Why portfolio investors are not flocking to Naira-based assets

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Thursday, August 11, 2016 12:55 PM / By Temitope Oshikoya**   

 “We have had countless of time that capital inflows are just waiting in the wings to pour back in if only Nigeria would devalue its currency. Recent evidence from emerging markets suggests that they should go and tell that to the marines!” 

This quote is from an article on “Currency Woes and Capital Flows in Emerging Markets,”published by this writer in BusinessDay in February, 2016. In that article, we had observedthat “in contrast to perceived wisdom there is no guarantee that capital inflows would surge into the country following further massive depreciations.”

It looks like our financial analysts and market intelligence gurus are just beginning to wake up from their slumber to this reality based on global data, economic fundamentals and empirical analysis on portfolio capital flows that we have been painting, starting with the article on “JPMorgan Index and Collective Self-Delusion” in August, 2015 in The Guardian.

Instead of reckoning with their irrational exuberance, euphoria, and fixation with the exchange rate, some financial analysts are now taking solace in the fact that Nigeria’s sovereign ratings are better than that of its non-oil relatively smaller neighbours. The real comparison should be among other oil exporters as shown in Chart 1.  

 

As earlier remarked, Harvard Economics ProfessorCarmen Reinhart’s articleThe Return of the Currency Crash in Project Syndicate has noted thatThe average cumulative depreciation versus the US dollar has been almost 35% from January 2014 to January 2016 for more than 75 countries. For many emerging markets, where depreciations have been considerably greater, weakening exchange rates have aggravated current problems associated with rising foreign-currency debts. But, thus far, there is little to suggest that the depreciations have had much of a salutary effect on economic growth, which for the most part has remained sluggish.”

We also observed that “Yet in spite of those depreciations, The Institute of International Finance (IIF), an association of international bankers, recently released estimates of massive net capital outflows of $735 billion from emerging markets in 2015 on top of more than $111 billion in outflows registered in 2014.” The Institute for International Finance is an association of over 500 global banks and other institutions including Citibank, JP Morgan, HSBC, World Bank, and Standards & Poor's, etc.

As illustrated in Chart 2from Quartz based on the IIF estimates, “money poured into the emerging markets over the last three decades. Now, like a nasty riptide, it’s pulling out.” We further noted that “Nigeria is not immune to the capital outflows sneeze that has affected Russia, Brazil, and China and weakened the Yuan, ruble, and Brazilian real. All the capital outflows are simply looking for safety, and recent history of global capital flows suggests that the U.S. Government treasuries and bonds provide the greatest safety in periods of uncertainty.”



In another article “The IMF on Nigeria’s Capital Flows Mirage,” we observed that stylized facts suggest that total capital inflows, in particular portfolio inflows into Nigeria, coincided with the period of high oil prices and low interest rates in advanced economies, and the associated search for yield by investors. According to the empirical analysis, Nigeria’s capital inflows, especially portfolio inflows, have been reduced by push factors of higher yields on the ten-year U.S. Treasury, the VIX volatility index, and the EMBI Global spread on emerging market sovereign debt, which measure the increased risk aversion either in general or toward emerging markets.  

The IMF also notes that while higher expected depreciation of the naira also tended to reduce capital inflows, but the results were not statistically significant. The largest impacts, on Nigeria’s capital flows, however, result from the rising U.S. Treasury yield and the lower oil price, which would continue to exert a drag on capital inflows and the external reserves (Chart 3 below).

 

The empirical findings point to risks that capital inflows to Nigeria will be lower in the near term than in the recent past. In the short run, Nigeria’s room to manoeuvre in an environment of low oil prices and rising external interest rates may be limited. In essence, portfolio flows flood in when you really do not need them, and begins to withdraw when you actually need them.The IMF concludes that in the long run, removing structural impediments to growth and enhancing the business environment and governance would be more crucial to increasing capital flows. 

Nigeria will probably receive its fair share of portfolio inflows once sentiments towards emerging markets improve, global oil prices show signs of rising, and global rating agencies start to review the country’s ratings upward. The pull factor is when the Central Bank of Nigeria has raised interest rate sufficiently enough to convince portfolioinvestors, while sacrificing growth. The inverted yield curve with Treasury Bills rates of 20%, which is now above long-dated bond yields point towards that outcome.  

While the financial analysts are still day dreaming about short-term portfolio capitalflows, however, we would like to remind them of the following words of wisdom It is hard, it turns out, to generate a sustained and stable net transfer of resources to emerging market economies. Every time this has happened, a severe crisis has resulted. The U.S. current account deficits of today are, I have concluded, the direct consequence of that failure. The United States has become the world’s spender and borrower of last resort, precisely because the world of globalized finance has proved unstable. This is the story I have been telling in my columns for the Financial Times.” Martin Wolf, chief economics commentator for the Financial Times in his book on Fixing Global Finance. 

Dr. Temitope Oshikoya, an economist and a chartered banker, is CEO of Nextnomics Advisory.

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