Investors who lend the government N100 million for a period of 12 months, could make a profit of around N17.5 million in as many months, as the Central Bank of Nigeria (CBN) bids rates higher in an effort to lure foreign portfolio investors and keep the exchange rate stable ahead of elections next February.
Yields on one-year government treasury bills are now around 17.5 percent from as low as 11 percent at the start of the year and that gives a 14.62 percent spread to the benchmark 10-year US treasuries of 2.8 percent.
“With the 12 month yield now around 17.5 percent and bond rates shy of 16 percent, the investment case for Nigerian debt is becoming more attractive,” said Samir Gadio, the head of research at Standard Chartered.
“It is possible that open market operations (OMO) bill yields will rise further, but even in this case the curve will probably bear flatten rather than shift in parallel. As such, duration losses at the back end could be contained, while investors will be able to average returns on their bill positions at higher rates (if they materialise),” Gadio said in an emailed response.
READ ALSO: CBN wades into OMO market as buyer of last resort
As yields on government debt inch back upwards, there are opportunities for investors but risks abound for Africa’s largest economy which has been slapped with growth downgrades from the International Monetary Fund (IMF), World Bank and local economists who say the government’s diversification efforts have not yielded sufficient results.
Investors can buy Treasury bills through their banks or through i-invest- a mobile platform for trading government securities.
The last time yields were this high was between 2016 and early 2017, when the CBN pushed benchmark interest rates to a record high 14 percent to make naira assets attractive to foreign investors who were rushing out the door.
Investors were fleeing then from capital controls targeted at defending the naira from weakening, but which ended up in acute dollar shortages that contributed to Nigeria’s first economic recession in a quarter of a century.
The apex bank governor, Godwin Emefiele got some stick from investors for defending the naira when it didn’t have the external reserves to back it up as foreign investments dried up.
It took a 40 percent devaluation of the naira and the creation of the Investor and Exporters window in April- which helped foreign investors get a fair market price for each dollar- for foreign investors to trickle back in; albeit foreign inflows have not recovered to the pre-crisis high.
Amid the rally in yields which led government’s debt servicing costs and the CBN’s interest payments to skyrocket, investors who parked substantial cash into treasury bills and bonds made significant profit without risk.
The zero default risk of lending to a government is the reason why yields on sovereign bonds are usually in low single digits and high single digits in most developed and emerging markets respectively.
And so, investors embraced Nigerian debt with opened arms. By the end of 2017, foreign portfolio inflows surged 305 percent to $7.3 billion in 2017 from $1.8 billion in 2016.
Even the commercial banks made a killing, booking over N500 billion in profit from investing in government securities.
The higher yield environment however came at a heavy cost for the country and the debate of whether the pain it took to lure foreign portfolio inflows was worth it, still rages on.
Not only did it dissuade companies from investing in the economy or banks from lending to the real sector, it piled pressure on an economy that had exited recession by the skin of its teeth with increased oil prices and production to thank.
It also caused the federal government’s interest payment as a percentage of revenue to balloon by a record-high of 66 percent in 2017, with the total debt stock rising three fold.
The high yield environment also took a toll on the CBN’s interest expense which jumped by 192.8 percent to N1.3 trillion from N459.3 billion the previous year on the back of a 44.7 percent rise in Open Market Operation (OMO) auctions to N11.3 trillion in 2017 from N7.8 trillion in 2016, according to the bank’s annual report.
Average OMO yields increased to 19.43 percent in 2017 as against 14.60 percent, feeding directly into the higher interest expenses.
The Central Bank has reverted again to aggressive OMO auctions since May, after what seemed like a slowdown at the start of the year when oil prices rallied and external reserves were growing rapidly.
The justification for the renewed aggressive OMO auctions is to fend off pressure on the exchange rate, as emerging market assets from currencies to equities suffer due to rising interest rates in the United States that has triggered foreign portfolio outflows.
Though the naira has depreciated marginally from mid-2018 levels, it has largely outperformed most emerging market currencies given the CBN’s focus on exchange rate stability.
And the CBN won’t rest on that fight now, as exchange rate stability is often used as a political tool in canvassing for electoral votes in Nigeria which heads to the polls in February 2019 with incumbent President Muhammadu Buhari seeking a second term.
The CBN allowed higher OMO bill yields to slow portfolio outflows after the naira came under relative pressure and external reserves fell from May-highs of nearly $50 billion to a little over $42 billion. The naira has weakened to around N364 per US dollar from N360 at the Investors and Exporters window.
The Abuja-based bank’s commitment to exchange rate stability means yields may go even higher between now and February, as Emefiele has taken every chance to reinforce the bank’s unwavering commitment to keeping the value of the naira steady.
Emefiele is working his talk. Despite lower oil prices in recent weeks, the CBN has continued to provide consistent FX liquidity and investors told Business Day that the track record of FX convertibility this year has been good, which should anchor confidence.
