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Nigeria’s Borrowing Spree…Any Cause for Worry?

Proshare

Tuesday, July 04, 2017, 9:08 AM /Afrinvest Research

Much has been said on Nigeria’s aggressive borrowing spree from domestic and international capital markets since 2016, and deservedly so. Since the start of a prolonged global oil price drop in H2:2014, the Nigerian economy has recorded a significant downturn in performance as plummeting government revenues and the resultant FX crisis dragged the economy into its first recession in 25 years. As a result, an expansionary budget of N6.1tn was adopted in the 2016 fiscal year to boost growth and fund more capital projects, with a deficit of N1.8tn estimated for the period. No thanks to the resumption of oil militancy in February 2016 and substantial underperformance of non-oil revenue relative to projections, actual FGN retained revenue was 18.0% short of target, thus deficit widened further. In order to plug this deficit, the Federal Government embarked on an aggressive borrowing spree and this has been sustained into 2017.

To this end, the Debt Management Office (DMO) decided to alter the public debt mix by leveraging on relatively underexplored foreign currency borrowing capacity. Multilateral loans were sought from the AFDB (US$646.6m) in addition to bi-lateral loans from the China EXIM Bank, France AFD and Japan JICA. Following improvements in domestic investment landscape at the turn of the year, Nigeria returned to the International capital market after a 3-year hiatus, successfully raising US$1.5bn via Eurobonds and US$300.0m in diaspora bond. On the domestic front, the DMO has continued with its monthly bond auctions and took it a step further by introducing atypical bonds such as the Savings Bond and a N100.0bn Sukuk offering closing today.

The 2017 budget is projecting another record expenditure year, with fiscal deficit estimated at N2.4tn - domestic borrowing accounting for 53.0% (N1.3tn) of the total while foreign borrowing was projected at N1.1tn. Whilst the deficit funded expansionary fiscal policy pursued in 2016 had a positive impact of growth - as seen in GDP by expenditure numbers in 9M:2016 - it has come at a cost as public debt profile has remained on the uptrend over the years.

According to the DMO, FGN total debt stood at N10.9tn as of year-end 2015 but has risen an astonishing 48.1% in 15 months to N16.2tn in Q1:2017. The rising debt profile is not surprising given the widening budget deficit and large depreciation of the Naira; however, the cost of servicing the mounting obligations took up more than 60.0% of revenue in H1:2016 and has become a major source of concern on debt sustainability. The major argument for increased deficit spending is that the economy is underleveraged with a debt to GDP ratio of 20.0%, but also hard to ignore is the offsetting low non-oil revenue to GDP ratio. Nigeria’s Tax/GDP ratio is 6.0%, which is relatively low when compared to SSA peers - South Africa (26.2%) and Kenya (15.4%).

The nation’s tax collection and administration system is still deemed inefficient with multiple tax system and a high tax evasion & avoidance rate. Despite the recent drive to increase tax revenue, not much has changed in terms of actual results. In fact, federally collected Non-oil revenue fell 4.4% in FY:2016 to N3.0tn. To their credit, fiscal authorities have doubled down on tax reforms including the recently launched Voluntary Asset and Income Declaration Scheme (VAIDS) which grants taxpayers a time-limited opportunity to regularise their tax status without penalty.

However, with the economy challenged, the odds of significantly boosting Tax revenue in the near term is slim and we expect budget deficits to remain high for the next 2-3 years. What does this imply for medium term debt sustainability? Our opinion on this is a bit nuanced. The structure of Nigeria’s public debt is heavily tilted towards the domestic market (up to 77.9% of aggregate debt) and this easier to deal with in the event of a credit crisis. Foreign debt obligations are also mostly multilateral and bilateral in nature (78.0% of total foreign debts) which are typically long tenured and granted at concessionary rate. Thus, we do not expect a debt crisis in the near term but policymakers will need to further diversify revenue base or start deleveraging to avert one in the medium term.


Global Market Review
On the global front this week, crude oil prices rebounded from last week’s loss as Brent crude appreciated 6.0% W-o-W to US $47.92/b as of writing today. The rebound was primarily driven by U.S oil production data released during the week which revealed that output fell by c.100,000b/d to 9.3mb/d in the previous week. Notwithstanding, performance across global equity markets under our coverage was mixed this week. However, as the market closes for the first half of the year today, investors can look back with comfort as all the indices under our coverage closed in the green in H1:2017.

