Can Nigeria ride the wave of current global liquidity glut?

On a scale of 0 to 100, with 100 being safe and 0 being extremely risky, the Bloomberg Country Risk Index scored Nigeria 4.42 in 2017 – indicating the extreme risk and volatility in Nigeria’s macroeconomic system.  Yet, when the country’s $1 billion Eurobond debuted in the market in February 2017, the issue was 8-times oversubscribed! This is astoundingly contradictory and beats the imagination of not a few detractors.  What explains this sort of paradox?

 

The fact of the matter is that the global financial system is presently awash with liquidity; two-year debt yields are negative in Germany and Japan and below 1% in America.  The Bloomberg’s ten-year real interest rate on inflation-linked bonds has been falling steeply from a high of 4.5% in 2000 to a range -1% to 0.3% in 2016.   In a recent paper (October 2016) in the US Council for Foreign Relations, Brad Setser, a Senior Fellow and Director of the Maurice R. Greenberg Center for Geoeconomic Studies, Iinks this “savings glut” to the astute savings habit of countries like Japan, China, Taiwa, South Korea and of course, city-states of Hong-Kong and Singapore.  Combined, these countries currently hoard about 40% of their collective GDP as savings, a 35-year high.

 

“Savings glut” is a phrase coined by Ben S. Bernanke in 2005 before he became the Chairman of the US Federal Reserve.  Then as at now, he explained that  a global excess of desired saving over desired investment, emanating in large part from China and other Asian emerging market economies and oil producers like Saudi Arabia, was a major reason for low global interest rates.  He argued that the flow of global saving into the United States helped to explain the “conundrum” of persistently low longer-term interest rates in the mid-2000’s while the Fed was raising short-term rates.

 

This same scenario is currently repeating in the global financial system with the additional outflow from Europe.  The implication of this unprecedented current account surplus in Europe and Asia is that investors in both regions are scampering all over the world chasing for marginal returns.  In the bid to maximize returns and escape the near-zero and negative returns trap at home, they are now seeking financial asylum  in the booming market for corporate bonds, including high-grade debt securities issued by the likes of IBM and General Electric and riskier fare churned out by energy and telecommunications companies.   Of course, investors are also not averse to junk and non-investment grade bonds coming from frontier markets like Nigeria – as far as there is a prospect of getting something better than zero returns.

 

So, rather than commit their cash to, for example, building bridges and roads at home or indulge in shopping sprees in China and Japan, investors show preference for accumulating and recycling their funds into global capital markets and thereby artificially dampening interest rates. It has become clear that large parts of the bond market no longer offer the rewards they used to.  Economists have argued the risk inherent in this potentially explosive bubble.  However, this is not our issue for now.

 

Our point this week is that while we may bask in the euphoria of oversubscribed bond issue, it is critical to point out that this strategy is sub-optimal. Nigeria’s bond came in at 7% when the market is trending in the negative and near zero territory. So, even if you are extremely risk averse, the attractiveness of an investment that promises 8 times more returns would definitely outweigh your risk aversion.   Faced with two options, one promising sure negative returns and the other promising strongly positive returns, a rational investor would prefer the later to the former.  This is what precisely happened in the case of our Eurobond.

 

Be that as it may, it shows that Nigeria is still attractive. However, much as we desire to finance our deficit budget, is this bonds-backed borrowing sustainable?

 

This is a very tricky question for several reasons.  First, the deluge of fixed income securities may inflate their values beyond what they are worth, potentially leading to a market bubble that would eventually burst.   The accompanying contagion would surely sink a frontier economy such as Nigeria that is exposed to such securities through such means as the Eurobonds.   This is something our policy makers need to consider.  Several pundits argue that the liquidity glut signals an impending financial meltdown and it is important for our policymakers to take notice of this.

 

Second, we think borrowing via debt issues is not the only way to finance our deficit budget.  In fact, it is not sustainable given the first point above.   We strongly believe that there are other more viable options that our policymakers must pursue.

 

Going by the budget and the recent Economic Recovery and Growth Plan, it appears the government is still relying exclusively on export income for forex supply, while neglecting opportunities to attract massive and much more stable diaspora and foreign direct investment inflows.     The government also relies heavily on portfolio investment as reflected in the current fiscal policy geared towards debt financing.   This is also not sustainable.

 

What the 8-times oversubscription of the recent international debt issue by the government should tell us is that Nigeria, given the current global liquidity glut, remains a heaven for foreign investors.  However, we haven’t given them many options in terms of asset classes.  Of course, any rational investor would like to minimize risk by investing in government/sovereign securities that are pretty much riskless.  But on the long run, such strategy of portfolio investment, which is very volatile, is not optimal for the country.  Foreign direct investment (FDI) remains the countries best bet to optimize the opportunities presented by the current wave of cheap international funds.

 

Rather than issuing indebtedness certificates to investors, we think that the country should embark on an aggressive scheme of deregulating and liberalizing the economy to attract foreign investment that seems to have limited opportunities elsewhere. We note that between 1990 and 2000, Nigeria was ahead of India, UAE, South Korea and South Africa in the quantum of FDI inflows.  But from the early 2000’s this changed and today FDI inflow is lowest in Nigeria compared to these other countries.

 

Also, considering migrant remittances, we note that Nigeria trails India, China and Mexico – countries that have large emigrant population to other countries.

 

Why both our FDI and migrant (diaspora) remittance inflow have diminished relative to our peers is simply because of the harsh operating environment of business at home.  A recent study finds that it is 6 times cheaper to do business in the UK than in Nigeria and the country remains among the most hostile business places in the world. While our government sells debts to portfolio investors, foreign owned businesses are closing everyday and relocating to other places.  The oil majors have almost all sold off their interests in Nigeria while acquiring new assets in countries like Angola, Mozambique and Equatorial Guinea.

 

There is also no doubt that the proposed $2 billion diaspora bond would be oversubscribed.  Likewise the planned additional $500 million Eurobond.  But we shouldn’t be celebrating these.  If anything, we should be sorrowful that we are compounding our woes in the event of a global reversal of fortunes that burst the current bubble.  The contagion effect would definitely be catastrophic as there is no more insulation for the country’s economy as in 2008.

 

We think that the country should borrow a leaf from India where aggressive liberalization and deregulation have occurred and norms relaxed in almost every sector including defense, civil aviation, private security, broadcasting carriage service, retail, etc.  In some sectors, there is an automatic route and investors may own 100% equity.    Rather than issue bonds and expose the country to financial contagion, we think now is an opportunity to open the doors and allow FDI to flow in.

 

The government should judiciously invest the proceeds of the bonds sales in infrastructure especially, transport and power.  Once done, the potential multiplier effect will act as a big push for FDI inflow and catalyze private sector led initiative in growing other sectors of the economy.

 

Bongo Adi