Nigeria Bonds: International Interest to Drive down Yields
Barely one month after JP Morgan added Nigeria Federal Government of Nigeria (FGN) bonds into its International Government Bond Index, Barclays has announced that it will add the bonds into its Emerging Market Government Bond Index by the first quarter of 2013.
In contrast to the inflow of only $1 billion into the bond market, a whopping sum of $14 billion is expected to enter the market along with addition to the Barclay's Index. The local currency responded immediately to the announcement as the Naira snapped a two day retreat to continue its appreciation. The Naira is currently the best performing currency in Africa for 2012 after being the second worst performing currency in the world in 2011; this is on the wake of the fuel subsidy fraud that leaked over $8 billion to rent seekers.
A day after Barclay's announcement, S&P suddenly upgraded Nigeria's rating from B+ to BB-. This was largely on the back of rising foreign reserves, stable currency and the tightening of the subsidy regime loophole following the nationwide strike in January 2012. This upgrade sent the bond market into a bullish run as investors sold off equity positions and rushed into the bond market.
Another factor that makes the bond market attractive is the fact that inflation has been trending down over the past several months. This was contrary to analysts' consensus that inflation was going to rise precipitously after the partial withdrawal of fuel subsidy. This means that investors are expected to be rewarded with real returns on investment. If this trend continues, the Central Bank of Nigeria (CBN) will be forced to cut interest rates in the first quarter of 2012.
Nigerian banks have been risk averse because of the high yields available in the sovereign bond market and have packed depositors funds in treasury bonds and bills instead of lending funds out. In order to keep potential borrowers away, they raised lending rates to over 30%. While the impact has been positive on the banks' books as non performing loans dropped across board, the impact was negative on the wider economy as businesses were either forced to look for alternative sources of funds or shut down. Many of them took the latter route.
With the rising interest in FGN bonds and lowering yields, the banks are likely to be forced to start lending by the first quarter of 2013. If the CBN also cut rates and/or improve liquidity by reducing liquidity ratio, the economy is expected to have a new lease of life as funds are pushed back into the economy. If the FGN also successfully shifts attention from raising funds in the local market to fund the budget deficit from the international market, the relatively smaller size of the local FGN bonds available for investment is likely to encourage more corporate bodies to access the bond market thus effectively taking care of the ongoing "crowding out effect".
As at the time of writing this the Nigerian Stock Exchange has been on a bearish mood as investor sell off to crystallize their gains. I believe that this is a good time for long term investors to start taking position in the equity market.