In the developed markets, the UK FTSE fell 1.1% W-o-W on the back of lingering concerns regarding the socio-political environment as well as rising inflation levels. Similarly, the US S&P 500 and NASDAQ slid 0.5% and 2.0% W-o-W respectively on account of renewed rout in technological stocks. In H1:2017, the US NASDAQ appreciated the most, up 14.1%.

Across the BRICS classification, performance was positive as all indices trended northwards save for the India BSE which slid 0.7% W-o-W. The Brazil IBOVESPA and Russia RTS appreciated 2.5% and 2.6% W-o-W respectively against the backdrop of rebound in global oil prices while the China SHANGHAI COMPOSITE climbed 1.1% W-o-W due to an unexpected strengthening in the country’s manufacturing sector. Among the BRICS indices, the India BSE recorded the best performance in H1:2017, up 16.1% followed by the Russia RTS (+10.9%) and Brazil IBOVESPA (+3.9%).

In the Eurasia segment, performance was largely bearish as all indices declined save for the Hong Kong HANG SENG which inched 0.4% higher W-o-W. The France CAC 40 and Germany XETRA DAX declined 2.0% and 2.7% W-o-W respectively amidst speculation of tighter monetary policy in Europe while the Japan NIKKEI slid 0.5% W-o-W due to the sell offs in stocks in the technological sector. The Hong Kong HANG SENG witnessed the highest half year gain in this region with a YTD return of 17.1%.

In the African markets, the Nigerian Bourse rebounded from last week’s negative close as the All Share Index rose 3.1% W-o-W - largely driven by bargain hunting in stocks that depreciated in the previous week - while the Ghanaian GSE advanced 1.2% W-o-W. Contrarily, the Egypt EGX and Kenya NSE fell 0.5% and 0.7% W-o-W respectively. Across this region, the Nigerian All Share Index recorded the highest half year gain with a YTD return of 23.2% followed by the Ghana GSE (
+16.3%) and Kenya NSE (+13.2%). 

Equities Market Review and Outlook
 
The Nigerian bourse recovered from previous week’s loss as investors resorted to bargain hunting in stocks that had depreciated in prior trading sessions. Consequently, the benchmark index climbed 3.1% W-o-W to close at 33,3117.48 points, bumping YTD gain to 23.2%. The positive performance was largely driven by price appreciation in NIGERIAN BREWERIES (+6.0%), FBNH (+8.3%), DANGCEM (+4.8%) and NEM (+10.5%). Accordingly, investors recovered N344.2bn in value as market capitalization rose to N11.5tn. Activity level however declined as average volume and value traded in the week fell 15.5% and 22.3% to 390.4m units and N3.8bn respectively.

Performance across sectors was broadly positive as all indices trended northward W-o-W save for the Insurance index which slid 0.1% W-o-W on account of losses in LAWUNION (-4.9%) and CUSTODYINS (-0.3%). The Industrial Goods index led sector gainers, advancing 3.3% W-o-W on the back of gains in DANGCEM (+4.8%) and WAPCO (+2.9%) while appreciation in UBA (+5.3%)  and ACCESS (+5.0%) pushed the Banking index 3.0% upwards W-o-W. Correspondingly, the Consumer Goods index rose 2.2% W-o-W as a result of positive sentiment towards NIGERIAN BREWERIES (+6.0%) and PZ (+9.7%) while the Oil & Gas index advanced 1.0% W-o-W due to upticks in TOTAL (+2.9%) and ETERNA (+7.3%).

Investor sentiment as mirrored by the market breadth (advancers/decliners’ ratio) improved to 1.4x (from 0.4x recorded in the previous week) as 37 stocks advanced while 26 declined. The best performing stocks were NEM (+10.5%), DIAMOND (+9.7%) and PZ (+9.7%) while SMURFIT (-28.9%), MAYBAKER (-18.1%) and UNILEVER (-14.2%) were the worst performers. Whilst we reckon that the performance of the equities market will remain largely driven by the positive macroeconomic developments in the past three months, we do not eliminate the possibility of some profit taking in the early trading sessions of next week. 

Money Market Review and Outlook
In a relatively short trading week, interbank money market rates moderated as financial system liquidity modestly improved due to OMO maturities. The CBN continued its drive to tighten liquidity, offering N80.0bn worth of OMO bills on Wednesday but only sold N52.0bn for the 358 days tenor and N1.8bn for 176 days maturity at 18.6% and 18.0% stop rates respectively. 

System liquidity improved on Thursday owing to an OMO maturity of N236.12bn, thus money market rates moderated 5.0 and 4.8 percentage points to 4.0% and 4.6% for OBB and OVN respectively. Both rates increased slightly on Friday due to an OMO auction to close the week at 5.3% and 5.8%, down 3.5 and 3.7 percentage points W-o-W respectively. 

