Nigeria and J.P. Morgan: The Inevitable Exile
Investors and Nigerian citizens keenly awaiting the formation of the President’s cabinet and the resultant clarification of the government’s economic plan were hit with more bad news as J.P. Morgan announced that it would phase Nigeria out of its Government Bond Index – Emerging Market (GBI-EM) series. The GBI-EM index helps potential investors by tracking the local currency bonds of emerging market governments, making it much easier for them to diversify their portfolios into emerging markets.
On the 16th of January, 2015, J.P. Morgan put Nigeria on a negative index watch, citing a lack of liquidity in the foreign exchange (FX) market as a result of severe restrictions placed on FX transactions by the Central Bank of Nigeria (CBN). The fall in oil prices since June 2014 has put significant pressure on the naira and the CBN has responded by establishing a host of restrictions aimed at supporting the value of the Naira.
On the 8th of September, 2015, J. P. Morgan announced that it would exclude Nigeria from its GBI-EM index, which consists of local currency emerging market sovereign bonds, in two phases. Given Nigeria’s weighting of 1.5% in the Index, Nigeria’s April 2017, June 2019, October 2019, January 2022 and March 2024 bonds would be phased out in two equal weights of 0.75% on September 30th and October 30th.
The index provider’s decision reflects the persistent challenges and uncertainty faced by investors transacting with the naira in order to replicate the weighting of the Index in their portfolios. This is due to the lack of a fully operational, price-driven, two-way FX market, and limited transparency. J.P. Morgan also indicated that Nigeria, which was added to the index in 2012 after former CBN governor Sanusi Lamido Sanusi abolished a rule that required foreign investors hold naira bonds for at least a year after purchase, will be eligible for re-entry in 12 months, subject to a consistent track record of satisfying the inclusion criteria.
What Does This Mean for Nigeria?
Exclusion from the GBI-EM index, which is tracked by $183.36 billion worth of funds, will result in a sell-off of about $3 billion worth of naira denominated sovereign bonds as portfolio managers look to rebalance their portfolios to the new Index weighting. However, there is reason to believe that most portfolios are already underweight of Nigerian bonds and the sell-off may be less than initially feared as most international investors who wished to exit the market have already sold off their Federal Government of Nigeria (FGN) bond holdings.
The potential sell-off will result in a hike in yields on FGN bonds due to the increased risk associated with these assets. Yields were already high reflecting the conversion of State Government debts to 20 year bonds, low oil prices, onshore sales of naira bonds and poor investor confidence.
Reaction from the Authorities
A joint statement from the Federal Ministry of Finance (FMF), Debt Management Office (DMO) and the Central Bank of Nigeria(CBN) rejected the claims made by J.P. Morgan and insisted that several measures had been put in place to create a functional, transparent and liquid, two-way order driven FX market.
Immediate Market Reaction
The announcement was made after the closure of Nigerian capital market sessions so the immediate impact was felt the next day. On the 9th of September, the Nigerian Stock Exchange All Share Index (NSE-ASI) lost 2.98% while yields on the April 2017, June 2019, October 2019, January 2022 and March 2024 bonds increased by 30 basis points (bps), 47bps, 36bps, 51bps and 48bps respectively to close at 16.53%, 16.68%, 16.56%, 16.62% and 16.68% respectively. Investor confidence which was already low further diminished as market participants sold off on both equity and fixed income holdings to reflect their more risk-averse positions.
What Next?
Since Nigeria is ineligible for re-entry for another 12 months, the exclusion will have long-term effects. Investors will continue to regard naira denominated assets with skepticism and a reduced risk appetite. However, for the bulls amongst us, this is the perfect opportunity to lock in on high yields and take advantage of future gains as yields and bond prices are negatively correlated. As the macroeconomic picture in the country improves and yields start trending downwards (and bond prices start going up), holders will enjoy capital gains on the sales of their bonds.
The announcement of the President’s cabinet, disclosure of the government’s economic policy plans and movement towards achieving the stated economic goals should clear up some negative investor sentiment. A departure from the CBNs tight monetary policy and FX controls should also see yields fall, although it is unlikely the CBN will depart from this stance of rigidly controlling the naira exchange rate.
However, crude oil prices remain low and with public revenue still dependent on revenue from crude oil exports, the outlook is not so rosy. The ball is squarely in the court of our financial authorities, the CBN, DMO and FMF to chart the course for macroeconomic recovery and growth.
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