Analysts see over N4trn of passive funds outflow
JP Morgan’s phased removal of Nigeria from its GBI-EM indices of local currency government bonds for failing its liquidity and transparency tests is already putting pressure on Nigerian assets classes, as well as banks capital adequacy ratio (CAR).
But, the Federal Ministry of Finance (FMF), Central Bank of Nigeria (CBN), and the Debt Management Office (DMO) have jointly responded to the decision saying they strongly disagree with the premise and conclusions upon which the decision rests.
In a statement signed by Ibrahim Mu’azu, director, corporate communications, CBN, the apex bank said: “While we would continue to ensure that there is liquidity and transparency in the market, we would like to note that the market for FGN Bonds remains strong and active, due primarily to the strength and diversity of the domestic investor base.
“For the avoidance of doubt, the Federal Government sees Nigeria and the interest of Nigerians as paramount. It will therefore only continue to take economic decisions that will impact positively in the lives of all Nigerians.”
However, at the equities front, the recent rally halted, as sell pressure robbed equities of N239 billion in value. Likewise, analysts said deposit money banks stand to face mark to market losses, while short-term rates on investment securities is expected to see some upward bias.
Analysts expect to see mark to market losses coming through for banks, particularly those with proportionately higher investments in bonds, given the upward bias in yields.
Analysts also see this leading to an outflow of about $2 billion (N4.3trn) of passive funds from Nigeria, as investors in the index seek to rebalance their bond portfolios.
According to the Gregory Kronsten-led team of research analysts at FBN Capital, “This is a demotion for Nigeria and amounts to reputational damage. Since the FGN as well as the CBN are fire fighting in the face of the global headwinds, we do not expect a dramatic response on their part. Nigeria is not eligible for re-inclusion in the GBI-EM indices for at least 12 months. We can assume that JP Morgan would not lightly restore Nigeria.
“The points of interest are the authorities’ response and the macro impact. The CBN is unlikely to scramble to make good the perceived flaws in the FX market for the reason that they (the flaws) support its exchange-rate policy. Its task of holding the line would not be possible if the market was fully functional.
“To make a broader point, the MPC members’ personal statements seldom now view monetary policy as a means of locking in foreign fixed income investors. This will change over time in our view, as the CBN and the MPC move to a more flexible exchange-rate regime.”
Adesoji Solanke, sub-Saharan Africa banking analyst, head of research – Nigeria, Renaissance Capital, said: “One simple read through in terms of implications for the banks is that short-term rates on investment securities should see some upward bias. Key beneficiaries here, given balance sheet positioning, should be GTBank, Zenith, UBA and Fidelity Bank. FBNH.
“On the flip side, we expect to see mark to market losses coming through for banks, particularly those with proportionately higher investments in bonds, given the upward bias in yields. This hurts equity and puts additional pressure on CAR. Based on first-half (H1) 2015 reported numbers, FBN Holdings and Skye Bank have the lowest capital ratios in the sector versus regulatory minimum of 15 percent and we think they could see the most pressure. Skye has a capital raise in the works.”
Yvonne Mhango, Renaissance Capital’s sub-Saharan African economist, said “this will lead to an outflow of about $2 billion (N4.3trn) of passive funds from Nigeria, as investors in the index seek to rebalance their bond portfolios. (NB: Nigeria’s weight in the GBI-EM index was 1.5%).
“FX reserves were at $31bn (30-day Moving Average) on September 7, and are falling. Given the tight FX market, it is likely that the outflow of the $2 billion may turn out to be protracted.”
She added: “We believe the recent build-up of FX restrictions likely accelerated JP Morgan’s decision to remove Nigeria from its EM bond index. Now that JP Morgan has removed Nigeria from the EM bond index, we think there is even less reason/urgency for the CBN to allow the naira to depreciate, and to relax the FX restrictions.
“We actually think the removal of Nigeria from the JP Morgan bond index pushes out the prospect of devaluation, as the threat of being removed from the index has come to pass. We think this means the risk has fallen of the MPC, allowing for a more flexible naira (depreciation) at the next meeting, scheduled for 22 September.
“However, we still believe the CBN will allow the naira to depreciate before YE15, given how low the oil price is and eroding FX reserves. Our YE15 naira view is NGN230/$1.”
FBN capital analysts noted that ahead of the addition of Nigeria to its indices in October 2012, JP Morgan suggested that the inclusion would translate into inflows of about $1.5 billion on the assumption that its tracker investors would adjust their holdings to make the new entrant market-weight.
“These investors will have exited Nigeria by the end-October, the second and final phase of the process. This would probably leave a maximum of $1bn invested by the offshore community in all naira-denominated Nigerian government paper. FGN domestic debt amounted to N8.40trn (US$42bn) at end-June. The same flaws in the FX market naturally apply to the offshore equities investor. However, Nigeria has a place (and the second largest weighting) in the benchmark equities index for frontier markets (MSCI), where the terms for eligibility are less taxing than those for JP Morgan’s indices for emerging markets” they noted.
Source : BusinessDay