A Review on Nigeria’s Macroeconomic Environment.
Fascinated by how the world managed to avoid a financial crisis in 2019, we are side-eyeing every move central banks both at home and abroad make. At the start of the year, international stock markets showed bearish performance influenced majorly by weak economic growth and heightened trade tensions. Also, fixed income securities of some developed economies became unattractive as yields were suppressed by monetary policy easing. As a result, we witnessed an increased appetite of foreign investors for high-yielding emerging and frontier markets financial securities. Not surprisingly, with an attractively high-interest rate on risk-free assets, Nigeria became an investment destination for some carry-traders in the first quarter of 2019.
According to the National Bureau of Statistics, the total value of foreign portfolio capital imported into Nigeria grew by up 412.4% q/q to $7.1bn and was concentrated in fixed income investments (90.8% of total Foreign Portfolio inflow).
In the quest to encourage sustained capital inflow and kick-start growth in the real sector, the Central Bank of Nigeria (CBN) and the Federal Government of Nigeria (FGN) actively utilized monetary and fiscal policies in 2019. The circulars sent out by CBN in 2019 alone were enough to alter the investment plans of investors as the policies focused on reducing over-concentration on risk-free assets and increasing gross credit in the economy. Firstly, the CBN raised the minimum Loan to Deposit Ratio (LDR) target for all Deposit Money Banks (DMBs) from 60% to 65%. To sustain the momentum, the CBN also placed a ban on local investors from investing in Open Market Operation (OMO) bills, creating an artificial shortage for other short-term fixed-income securities. While some analysts are of the view that the reason for this move is to reduce debt servicing by inducing low-interest rates, we believe that this corroborates efforts by the government to drive investments in the real economy and to ensure that banks lend to their customers (especially SMEs).
According to CBN, credit to the private sector increased by 15.1% from N22,947bn in January 2019, to N26,413bn in November 2019
On the fiscal front, the 2019 Finance Bill which was passed alongside the 2020 Budget, proposes fiscal measures with extensive tax implications for the country. With a total proposed expenditure, expected revenue and deficit of N10.33 trillion, N8.15 trillion and N2.18 trillion respectively; the 2020 Budget is projected to be financed partly by tax revenues to be generated through the key fiscal changes introduced by the Bill.
Some key changes introduced by the bill were:
- Exemption of companies with an annual turnover of less than N25m from the requirement of filing VAT returns (driving SME growth and improving the ease of doing business).
- Introduction of lower company income tax rate of 20% on the income of medium-sized companies with an annual turnover of between N25m to N100m.
- An increase in the VAT rate from 5% to 7.5%.
The combination of expansionary monetary and fiscal policy exerts inflationary pressures that lay concerns around the stability of the Naira and the likelihood of a possible depreciation. While concerns are valid, prospects of increased oil revenue (due to forecasted increase in price) and less capital reversal (due to global low-interest rates) may keep significant currency weakening off the table at least in the first half of the year.
Our outlook for Nigerian capital markets in 2020 is one of cautious optimism
Fixed Income which can be seen as the “free lunch” of local and foreign investors in Nigeria have historically offered investors high returns with literally little or no risk. However, it came as a shock when CBN restricted the purchase of OMO bills to foreign investors. For foreign investors, OMO bills are attractive as the primary market rates for the 364-day OMO bills are in the 15.0%-15.3% range. However, the case is slightly different for domestic investors who are excluded from participating in these securities.
This restriction created excess demand for other short term fixed income instruments thereby exerting downward pressure on interest rates. Currently, rates on T-bills are down to lower single-digit levels while longer-term sovereign and corporate bonds remain slightly attractive with returns ranging from upper single-digit to low double-digit levels.
Short-term fixed income securities should not be completely off the table despite the decline, rather, investors should focus on the timing of purchase. We believe rates on short-term fixed income securities will continue to trend lower as more liquidity enters the market, however, this will average out towards the end of the year. Depending on investment objectives and/or horizon, investors could also seek better returns in longer-dated securities.
Equities: The current macroeconomic environment dominated by low rates and increased credit poses questions as to if investors will be incentivized to move to riskier assets such as equities. The Nigerian equities market has lost so much value since 2018, that it leaves no doubt as to whether the current value companies are trading at is less than intrinsic value.
A key sector to watch out for is the ICT sector.
In 2019, the equities market witnessed the overdue entrance of two leading forces in the ICT sector; MTN Nigeria Communications plc (MTN) and Airtel Africa. MTN, Nigeria’s biggest telecommunication company, listed a total of 20.4bn units of shares worth N1.8tn. The large demand for the shares, which was listed at N90/share, drove the market price to a high of N150.0/share. We believe there is still potential for growth driven partly by the increase in informal banking (such as USSD-Transfers). Airtel Africa also listed on the Nigerian Stock Exchange in a 1.36 trillion Naira flotation. The shares of the company grew by 10% from their N363/share listing price after the float went live.
In conclusion, the choice of whether or not to invest in Nigeria at a time of global uncertainty depends on the investor’s risk appetite and investment horizon. Long term investors could benefit from the continued growth in the IT sector and foreign investors can benefit from the high yields offered by OMO bills. A key factor to consider, however, is Nigeria’s exposure to the global oil market. As geopolitical tensions arise within the middle east, it is important to be aware of shocks in oil prices as they could support or suppress returns.
Disclosure: Please note that this article has been prepared for general guidance on the subject matter. There is no consideration given to the specific investment needs, objectives or tolerances of any of the recipients. You are advised to obtain professional advice before acting on the information contained in this article. This report is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned.
This article utilizes data and information from public sources such as Bloomberg, CBN, NBS, NSE. While we consider information from external sources to be reliable, we do not assume responsibility for its accuracy. The views expressed herein are solely those of Afriknowledgebank as of the date of this report and are subject to change without notice.