Nigeria Fixed Income Weekly

The man of system…is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it… He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chessboard. He does not consider that in the great chessboard of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it – Adam Smith

The opening quote captures my thinking about the period between 2015 and 2023. Over the last eight years, the key decision makers in Nigeria’s economy changed how they allocate resources like credit, dollars, and fuel subsidies over the last 8 years. In lieu of market signals, they base decisions on largely adhoc personal opinions. However, this approach has not worked well and has caused problems in markets like fixed income and currency.

Front-end yields collapse under the weight of a liquidity overhang across financial markets: NTB yields and short-dated rates have buckled under the weight of a liquidity surfeit across Nigeria’s financial system since the start of 2023. Financial system liquidity has been boosted by a mix of FGN coupon payments (usually large in January), larger FAAC inflows (NGN1trillion) and inflows from the ongoing de-monetization program. Though the CBN has conducted CRR debits, it would appear that CBN sterilization has been usually meek which has resulted in daily opening balances at over NGN1trillion which has underpinned a decline in interest rates.

Nigeria’s oil output increased further to a 10-month high in January 2023: Data from Nigeria’s upstream regulator, the NUPRC, indicates that oil production reached a 10-month high of 1.49 million barrels per day (mbpd) in January, an increase from December’s 1.41 mbpd. This growth extends the pattern of steady increases since November, when the NNPC began taking steps to stabilize oil output. The significant gains were largely due to recoveries in the production levels of Agbami (+161% to 101kbpd), Erha (+94% to 69kbpd), and Forcados (+5% to 253kbpd), which compensated for the decline in Bonny (down 30% to 71kbpd). Overall, it appears that oil production is on track to reach the 1.6-1.7 mbpd range, but this will require a recovery in the production levels of Brass and Bonny to over 100kbpd from their current low levels.

Figure 1: Nigeria – Oil Production

Source: NUPRC

End game on CBN’s naira pretense:  Though the CBN and its associate company FMDQ continue to report an official exchange rate of NGN461/$, the presentation by the CBN governor to the National Council of State included a strange slide which showed a strengthening in the parallel market exchange rate from NGN768/$ to NGN550/$ which is puzzling. Within its intervention windows, the CBN has been executing sales at NGN490-500/$ range which likely reflects the near-term direction. It is unclear if the NGN 550/$ level is intended as guidance, but it is possible that if the current CBN governor retains his position in the next six months, the Naira may fall to a level closer to NGN 600/$ to be considered credible. From a Real Effective Exchange Rate (REER) perspective, anything above NGN 600/$ would be considered at fair value levels. However, for Nigeria to truly restore stability in its currency exchange system, a more structured approach, similar to the pre-2015 2-way quote trading system with weekly WDAS auctions or the IE window system between 2017 and 2019, will need to be implemented.

Currency re-design or Naira De-monetization? In October 2022, the CBN announced a plan to re-design some denominations (#200, #500 and #1000) of the Naira in circulation alongside a plan to reduce the volume of cash transactions in circulation. The latter entailed lower limits for cash withdrawals and a short time frame between the introduction of the new notes(December 15, 2023) and withdrawal of old notes were to be withdrawn (January 31, 2023). At the end of December 2022, currency outside banks (COB) stood at NGN2.6trillion or 5% of money supply, down from 9% in 2010 and 26% in 2000. In justifying its position, the CBN cited a desire to increase monetary policy effectiveness in curbing inflation even as it echoed confidence that it was in position to manage the entire process seamlessly.  

Figure 2: Currency Outside Banks

Source: CBN

We now have the benefit of time and as with India’s 2016 currency program, Nigerians are experiencing a severe shortage of the new notes, long queues outside banks and facing high costs of transacting in alternative payment platforms especially POS machines. In response, the CBN claims that corrupt bankers are behind the entire episode as it had supplied the banking system with adequate notes. In the media, this narrative of a corrupt banker as well as the red-meat of the need to persist with the policy as a means of fighting vote buying has dominated the airwaves. Interestingly, while the CBN was willing to share data about the amount of cash withdrawn from the system (NGN1.8trillion), there is relative silence of how much cash it has injected, which in my opinion is illuminative. The reason for this is that the CBN has simply been unable to match the pace of withdrawals likely due to capacity constraints of the mint to deliver the required notes. Everyone knows what the demand is but radio silence on the supply of new notes. We are facing a classic inadequate supply problem not due to any sinful banker but a fundamental scarcity as the CBN is simply unable to meet the demand for cash that it chose to create when it placed a deadline on the usage of the old notes. In a manner consistent with the policy making under the CBN Governor, rather than fix the issues, they go about selling a saint-sinner to a desperate Nigerian public eager to find someone to blame for the ongoing struggles. As with exchange rate and the broken interest rate regime, the ongoing issues lie at the foot of the CBN. If the CBN is confident how about announcing how much of the new notes have been printed. What is the solution? Remove the deadline or extend it for 6-12months. The deadline is what marks this entire program as a currency demonetization program and not a currency re-design.

Fundamentally, due to increased adoption of electronic payment channels, cash use in Nigeria is not very large. The CBN has marshalled a red-herring argument that currency outside banks (COB) is a high ratio (85%) of currency in circulation (CIC) and that this had increased from 75% in 2015. This is irrelevant as COB has historically averaged over 80% of CIC given the relatively large informal share of Nigeria’s economy which has a lot of low value transactions. The key metric is what share of aggregate money supply is held in the form of cash balances. That metric has declined over the last two decades to a level lower than what is obtainable in similar countries. The idea that somehow the less than NGN3trillion cash milling around the economy at the end of 2022 was somehow a bigger threat to monetary policy efficacy than the NGN22trillion printed by the CBN when it was lending money to the FGN in breach of statutory limits is an exercise in deceit. The big problems have nothing to do with that cash and this episode continues in the long line of deliberate policy misteps pushed by the CBN leadership over the last nine years.

The Week Ahead (February 13-17)

Higher fuel prices likely drove inflation higher in January 2023: The NBS is set to release the first inflation scorecard in 2023 and my sense is that fuel shortages and higher petrol prices over the month likely drove further deterioration in CPI over the month. My expectation is for an acceleration in m/m to 1.7-1.8% which should result in annualized inflation at 21.6-21.8%.

February 2023 bond auction: The DMO looks to sell NGN360billion evenly split across four tenors (FGN 2028, FGN 2032, FGN 2037 and FGN 2045). In the secondary market, the liquidity surfeit has weighed on the 2028s which are now trading at 13.6% levels while the 32s are trading. The two long end papers (2037s and 2049s) are hovering at the 15.9-16% levels. Given the bulging liquidity and compression in front-end and bank placement rates, demand should be strong which should provide the DMO a window to contain upside and manage the auction better. My sense is the DMO will look to limit upside from these levels. My guess is for stop rates as follows: FGN 2028 (13.5-13.8%), FGN 2032 (15%), FGN 2037 (15.8-15.85%), FGN 2049 (15.85-15.9%)


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