JP Morgan has threatened to remove Nigeria from its Government Bond Index (GBI-EM) by October this year, unless the Central Bank of Nigeria, CBN, restores liquidity to foreign exchange market to allow foreign investors tracking the benchmark to transact with minimal hurdles.
It said it has extended the earlier deadline to eject Nigeria by another six months to take into account the coming of President Muhammadu Buhari into office.
JPMorgan, which runs the most commonly used emerging debt indexes, placed Nigeria on a negative index watch in January this year and then said it would assess its place on the index over a three to five-month period. “Nigeria’s status in the GBI-EM series will be finalised in the coming months but not later than year-end,” JPMorgan said.
In reaction to the development, the federal government through the Federal Ministry of Finance, the Central Bank of Nigeria and Debt Management Office, released a statement expressing that although government respects the decision, it disagrees with the premise upon which the decision was taken.
Nigeria was added to the widely followed index in October 2012, when liquidity was improving, making it only the second African country after South Africa to be included. It added Nigeria’s 2014, 2019, 2022 and 2024 bonds.
Nigeria’s inclusion was based on the existence of an active domestic market for FGN Bonds supported by a Two-Way Quote System, dedicated Market Makers and diverse investors.
However, in January, J.P. Morgan placed Nigeria on an Index Watch as a result of their concerns in the operations of our Foreign Exchange, FX, Market, namely: (1) lack of liquidity for transactions; (2) lack of transparency in the determination of the exchange rate; and (3) lack of a fully functional two-way FX Market.
In a bid to strengthen the Nigerian financial market and enhance her status as a preferred destination for investors, the CBN took measures to improve the market. Despite the fact that oil prices fell by nearly 60 percent in one year, which should expectedly reduce the amount of liquidity in the market, the CBN ensured that all genuine and effective demands were met, especially those from foreign investors.
On transparency, the CBN directed that all FX transactions should be posted online in the Reuters Trading Platform, so that all stakeholders could easily verify transactions in the market. In addition, the Official FX Window at the CBN was closed to ensure a level-playing field in the pricing of foreign exchange.
The announcement of Nigeria’s inclusion in the JP Morgan Emerging Market Bond Index, JPMEMBI, in 2012 sparked a seismic shift in Nigerian bond markets. Yields dropped 300 bps leaving traders that had taken short positions in bonds on the back of the fallout of monetary tightening in July scrambling to cover positions in the face of substantial influx of portfolio flows. The event caused widespread excitement in asset markets and, alongside announcements of quantitative easing soon after, helped set the stage for a massive 9.5 percent rally in equity markets by the beginning of the 4th quarter.
The dive in yields understandably left many investors expectant. With the actual commencement of the incorporation of Nigerian bonds into the index, there were hopes that further substantial yield declines were on the cards. This view received quasi-official sanction in a recent JP Morgan report which cited factors like a 700bps yield premium, positive dynamics in macro-fundamentals, a 13bps bump in Nigeria’s estimated weighting in the index to 0.72 percent and a survey of benchmark users in arriving at a 10.5 percent yield target for Nigerian FGN 2022 bonds.
While the euphoria was on, Nigeria’s forex and bond markets came under pressure after the price of oil, Nigeria’s main export, plunged in 2013/2014 fiscal year. In response, the CBN fixed the exchange rate in February this year, after devaluing the naira last year and tightened trading rules to curb speculation. So far, the naira has lost 8.5 percent this year.
No matter the position of Nigeria on the impending delisting, analysts agree that it would have significant downside implication on the naira. First, the delisting, if it eventually happens, would trigger a massive sell-off of Nigerian fixed-income assets by foreign investors tracking the bond index.
Secondly, it will further increase the risk of premium investors to require holding the Federal Government bond securities because the CBN decision to stop banks from selling dollars sourced from the CBN among themselves has further increased the pressure in the foreign exchange market.
Also, the shortage of dollars in local market has made it difficult for foreign investors to repatriate funds from Nigeria. Hence, if Nigerian bonds are removed, it will only have a limited impact in the short term because many foreign investors have already liquidated their Nigerian bond holdings.
However, if Nigeria was not swiftly re-admitted to the EMBI, the level of portfolio inflows would remain relatively low, and this will undermine the naira and weaken growth prospects of our economy.