Nigeria’s risk premium hits 1yr high despite rising oil prices
Investors are demanding higher returns from Nigeria to be holders of its debt as compensation for tolerating its high-risk environment, even at a time when oil prices are on a tear.
The extra compensation investors demand to hold Nigeria’s benchmark 10-year bond rather than the 10-year US Treasury hits 9.4 percent in February from 8.9 percent in the same period last year.
This is a sign that investors’ risk perception of Nigeria has risen over that period. The trend is curious given that oil prices are rallying.
Brent crude, the international benchmark grade, hits $68 per barrel on Friday, the highest in 14 months after OPEC+ shocked markets with a decision to keep supply limited as the global economy recovers from a pandemic-driven slump.
Bismarck Rewane, an economist/CEO of Financial Derivatives Company, says the rising risk premium could be as a result of investors’ perception that the rally in oil prices is largely artificial.
“The risk premium that investors are putting on Nigeria is because they are unsure what could happen if the market comes to normal,” Rewane notes.
A risk premium is a return in excess of the risk-free rate of return an investment is expected to yield.
Rising insecurity in many parts of the country of over 200 million people may have also contributed to the widening risk premium.
“The issue of insecurity has continued to hit the global headlines and this is affecting Nigeria’s risk premium,” Muda Yusuf, an economist/director-general, Lagos Chamber of Commerce and Industry (LCCI).
Recently, unidentified gunmen kidnapped about 300 schoolgirls in the Northwest Nigerian state of Zamfara, the second of such kidnapping in a little over a week.
These kidnaps coupled with numerous cases of killings by terrorists have continued to put a dent in the perception of foreign investors regarding the safety of their investments.
Nigeria has been named the third-most terrorised nation in the world, according to Global Terrorism Index.
An asset’s risk premium is a form of compensation for investors who tolerate the extra risk, compared to that of a risk-free asset, in a given investment.
For example, high-quality government bonds issued by a developed country like the US typically have very little risk of default, therefore offering low yields than bonds issued by developing and emerging market economies where there is a higher risk of default.
For sovereign bonds, the US bond is considered risk-free, and as such another sovereign’s risk premium can be determined by comparing the yields on the sovereign’s local bond to that of the US treasury.
The US 10-year treasury yielded 1.47 percent as of February 2021, while investors demanded as high as 10.7 percent to hold Nigeria’s 10-year benchmark bond. That leaves the risk premium at 9.4 percentage points, the highest spread in a year.
The spread between a developed market’s bond and that of the developing market is the risk premium.
Gbolahan Ologunro, a research analyst at Lagos-based Cordros, also explains that Nigeria’s currency crisis also continues to be a major problem for foreign investors.
The Nigerian naira has lost over 24 percent in value within the last year.
“Nigeria’s FX challenges over the past year have also contributed to the increase in the risk premium, so investors would want to cover for this risk,” Ayodeji Ebo, Head Retail Investment, Chapel Hill Denham, points out.
Dollar shortage was a major challenge that foreign investors faced last year as they were unable to repatriate capital or take out their cash due to the central bank’s attempt to defend the naira.
Experts say investment-led growth is necessary for the country’s economic recovery from the pandemic. However, investors are reducing their exposure to the Nigerian economy.
According to the global investment trends monitor report released by the United Nations Conference on Trade and Development (UNCTAD), Foreign Direct Investment (FDI) inflow hit $2.6 billion in 2020, the lowest since 2005.
Foreign portfolio investment fell to $5.13 billion in 2020, the lowest in four years.
Analysts say Nigeria might not seem like a good investment destination compared to advanced countries at the moment despite its status as a frontier market with growth potentials and market accessibility.
“The prospect for recovery is stronger now in advanced economies than ever before considering a number of vaccines that have been developed to tackle the COVID-19 crisis,” Olugunro notes.
This implies that if they will consider investing in a risky economy like Nigeria, it means they would have to give them higher returns to compensate them for the additional risk.