The Standard Chartered Bank study has claimed that an increased flow of foreign investments into Nigerian government bonds would depend on the normalization of foreign exchange conditions. The bank also predicted that further realignment of foreign exchange rate would soon take place in Nigeria.
The study, which was signed off by Samir Gadio, Head, Africa Strategy, FICC Research, said that stakeholders will likely seek to preserve Nigeria’s inclusion in the JPMorgan Government Bond Index-Emerging Markets Indices (JP Morgan GBI-EM Index) noting that Nigeria’s potential exclusion from the GBI-EM indices is an avoidable outcome.
The JP Morgan GBI-EM Index serves as benchmarks for local currency bonds issued by emerging market governments. The index was launched in June 2005 and is the first comprehensive global local emerging markets index. The JP Morgan GBI-EM Index is widely regarded as reference point for foreign investors seeking to diversify their portfolios by investing in sovereign bonds issued by emerging market countries.
Nigeria celebrated its admission to the JP Morgan GBI-EM Index on October 1, 2012. Nigeria was the second African country after South Africa to be included in the widely followed index.
Analysts at CardinalStone Partners Limited said Nigeria is at a risk of capital flight involving about $3.9 billion as possible reactions and impact of the previous downgrade and eventual removal on the local bond market could lead to significant capital flight.
Analysts noted that the total value of investor money benchmarked against the whole JP Morgan GBI-EM suite of indices is about $217 billion. The GBI – EM Global Diversified Index is the most frequently used local emerging market index and Nigeria accounts for 1.8 per cent of its value, about $3.9 billion.
“Hence, Nigeria’s removal from the Index would trigger capital flight at a time when the country needs to attract capital inflow. Bond yields will also spike in reaction to the significant exit by funds which mirror the composition of the index and may subsequently lead to the exit of Nigeria from the Barclay’s Bond Index as well,” CardinalStone Partners stated.
StanChart said it expected Nigerian bonds to remain in the GBI-EM indices provided reforms are undertaken to normalise exchange rate conditions and move towards a price-driven foreign exchange trading platform in the coming months.
“From the government and Central Bank of Nigeria’s standpoint, it represents a significant setback in the development of domestic financial markets and undermines the country’s external credibility. For the index provider, it may test the credentials of the GBI-EM inclusion process, while exclusion on account of foreign exchange liquidity-related factors is largely unknown territory. International investors would also likely prefer Nigeria’s GBI-EM eligibility to be reaffirmed,” StanChart stated.
According to the bank, as the public policy focus shifts back to the economy, Nigerian authorities will probably pay more attention to the needs of corporates and onshore market participants, and streamline the FX market operating environment.
“We see the authorities potentially reintroducing a more flexible price-driven foreign exchange trading platform and moving away from the order-matching system in the foreseeable future. This is likely to be accompanied by an upward adjustment to the exchange rate,” StanChart stated.
It noted significant foreign outflows in late 2014 and early 2015, pointing out that the investors’ interest in the Nigerian bonds remained slow.
“Assuming these conditions are met, we expect decent foreign portfolio inflows to resume,” StanChart said while calling for flexible price-driven foreign exchange.
The report pointed out that Nigerian government bonds may benefit moderately from the index provider’s decision, as market sentiment turns more constructive early this week. However, it believed the extension of the GBI-EM review period has already been largely priced in. Nigerian bonds appear to have found a new level in sub-14 per cent yield territory in recent weeks.
JP Morgan had last Friday extended Nigeria’s Index Watch status in the GBI-EM indices, providing the country with more room for policy reforms. Nigeria’s status review will now be befinalised in the coming months or before year-end at the latest. JP Morgan indicated in its notice that Nigeria’s index eligibility at the end of the extension period would be conditional upon a consistent record of a functioning and transparent foreign exchange market. Specifically, JP Morgan highlights adequate foreign exchange liquidity and two-way flow trading to ensure that benchmarked investors can transact with minimal constraints. JP Morgan had placed Nigeria on Negative watch in the GBI-EM indices in January, citing difficulties for offshore investors to replicate Nigeria’s allocation in the benchmark.
“This extension of the review period is broadly in line with market expectations,” StanChart noted.
JP Morgan had placed Nigeria on “index watch negative” due to what the global financial company described as lack of liquidity induced by regulatory policies of the Central Bank of Nigeria (CBN).
JP Morgan hinged Nigeria’s downgrade to “index watch negative” on recent policies by the CBN, which limited liquidity in the spot foreign exchange market and local treasury liquidity market. The CBN had on December 17, 2014 reduced the net open position (NOP) of commercial banks from one per cent to zero per cent of shareholders fund, before subsequently revising it to 0.1 per cent in January 2015.
JP Morgan stated that this measure effectively resulted in a lack of liquidity in the spot foreign exchange market and domestic bond market thus hindering the ability of foreign investors to replicate Nigeria’s exposure to the GBI-EM Index.
By Dike Onwuamaeze