nigeria Weekly
Update, Saving Interest Rates?, 7 December). Now we have an answer, namely that
the effect of the CBN's Special Bills issue (bills granted to banks in respect
of their excess cash reserve ratio held by the CBN), with a yield of 0.5%, has
been to support interest rates. T-bill rates have been rising for two weeks.
This is a change in the way the market sees interest rates rather than a guarantee
that the CBN is in favour of raising them. The market has seen market interest
rates crash this year and was wondering whether negative market interest rates
would emerge. The CBN's response was to address the liquidity issues caused by
its cash reserve ratio (officially 27.5% but effectively much higher, hence the
excess CRR) by issuing N4.1 trillion (US$10.5bn) of Special Bills to banks. But
its 0.5% rate was, presumably, a signal to the market.
What options are now open to the CBN? 2021 will be
another year of significant deficit financing for the Federal Government of
Nigeria (FGN), with the result that, according to the draft budget, N5.2
trillion (US$13.3bn) needs to be raised. From the point of view of the
government's Debt Management Office (DMO) it is preferable to raise this at low
interest rates. But, before the question of what rate is going to be achieved,
it is probably advisable to ask where the money is going to come from.
In 2020 the CBN achieved effects of quantitative
easing (QE) without announcing a bond-buying program. It did this (starting in
October 2019) by preventing Nigerian institutions from buying new issues of its
open market operation (OMO) bills, effectively reducing the size of the OMO
market over time (e.g., from N9.8 trillion in January to N5.5 trillion in
mid-December) and causing these funds to be diverted into the Treasury Bill and
FGN Bond markets. At the same time the CRR took liquidity from the banking
sector into the public sector.
This can only be done once, in our view. The OMO
market cannot be run down indefinitely (part of it is foreign-owned, in any
case) and the CRR cannot be raised indefinitely (the CBN has acknowledged that
it causes banks liquidity problems). So, the options for financing the budget
deficit in 2021 include raising interest rates to attract institutional money
and, possibly, expanding the CBN's balance sheet (as would happen in a
conventional QE program). Meanwhile, while the aim of increasing bank lending
has been achieved, inflation is rising, with headline inflation at 14.89% y/y
and food inflation at 18.30% y/y (November). We doubt that the CBN wants to
address inflation with interest rates, but it may tolerate a rise in interest rates
over the coming months as a way of stabilizing public finances.
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