Nigeria is showing mixed signals of overheating in its capital markets, as fast growth and better fundamentals which are making emerging markets attractive investment destinations begin to show increased risk of a crowded trade.
This is according to analysts at Deutsche Bank, who looked at three factors which give early warnings on whether economies are overheating for a set of 36 emerging markets, and noticed that two-thirds of the countries have shown signs of “excess growth” to varying degrees in at least one of the indicators during the past three years.
The three factors that analysts Maria Laura Lanzeni and Christian Weistroffer looked at in their research were credit-to-gross domestic product (GDP) ratios, equity prices deflated by consumer price inflation and the real effective exchange rate (REER).
In the Middle East and Africa, “there are strong and persistent signs of overvaluation” for Nigeria,
with a 30 percent REER gap with respect to the long-term trend and a 21 percent gap for equities.
“Credit growth, on the other hand, remains subdued, possibly related to Nigeria’s past banking problems. This may mitigate overheating pressures emanating from the other two indicators, at least for now,” the analysts said.
Their analysis compared the actual performance with the trend and they say that it does not necessarily mean that if an indicator shows rapid growth it is a negative sign, as for instance, a country could experience financial deepening starting from a low credit-to-GDP level.
The domestic credit provided by the banking sector as a percentage of GDP in Nigeria at 34.5 percent is low, compared to its peer country, South Africa at over 77.5 percent at the end of 2011.
Read also: Why our services as valuers are critical in capital market business – Ubosi
Nigerian equities which rallied by 34 percent in 2012, have risen 18 percent year to date, helping to stoke the fears of overheating found in the report.
The naira appreciated 3.9 percent versus the dollar in 2012, and has appreciated in real terms in the past three years.
Gross portfolio inflows in 2012 amounted to $13.4 bn, nearly three times the 2011 total of $4.51bn, as JPMorgan added the nation’s bonds to its emerging markets index, while offshore dollar inflows in January 2013 alone was $2.38 bn, according to CBN data.
There have however been signs lately of a cooling in portfolio flows to the country.
Thailand has the strongest signals of overheating, with the current stock market gap versus the long-term trend at 66 percent and the REER almost 10 percent above trend, while credit-to-GDP is around 8 percent above trend.
Five countries – China, Malaysia, the Philippines, hailand and Peru, showed alert levels for two indicators, “warranting a more in-depth look at possible overheating risks in these countries,” according to the Deutsche Bank analysts’ report.
For China, the “strongest and most persistent signal is for the REER – it has flagged since early
2008,” the report said.
“Whatever one’s opinion about the fair value of the renminbi, our findings show a fairly strong real appreciation in recent years,” the analysts added.
The second indicator that could constitute an alert signal for China is credit growth, but this is concentrated at the beginning of the three-year period, with recent developments showing more moderate credit-to-GDP growth.
For Malaysia, the signs to watch are “the sizeable REER appreciation” – a cumulative 16 percent since 2010 – and “significant credit growth in excess of GDP growth,” a 12 percentage points increase since 2010.
In the Philippines, the Deutsche Bank analysts said their model shows “frothiness” in stock markets over the past three years, including the recent months, as well as robust credit-to-GDP in 2011 but which has since slowed down.
The analysts stressed that the threat of “full-blown crises” in emerging markets – which are in much better economic shape, as they had improved their economic policies and reduced external and internal imbalances – has “receded markedly” but a “hard landing” after overheating could still be damaging
