Nigeria finds itself again at a familiar juncture, where it must choose whether to prioritise the health of its economy by lowering interest rates or cave in to the wishes of foreign portfolio investors by leaving rates elevated.
That’s after the Central Bank’s renewed push to drive rates lower has been met with resistance by foreign portfolio investors, who are demanding higher yields to compensate for lower oil prices and a weakening naira.
Investors are keen to see what the CBN’s next move will be with some N300 billion of OMO maturities due this week.
Does the apex bank stick to offering lower rates and risk subdued demand from investors like last week’s OMO auction or does it come to the market with a higher offer that’ll be enticing enough to attract interest?
At last week’s monthly auction of FGN bonds, the Debt Management Office (DMO), the agency in charge of raising debt for the Federal Government, sought to collect N145 billion, raised N15 billion (US$50 million) and attracted a total bid of N95 billion for the five-, 10- and 30-year benchmarks.
Sales at the auction were the lowest since December 2018.
The DMO later said it raised a further N44 billion from sales on a non-competitive basis.
The outcome for the DMO was a disappointment, according to Gregory Kronsten, head of fixed income research at Lagos-based FBN Quest.
“The DMO had the thankless task of trying to hold the line on rates in an unfavourable market environment,” Kronsten said in a note to clients August 23.
“Bond rates had fallen too far and too fast, as some foreign portfolio investors (FPIs) made their exit,” Kronsten added.
The discount rate on offer at the bond auction was around 13 percent, down some 200 basis points from 15 percent at the last auction.
While foreign demand has waned on the back of lower yields, local investors are also looking away.
The banks, who are one of the heavy buyers of local debt, are pre-occupied with extending credit to small businesses to meet a CBN directive to increase their loan-to-deposit ratio to 60 percent by the end of September.
That has shaved some demand off the market, according to Egie Akpata, a director at financial advisory firm, Union Capital Markets.
“Rates have to go up to get demand back, because at the current rates it doesn’t make sense for local buyers,” Akpata said.
Foreign investors want rates to go up to compensate them for lower oil prices even as there are concerns over the cost of a lawsuit that may see the CBN part with $9 billion.
That could set back the external reserves ($44 billion) by as much as 20 percent and foreign investors are not comfortable with that.
“Investors want extra compensation for Nigerian debt which they feel is riskier today than when oil prices were above $60 per barrel and dollar inflows were strong,” one trader said.
“If the CBN must keep interest rates low, then it could give additional return to FPIs through the FX futures market by putting the futures rates slightly lower than where it is now – like, say, between N360-N370 per US dollar while spot moves to N370/380,” the trader said.
The CBN was faced with a scenario like this in 2016 when it had to prioritise satisfying foreign portfolio investors with higher yields to attract inflows and stabilise the foreign exchange market, even if it came at the cost of cut-throat debt servicing costs for the apex bank and the Federal Government.
Although the high yields on offer attracted dollar flows, the economy was on shaky grounds.
The Federal Government was borrowing at a record 18 percent and that crowded out the private sector in an economy plagued with low growth and negative GDP per capita, despite having just exited recession.
Though yields would later fall to as low as 12 percent on average, foreign investors kept the dollars flowing, snapping up everything from Treasury Bills to OMO bills. Even the political uncertainty in the build-up to the February 2019 elections and its outcome that hammered stocks did not deter foreign flows into Nigerian local debt. The carry trade opportunities were enticing, traders said at the time, and foreign investors were satisfied.
That love affair has, however, been strained recently, with the CBN offering lower rates, to the ire of foreign investors.
The CBN’s change of tack is quite rational. The high yield environment, despite keeping dollars flowing and ensuring exchange rate stability, has become unsustainable since then.
Today, the Federal Government’s debt servicing cost as a percentage of revenue is as high as 65 percent and is forecast by economists to hit 70 percent by year-end on the back of lower-than-expected non-oil revenue.
If oil prices stay lower than the budget peg of $60 for longer and the budgeted oil revenue turns out lower than planned as well, the government could be paying N80 of each N100 earned to service debt.
That’s a risky fiscal scenario for Nigeria.
If 80 percent of revenues go to debt servicing, it means only 20 percent will be left to cater for non-debt recurrent expenditure, from payment of salaries to overhead costs and capital spending.
With the Federal Government faced with the risk of a fiscal crisis and the economy still reeling from low growth, the CBN took the initiative to lower rates. But that is leading to investor apathy for local debt, with the government struggling to attract sufficient appetite.
LOLADE AKINMURELE
