Onshore Nigeria Investing to Remain Problematic

Flag of Nigeria in a stack of coins.(series)

Nigeria saw strong demand for its recent USD-denominated global bond.  Until the country addresses its FX problems, investors should be wary of investing onshore in Nigeria.

POLITICAL OUTLOOK

There have been rising concerns about President Buhari’s health.  He left the country for a holiday back on January 19, and was due to return in early February.  Buhari then sent a letter to the National Assembly as notification that he was extending his stay in the UK in order to undertake some medical exams.

President Buhari’s health was a concern when was running for President in 2015.  Officials just described Buhari as “hale and Hearty.”  However, Buhari’s wife recently asked Nigerians to pray for her husband.

BBC reported that Presidents Trump and Buhari spoke by phone yesterday.  It was described as “cordial” and Buhari was reportedly invited to Washington at “a mutually convenient date.”  Trump reportedly pledged more aid in the fight against terrorist groups.

Meanwhile, militant groups continue to bomb oil pipelines.  Oil Minister Kachikwu estimated that Nigeria lost as much as $100 bln in oil income from supply disruptions last year.  Boko Haram remains active as well, not only in pipeline bombings but also mass kidnappings.  Military clashes have become routine.  The army killed over 100 people this month when it mistakenly bombed a refugee camp that it mistook for Boko Haram.

ECONOMIC OUTLOOK

The economy is in recession.  GDP growth contracted by an estimated -1.5% in 2016.  Growth is forecast to accelerate modestly to around 1% in 2017.  Higher oil prices should help boost growth in 2017, but Nigeria is unlikely to realize all of the potential benefits.  Why?

Oil output remains well below potential.  According to Bloomberg, Nigeria produced only 1.64 mln bbl/day of oil in January, well below its estimated 2.2 mln capacity.  Nigeria was exempt from the recent OPEC output cut, as the nation continues to have trouble maintain output in the face of continue pipeline bombings.  The government targets output of 2.5 mln bbl/day by 2020, but this may be optimistic.

Price pressures are still rising, with CPI accelerating to 18.6% y/y in December.  This is the highest rate since October 2005.  This supports the case for further tightening, but the central bank has been on hold since its last 200 bp rate hike in July 2016.  Cleary, boosting growth is being given priority over fighting inflation.

Fiscal policy has deteriorated.  Obviously, low oil prices took a toll on revenues.  However, we are concerned that President Buhari recently proposed a 20% increase in this year’s budget to stimulate the economy.  The budget deficit came in at an estimated -3% of GDP in 2016, little changed from 2015.  It is expected to narrow slightly in 2017.

Press reports that the government will reportedly announced plans for $16.4 bln of asset sales over the next four years.  Officials said that the plan has not been finalized, however, and further details will be released later this month.  While such a plan should help plug some fiscal holes, asset sales should be seen as one-off measures.  Higher oil prices are a good development, but the government needs to do more to limit the fiscal gap.

The external accounts bear watching.  Low oil prices hurt exports, but the recession helped reduce imports.  The current account gap moved into deficit in 2015, and is expected to remain in deficit for the next several years.  The gap is expected to come in around -2% of GDP in both 2017 and 2018.

Foreign reserves fell to a multi-year low of $24 bln in October, but have since recovered.  In January, reserves rose to $28.2 bln.  This covers nearly 5 months of import and is almost 7 times larger than its stock of short-term external debt.  Officials have said that they are hoping to increase reserves to $35 bln by mid-year and $40 bln by end-Q3.

INVESTMENT OUTLOOK

A senior central bank official stressed that the level of foreign reserves is very important in regaining investor confidence.  The official downplayed the need for devaluation, instead focusing on allaying investor concerns about repatriating their investments.  This suggests to us that there are no imminent plans to adjust the official rate.  As it stands, foreign investors face very long delays in repatriating even small amounts of investment ($2-3 mln).

The official naira rate has been kept steady around 315 since June, when the naira was “floated.”  Yet this official rate is meaningless, since no one can readily access dollars at this artificially strong rate.  The black market rate is reportedly trading around 500, while 3-month NDFs are trading around 330, 6-month NDFs around 353, and 12-month NDFs around 395.  The black market is utilized mainly by domestic importers, while the NDF market is typically used to hedge onshore investments.

Where might NGN trade if it were freely floated?  Black market rates often provide the clearest signal since parallel markets are for the most part unfettered by official interference.  When Argentina floated the peso in 2015, the new rate quickly converged with the black market rate.  The same held true for Egypt when it floated the pound in November.  However, there is always risk of overshoot above the current black market rate of 500.

Nigerian equities are underperforming.  In 2016, MSCI Nigeria was up 2% while MSCI Frontier was -1%.  So far this year, MSCI Nigeria is -7% YTD and compares to +8% YTD for MSCI Frontier.  This underperformance is likely to continue until there is more clarity on the nation’s FX policy.  There is simply no reason to invest onshore when there are no guarantees that those funds can be repatriated.

Despite concerns about onshore, NGN-denominated investments, global investors piled into Nigeria’s recent offshore USD-denominated bond issue.  Bids were said to total nearly $8 bln for the $1 bln issue.  This was the first global bond issuance by the nation since 2013.  As long as oil prices remain in current ranges, the nation should have no problems servicing its external debt.

Our own sovereign ratings model shows Nigeria’s implied rating at B+/B1/B+.  This is mostly in line with its actual ratings of B/B1/B+.