Given the record high inflation and the CBN’s resolve to fight inflation with higher interest rates and higher CRR debits, FGN bond yields are likely to hit new highs in the first quarter of 2023, according to Egie Akpata, Chairman, Skymark Partners Limited, a Lagos-based proprietary investment firm.
In this interview with Lolade Akinmurele, BusinessDay’s Deputy Editor, Akpata, whose 25-year career has spanned 4 countries including roles at Deutsche Bank AG in New York, United Capital PLC and UCML Capital Ltd, spoke on the latest developments in the debt market, what Nigeria can learn from Ghana’s debt crisis and the first thing Nigeria’s next president must do.
1. What impact is the rise in global interest rates having on Nigeria and when do you think the rise in rates could start to slow?
The Central Bank of Nigeria (CBN) seems to be aligning with most global Central Banks in raising interest rates to fight inflation. This rate hiking cycle is likely to continue into early next year. It remains to be seen how quickly higher interest rates will reign in inflation. However, eventually, the base effect will kick in next year and the inflation rate will trend down. This will provide the room for either the CBN to officially cut rates or for market rates to come down from what would likely be a record-high peak.
The US is leading the way with a rapid rise in interest rates and that is having a negative impact on most currencies as they depreciate relative to the US dollar. The Japanese Yen is down 30% against the USD this year. The British Pound is down 20%. Miraculously, the Naira is officially down 5% but in the parallel market, it is down 30% which is in line with many other major global currencies.
2. Ghana’s currency is down more than 100 percent against the USD this year alone. The sell-off in its Eurobonds is also well publicized. How exactly did Ghana get here and what lessons can Nigeria learn?
Ghana simply has too much debt, particularly foreign currency debt. The total debt is 80% of GDP and FX debt of $28b is more than 3x their $7.6b reserves. By comparison, Nigeria’s FX debt of $40b is 1.1x $37.8b FX reserves. Nigeria needs to, however, be very careful not to end up with way too much debt in either Naira or USD. Extrapolating the current growth in FGN debt suggests that we could end up like Ghana in 5 years or so.
From the collapse in Ghana Eurobond prices, it is clear that investors do not believe that bond repayment terms will be met. We await their agreement with the IMF on debt restructuring.
The lesson for Nigeria is to simply avoid foreign currency debt as much as possible. Contrary to popular belief, the Naira cost of foreign borrowings is substantially higher than the cost of borrowing in Naira due to long-term Naira depreciation against USD and perennial FX scarcity issues.
3. The CBN’s loans to the government will be securitised according to the finance minister. What impact would that have on system liquidity and what can investors expect?
Recent information from the Minister of Finance is that the CBN loans will be converted to 40-year bonds at a 9% coupon. This means an annual coupon of at least N1.8tr a year whose payment puts liquidity in the financial system. This is positive.
A lot depends on where these bonds end up. If they remain held by CBN till maturity, then the market impact will be limited.
However, if as expected, a significant amount of these bonds ends up on bank balance sheets as refund of excess CRR, the huge jump in total outstanding FGN bonds in the market could put some downward pressure on bond prices and increase in yields.
4. The government has consistently spent more on debt service than capital expenditure for 8 years with the trend set to continue next year when you consider the 2023 budget proposal. Is that a sign Nigeria is borrowing too much and not properly utilizing loans?
The FGN has been living way beyond its means for several years. The total of personnel costs, overheads and debt service has been more than revenues for a long time. Meaning that every Naira spent on capital expenditure is effectively borrowed. So, it is not surprising that total capital expenditure is constrained.
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The FGN will likely need to move away from a model where it tries to fund all major infrastructure nationwide. It simply has to give up some sectors to the private sector and allow global players with really deep pockets to take over certain infrastructure projects and provide all needed financing.
The problem is that most government borrowing is not for long-term assets which can either generate income to pay off their loans or stimulate a significant amount of economic growth. Rather, borrowing is to pay for operating costs, debt service and petrol subsidy. It would be fair to say that is not an optimal way to utilize borrowed funds.
5. Companies raised a record amount of cash in Commercial Papers (CP) last year. Do you see the interest rate rise muting that appetite or even fuelling it (as banks charge more in loans) and what has been the trend this year compared to last year?
The number of CP issues and the amount raised is substantially higher this year than last. A wide range of issuers have taken to the CP market in order to disintermediate banks who have proven to be a much more expensive source of finance.
However, the current trajectory of interest rates suggests that at some point, CP issuers would be discouraged by high-interest rates. However, at this point, the biggest issue is liquidity rather than pricing as CBN activity via Cash Reserve Ratio (CRR) increase is having an impact on the subscription level of CP offers.
6. What is Skymark Partners up to these days? Your recent CP was oversubscribed yet again.
Skymark Partners Limited is focused on executing our strategic objectives across various industries. In March, we issued our first CP under our N5bn FMDQ-approved CP programme and have raised N5.4bn so far and repaid N1.1bn. We are scheduled to make more repayments before year-end. Thankfully, our CP offers have been oversubscribed due to our financial performance and institutional investors’ belief in our credit quality.
7. What should be the priorities of the next president if he must have to steer Nigeria out of its fiscal crisis?
I would suggest making the most difficult choices very early on so as to have enough time to build up goodwill before going for re-election.
Subsidies on petrol and electricity would have to be stopped as every Naira of subsidy is borrowed. The government simply does not have the option to continue those subsidies.
Freeing up the Naira to trade at a level that encourages foreign investors to come in and for remittances and other inflows to come through formal banking channels is critical. Very few Nigerians have access to FX at the official rate and the economy has substantially benchmarked to the parallel market rate. Besides, the government is losing a huge amount of money by selling its scarce dollars at substantially below what it is worth.
However, the very first thing the President-elect should do once announced as the election winner is to build up the confidence of the local and international investment community. Sending the right signals to the Eurobond market, to foreign investors etc will go a long way to galvanising the support of those whose funding is needed to rebuild the Nigerian economy and boost government finances.
8. What’s your outlook for the naira and when do you think the dollar scarcity will abate?
Dollar scarcity will abate when oil production rises substantially and the FX market is reorganized to be more market reflective which will encourage significant inflows to the official markets.
The global rise in the USD due to its relatively high-interest rates coupled with the huge inflation differentials between the USA and Nigeria suggests that the Naira will keep losing value against the USD for now.
9. What would it take for the gap between the official and parallel market rates to be harmonized and when do you expect that to happen?
Harmonization is likely to happen with both rates converging. That can only happen with a more flexible fx market system. It is hard to tell when that will happen but it is unlikely to be this year.
10. What interesting investment opportunities are in the market these days?
There are always interesting investments depending on your risk tolerance and time horizon. What is clear is that rising interest rates make long-duration assets a challenging option. For low-risk investors, short-term investments in some CPs can provide above-inflation returns.
11. What is your outlook for bond yields given the persistent rise in inflation? Are we heading back to 2016’s high yields?
Given the record-high inflation and the CBN resolve to fight inflation with higher interest rates and higher CRR debits, I would not be surprised if we see FGN bond yields get to new record highs in Q1 2023. However, yields are likely to trend down from Q2 next year. The very poor demand in the October DMO bond auction combined with a spike in issuance rates is a trend that is likely to continue.
