Uncertainty is growing in Nigeria’s bond market as falling investor demand combines with rising yields at a time that Africa’s largest economy is financing a record budget for the second year running.
Higher yields on Government bonds failed to attract buyers at the Federal Governments (FG) last bond auction, as bears shunned the sale, betting that yields have nowhere to go but up.
This comes as the Government struggles with higher benchmark interest rates, faster inflation, and a worsening budget deficit that will likely result in more debt issuance.
“The FG deficit may overshoot in view of poor non-oil revenue collection and because there are uncertainties surrounding the attainment of the target of N1.07 trillion ($3.5 billion) for external financing of the deficit,” FGN Quest analysts led by Gregory Kronsten said in a Friday note to investors.
“When the Debt Management Office (DMO) drills down into the results, it may ask why the bid for the long bond (Apr ’37) slumped to a record low of N33 bn and whether the PFAs, the core players in the auction, have developed fatigue.”
The monthly auction saw the lowest total bid since November, even as the DMO paid 16.80 percent for the 2021 and 2027 bonds and 16.90 percent for the 2037 debt, an increase in marginal rates on the level of the previous month.
The bid to cover ratio printed at an abysmal 0.47x, while the Government filled only 42 percent of the offer, managing to only raise N56.05 billion, compared to the N135 billion on offer.
Nigeria’s budget gap will probably be larger than the government estimates this year because revenue from taxes and state companies will be lower than forecast, the International Monetary Fund said this year.
“The larger deficit would likely have to be financed domestically, further raising yields and crowding out private-sector credit,” the IMF said in an article IV report.
Investors demanded for yields as high as 17 percent at the DMO auction, with pension funds and insurance firms largely shunning the sale.
The Federal Government’s budget deficit may reach 3.7 percent of gross domestic product (GDP) this year, higher than its projected gap of 2.8 percent, the IMF said.
There has been reduced demand for FGN bonds since the end of July, as the inverted yield curve lead investors play more in the short end.
A recent directive by regulators to Nigeria’s N6.5 trillion Pension Funds Industry to adopt International Financial Reporting Standards (IFRS), for preparing financial statements is causing apprehension among Pension Fund Administrators (PFAs) regarding playing in long bonds, sources tell BusinessDay.
The circular from Nigeria’s Pensions regulator, PenCom and its Financial Reporting Council (FRC) requires that PFAs adopt a business model approach to how they classify government bonds.
“If interest rates move south towards the end of 2017 the PFAs that adopt a held to maturity (HTM) view lose out of the valuation gains, which would put their performance behind peers that adopt a trading definition,” a banking source speaking on condition of anonymity, said.
“Importantly, once you pick a model, you are stuck for three years. So this would mean PFAs would rather be apprehensive of playing bonds for now.”
Data from PenCom shows that as at April 2017, Pension Funds owned N3.617 trillion of FGN bonds, equivalent to 44 percent of total outstanding of N8.177 trillion.
FGN bonds are the largest asset class for PFAs representing 55 percent of assets under management of N6.49 trillion.
The FGN bonds are the principal element of financing for the Federal Government, although the recently introduced retail savings bonds have provided modest contributions.
The DMOs front-loaded its issuance this year and has now raised N1.02 trillion in eight months, towards the target of N1.25 trillion for domestic financing of the 2017 budget deficit.
A surging stock market up 36.63 percent year to date may also be taking the shine out of bonds.
While an introduction by the Central Bank of a more liberal Foreign Exchange (FX) market, through an Investor and Exporters (I & E) window has attracted significant flows to the equity market, offshore funds are still largely underweight Nigerian sovereign bonds.
In the second quarter of 2017, inflow into bonds accounted for only 7.5 percent ($57.9 million) compared to $614.05 million that flowed to equities, according to latest capital importation data from the National Bureau of Statistics (NBS).
Investors are probably looking at the deterioration in the sovereign balance sheet and sticky inflation figures and avoiding the bond market, sources say.
The budget deficit was 2.8 percent last year, and 4.7 percent on a consolidated basis, preliminary estimates show. Inflation for June printed at 16.1 percent, the NBS said last month.
Nigeria has proposed a record N7.3 trillion ($23.1 billion) budget for 2017 to boost infrastructure investment and help its economy recover from a contraction of 1.5 percent in 2016, the first such slump since 1991.
The average yield on the government’s sovereign naira-denominated debt has risen 424 basis points over the past year, to 16 percent, the highest level among 31 major emerging markets, according to data from Bloomberg.
“The marginal rates were the highest since January. In part, this reflects the poor bid. Once the FGN’s debt restructuring proposal is approved and launched, we hope to see a narrowing of yields on the FGN’s naira-denominated paper,” FBNs Kronsten said.
PATRICK ATUANYA
