Wednesday, August 23, 2017 04:35 PM / Vetiva Research
· Capital imports recovers in Q2’17 – up 97% q/q, 72% y/y
· Portfolio flows make welcome return
· Foreign Direct Investment remains picky
· Tight monetary policy needed to sustain inflows
Capital imports recovers in Q2’17 – up 97% q/q, 72% y/y
Foreign investments into Nigeria rose to $1,792 million in the second quarter of the year, a marked improvement on the previous quarter ($908 million), as well as the corresponding period in 2016 ($1,042 million). The main drivers of this surge were Foreign Portfolio Inflows (FPI) and Other Investments in the form of loans. These rose from $317 million and $383 million in Q1’17 to $771 million and $747 million respectively.
Meanwhile, we highlight that Nigeria raised a $1,500 million Eurobond in March and a $300 million Diaspora Bond in June, but these have not yet been recorded in the capital import figures for the first half of 2017. Accounting for these, foreign inflows into the country compare favorably to recent years.
Overall, this brought recorded capital imports for the first half of the year to $2,701 million, a 54% increase over H1’16, but still significantly weaker than historical levels.
Portfolio flows make welcome return
The mini-recovery in FPI is particularly encouraging given 2016 FPI ($1,813 million) was the weakest since 2009 ($1,540 million). This made FPI the highest contributor to capital imports for the quarter, a return to historical trend, excluding the blip in 2016.
As FPI really only picked up in May – $337 million vs. $119 million in April – we attribute this improvement to the establishment of the “Investors & Exporter’s” Foreign Exchange Window (i.e. the I&E Window).
The window, ostensibly targeted at boosting foreign portfolio flows, has significantly improved liquidity, encouraged autonomous dollar inflows, and enhanced price discovery in the foreign exchange market. We believe this development was supported by an improving macroeconomic environment, reflected in above-50 Purchasing Managers’ Index readings in the quarter.
We note that FPI in the quarter was predominantly for equity investments. Portfolio investments in equity instruments registered at $614 million, 80% of Q2’17 FPI, compared to $102 million (33%) in Q1’17, as equities recorded their strongest inflows since the end of 2015.
This return of foreign capital to the Nigerian Stock Exchange (NSE) is consistent with the surge in equity market average daily turnover which doubled from ₦2 billion in the first quarter to ₦4 billion in the second quarter of 2017. Whilst the I&E Window played a primary role here, we believe that impressive corporate earnings in Q1’17 also enticed players into the market.
Foreign Direct Investment remains picky
Notwithstanding a 30% q/q and 49% y/y improvement in Foreign Direct Investment (FDI) in Q2’17, foreign direct investment in Nigeria still compares unfavorably to historical levels and regional peers. Moreover, the historical FDI trend is worryingly negative, indicating that the Nigerian economy has attracted dwindling levels of long-term foreign investment.
FDI in 2007 was $4,282 million (45% of total capital inflows and 2.0% of the Nigerian economy). At the end of 2016, FDI had fallen to $1,044 million (20% of total capital imports and just 0.2% of the economy). We highlight that the Federal Government has indicated a number of industries that it would encourage foreign investment in; such as the midstream oil & gas industry, mining & solid minerals, and the ICT space.
However, success on this front would largely depend on the effective implementation of the Economic Recovery & Growth Plan which, amongst others, seeks to tackle constraints to the growth of business in the country, create an enabling environment for markets to work, and develop Nigeria’s human capital.
Monetary policy evolution key for capital account
One key determinant of capital imports going forward is the medium-term trajectory of interest rates in the global and domestic environments. The United States is currently in a monetary tightening cycle, and our expectation is that financial conditions will tighten further there once the Federal Reserve begins to unwind its balance sheet and partially reverse the Quantitative Easing process. Similarly, the European Central Bank has intimated a more hawkish monetary stance in 2018.
A more attractive yield environment in advanced economies could dampen interest on emerging market assets and stall the recovery in Nigeria’s capital imports. Meanwhile, we expect domestic monetary policy to remain tight amidst stubborn inflation and a need to support the naira in floating segments of the currency market.
However, we have observed slightly dovish body language from the Monetary Policy Committee, with two out of eight members voting to cut interest rates at the July meeting. We underscore the fact that loosening monetary conditions in Nigeria, when the opposite is taking place in advanced economies, is unlikely to be positive for Nigeria’s capital account.
Capital inflows to remain resilient in H2’17
Beyond monetary policy, the health of the currency market will remain key for foreign investors for the foreseeable future. With improved oil earnings bolstering Central Bank of Nigeria dollar injections and external reserves rising, we are cautiously optimistic about foreign exchange liquidity going into 2018.
In addition, improving macroeconomic conditions should spur capital imports whilst investors will be eyeing policy and political stability as they look to bring in more patient capital.
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