Nigeria to be excluded from the JP Morgan Emerging Market Indices

Background

The managers of the JP Morgan GBI-EM Index have decided to phase Nigeria out of the series, through two (2) month end rebalancing periods. The country’s bonds will be removed from each of the GBI-EM indices, and the weight change will be done linearly over a 2-month period, with half of the adjustment being done on the 30th of September, while the remaining will be done on the 30th of October.

This follows on from the managers of the index placing the country’s bonds on ‘Negative watch’ in January, 2015 following policy measures which greatly restricted the liquidity in the FX market, which meant foreign investors were unable to match the index’s weightings.

The Watch period was extended in June 2015 ‘to monitor a reliable track record of transparency and liquidity to transact in the Nigerian market’. However, transacting in the FX market remains constricted given more controls being implemented across other segments of the FX market (BDC and parallel markets).

After the removal is complete, the country will not be eligible for re-inclusion into the indices for a minimum period of 12 months, upon which the country would only be eligible again after a sustained, consistent track record of satisfying the index’s inclusion criteria.

Impact on the fixed income market

According to data compiled from JP Morgan, assets under management worth approximately USD208.29bn tracks the three indices in which Nigeria is included, and of the total sum USD3.22bn tracks Nigerian bonds across three indices (GBI-EM Global Div., GBI-EM Div., GBI-EM Broad Div.) for a total weighting across all three of 6.77%.Although we note here that while this is the AUM which should be tracking the fund, the inability of investors to track the index will mean that the actual funds tracking Nigeria might be quite smaller. Also, it is more than likely that with the country’s recent travails, funds may have been flowing out in the year, and so the actual resultant capital outflows could be exponentially lower.

Besides the impact of the sell-down across the benchmark 2, 7, and 10-year bonds, going forward participation will decline, which should consequently lead to a hike in yields. While we expected only a marginal rise (0.25%) by yearend given our expectations that the Apex authority would not allow for this eventuality, given the CBN governor’s assurances of same, we have now revised our expectations and expect about a 1% rise over the current levels.

While we anticipate government’s borrowing costs will increase, we note that recent auctions have shown that the DMO and the CBN (when allotments were not filled, and OMO auctions were not held due to yields required by market participants) will not issue securities at any cost.

Impact on the equities market

The performance of the equities market in the year so far has been partly due to the lack of participation by foreign investors, who have alluded to the currency not being ‘fairly priced’. And so, it had been widely anticipated that there might be a further devaluation of the currency to align with general market perceptions, although we note that the CBN has vehemently denied that it would pander to these expectations.

The anticipated resurgence of the equities market has been heavily premised on the expectations that the FX market would be liberalized, with most market participants predicting a yearend deadline for this due primarily to the deadline given by the managers of the JP Morgan index, shirking the adamant protestations of the Apex authority to the contrary. Given recent happenings, we do not anticipate a sustained resurgence in the near-term unless the Apex authority’s stoic stance re-instills confidence.

Impact on the exchange rate

Under normal circumstances persistent outflows over a two-month period should place significant pressure on a country’s currency. However, this is not a normal situation. Nigeria’s currency has depreciated by a marginal 1.84% at the interbank in the period from the start of March, 2015 to-date, while the CBN has instituted strict controls at the BDC and parallel market which makes marked depreciation quite difficult.