The Treasury Bills market saw renewed buying interest this week and as a result average rate on benchmark bills dropped 16bps W-o-W to settle at 18.0%.  At the beginning of the trading session this week, average T-bills rate declined 8bps to 18.1% (from 11.2% on Friday) on the back of renewed buying interest at the short end of the curve. Rates inched lower on Thursday, down 15bps to 18.0%, as investors showed interest across tenors, closing at the same level on Friday.

In the week ahead, N187.0bn worth of Treasury bills will be maturing and the CBN will be conducting a rollover of the same amount; thus, we do not expect to see its impact on system liquidity. We expect money market rates to remain around same levels barring any major inflow or outflow from the system. 


Foreign Exchange Review and Outlook
During the first half of 2017, the Apex bank released several guidelines for a new FX framework which includes the resumption of sales to BDC operators and provision of foreign exchange to all commercial banks to meet retail demand for personal travel allowances (PTA), business travel allowances (BTA), medical needs and school fees with approved rate pegged at 20.0% above the interbank market rate. In April, the Apex bank introduced a new window for sale of FX to SMEs for visible imports up to US$20,000.0/quarter and increased weekly FX sales to BDC operators to US$20,000.0 twice a week.

In response to the weak level of autonomous participation in the domestic FX market, the CBN launched the I & E FX window which caters to portfolio investors, exporters, authorized dealers as well as the Commercial Banks as market participants. Furthermore, the CBN also continued its special wholesale intervention forward sales of FX for maturing LC obligations as well as spot sales. The opening of different FX windows and targeted intervention by the CBN have had a positive knock-on impact on capital liquidity and resulted in a stronger Naira in the parallel market.

At the official market, the naira traded flat within N315.10/US$1.00 to N305.90/US$1.00 in H1: 2017. At the FMDQ NAFEX segment, NGN appreciated 2.5% since the launch of the window from N375.70/US$1.00 to close H1:2017 at N366.41/US$1.00 while rate at the parallel market also appreciated 33.2% from N490.00/US$1.00 at the beginning of the year to close at N368.00/US$1.00.

At the FMDQ OTC Futures market, activity has slowed of recent due to upward revision of contract prices, hence the total value of open contracts declined to US$2.7bn in H1:2017 from US$3.8bn at the beginning of the year. Six contracts have matured this year and replaced with 6 new ones which are largely undersubscribed.

The CBN’s policies over the past months have led to a convergence between parallel and autonomous market rates, but investors still await the last leg of the reform which is replacing the current system of multiple rates with a transparent interbank market.


Bonds Market Review and Outlook
The performance of the domestic bonds market in the first half of 2017 has been lacklustre in comparison to the Treasury bills market as well as the equities market. Despite the seemingly attractive yield environment, investors have consistently favoured shorter tenored instruments (T-bills and OMO) which are trading at higher rates than the longer dated bond instruments. Consequently, average yield across all trading bond instruments increased from 16.4% at the start of the year to 16.7% at the end of H1:2017. We believe this trend will persist until we start to see the CBN ease short term interest rates.

In the current week, there were only three trading sessions and activity level remained largely suboptimal. On the first trading day of the week, average yield across all instruments increased 3bps to close at 16.7% as buying interest in the Short end of the curve was offset by sell pressures on long tenored instruments. Yield traded flattish on Thursday and Friday, eventually settling at 16.7% on Friday, up 1bp W-o-W.

Performance of Sub-Saharan Sovereign Eurobonds under our coverage was mixed this week. As opposed to generally bearish sentiment last week, investors’ took interest in Nigerian, Ghanaian, Ivorian and Gabonese instruments with yields declining across tenors W-o-W. However, the sell off on South African, Zambian and Senegalese Eurobonds persisted. In H1:2017, the best performing instrument was the KENYA 2024 (+8.0%) followed by ZAMBIA 2024 (+6.6%) and NIGERIA 2023 (+6.4%).

Similarly, performance of the Nigerian Corporate Eurobonds was mixed. Yield on FIDELITY 2018, ACCESS 2021, ZENITH 2019, FBN 2020 and DIAMOND 2019 declined 64bps, 20bps, 5bps, 3bps and 2bps respectively while yield on ACCESS 2017, GUARANTY 2018, FBN 2021 and ACCESS 2021 increased 295bps, 13bps, 2bps and 1bp respectively. Interest in the Nigerian corporate Eurobonds persisted in H1:2017 as all instruments, save for the ACCESS 2017 (-1.3%), closed in the green for the period. 


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