Home Companies&Markets Analysis: CBN’S FX rationing, uncertainty pressure Foreign Portfolio Investment

Analysis: CBN’S FX rationing, uncertainty pressure Foreign Portfolio Investment


SAT, SEPT 12, 2020-theGBJournal-Second-quarter data on foreign capital inflows to Nigeria reveals the depth of the decline caused by the COVID-19 pandemic and consequent risk aversion towards naira assets by foreign investors.

Capital importation into Nigeria in Q2-20 plummeted by 78.6% y/y to USD1.29 billion, according to latest National Bureau of Statistics data (NBS). The drop is the lowest since Q1-17 (USD908.27 million), as investors flocked to safe-haven assets due to the COVID-19 pandemic.

The magnitude of the decline was most significant in Foreign Portfolio Investment (FPI) which has historically accounted for the largest proportion of foreign inflows.

The drop in capital importation was aggravated by Nigeria’s FX illiquidity situation as the CBN intensified its FX rationing following the oil price crash and the subsequent decline in oil receipts. Sequentially, capital importation fell by 79.9% q/q.

Portfolio investments have historically been the largest component of capital imported into Nigeria, comprising c.58.8%, on average, of total capital importation over the last six years. However, inflows via the segment plummeted 91.1% y/y (-91.1%q/q) to USD385.3 million in Q2-20, the lowest level since Q1-17 (USD313.6 million) following increased risk aversion towards naira assets.

Inflows into money market instruments, the darling of foreign investors due to the attractive carry trade, declined to a three-year low (USD332.1 million), while equity inflows (USD53.3 million) also declined to the lowest level since at least Q3-13.

Recall that the CBN’s segmentation of the domestic fixed income market has led to a crash in short term yields, with average yields on OMO bills and NTB declining significantly to 8.3% (Q1-20: 13.6%; Q4-19: 13.4%) and 2.8% (Q1- 20:3.9%; Q4-19:7.5%), respectively, in Q2-20.

However, foreign investors still found money market returns sufficient, despite equities looking more attractive, as money market returns made up 82.6% of total portfolio flows. Bear in mind that with equities, investors take on company risk over and above sovereign risk.

Inflows into bonds have been relatively weaker in the years following Nigeria’s exclusion from the JP Morgan Government Bond Index-Emerging Markets (GBIEM) and the Barclays Emerging Markets Local Currency Government index in Q4-15 and Q1-16, respectively, with investors favouring short-term securities.

The CBN introduced new OTC FX futures contracts in February 2020, extending the tenors to five years. The intention was to allow foreign investors to hedge over a longer period, and attract more longer-term capital.

Despite this initiative, for the first time since Q1-17, there were no inflows into local currency bonds during the quarter. This is attributed to lower bond yields which resulted in a situation where Nigerian LCY instruments became less attractive compared to African peers with similar credit ratings and more liberal FX markets.

FDI during the quarter (USD148.6 million) was the lowest since Q3-17 (USD117.6 million) contracting by 33.4% y/y (Q1-20: -13.4% y/y). Overall, FDI contributed 11.5% (vs. 3.7% in Q1-20 and 6.8% in Q4-19) to the total capital imported into the country during the review period.

The FDI performance is also hampered by unclear and inconsistent policy frameworks which has kept it Muted.

The low FDI flows were exacerbated by COVID-19 uncertainties, which reduced investment intentions, as the lockdown made it practically impossible to evaluate and execute investment projects. Data from the Nigerian Investment Promotion Commission (NIPC) shows that the total investment announcements into the country amounted to USD249.9 million in Q2-20 (Q1-20: USD4.8 billion).

However, long-term investments continue to be dampened by unclear and counter-productive policy frameworks at the Federal and State levels. The tax structure is complex, with the Government having a huge role to play in who gets taxed and by what amount and the level of trust in the Government is also low due to over-night policy pronouncements, which disrupts business models.

The infrastructure deficit in Nigeria remains an issue and although the government has rolled out plans to solve this, the pace of development remains slow. Data from the CBN Economic Reports shows that capital expenditure (CapEx) as a percentage of total expenditure has been weak in recent years, averaging 19.7% between 2016 and 2019. Year-to-Date, CapEx as a percentage of total expenditure has averaged just 21.0%.

In the 2020 World Bank Ease of Doing Business report, Nigerian ranked 131st out of 190 countries, well below Ghana (118th) and Egypt (114th) which are seen as viable alternatives for long term capital flows. The WEF Global Competitiveness Index also ranked Nigeria 116th in 2019 (vs. Ghana: 111st and Egypt: 93rd), with the country notching up in market size but ranking low in trade openness, infrastructure, and stability of the financial system.

On other investments, inflows from Loans which made up 56.1% of total capital importation in Q2-20, printed USD726.00 million, slightly above its 7-year average but still 32.0% weaker y/y compared to Q2-19.

In contrast with the norm, naira yields have been close to or even lower than dollar yields for most of 2020 due to the CBN’s segmentation of the fixed income market.

As a result, we have seen corporates abandon foreign debt for much cheaper local currency debt. However, loans inflows grew 29.7% q/q in Q2.

Cordros Research analysts suspect the inability of Nigerian corporates to access hard currency to meet their obligations resulted in foreign parent companies stepping in to provide liquidity for their subsidiaries.

Meanwhile, Cordros reckons that ‘’anxiety will Continue to Weigh Down Capital Importation in H2.’’

‘’Using interest rate parity, we estimate the naira, which is currently at N386/USD at the NAFEX window is overvalued by c.10%. A wide margin (NGN54.00/USD) still exists between the NAFEX and parallel market exchange rates even though the gap between the official and NAFEX rates has been narrowed to c. NGN6.00/USD. In our view, it’s a case of “once bitten, twice shy” for foreign investors, and it will take a further devaluation, and increased FX liquidity to attract new inflows.’’

On liquidity, we note that the CBN has started the process of clearing the backlog of FX demand with the daily sale of USD50 million to Foreign Portfolio Investors.

Although this is positive for exiting investors, the CBN would have to issue instruments at yields higher than the prevailing secondary market rates to make the market interesting for new foreign inflows. Peers with similar ratings and less currency risk have yields on one-year government securities at between 4.9% and 13.7%, compared to Nigeria at 3.6%.

Given the level of liquidity in the system, coupled with the funding needs of the government (c.NGN588.90 billion planned domestic borrowing over the next four months), we do not see yields rising significantly over the rest of the year.

On improving its prospects for attracting foreign investments, efforts need to be made by the government towards communicating policies in a timely manner, promptly executing projects, upgrading critical infrastructure across critical sector value chains, solving credit market imperfections, and resolving legislative barriers to investment.

In our view, relying heavily on tax incentives, as is the current practice, is rather tricky for a government that is looking to diversify its revenue base.

Recent developments in the downstream oil and gas and power sectors bode well for FDI prospects- on the former, the total removal of fuel subsidies and the government regulated pricing, and on the latter, the tariff increase by DisCos. In our view, these are steps in the right direction, towards attracting longer-term capital investments. With Cordros Research.

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