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Economy | Nigeria Economy

Interest Rates on the Rise

Dec 22, 2020   •   by   •   Source: Proshare   •   eye-icon 1593 views

Tuesday, December 22, 2020  /  7:54 AM / By CoronationResearch / Header Image Credit: Dave Ramsey


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Nigerian market interest rates are on the rise. Thismarks the end of the long - over a year - march south. But what next? In ourview the key determinants are how the 2021 budget deficit will be financed andhow normal (given that the present interest rate/inflation mix is not normal)the Central Bank of Nigeria (CBN) wants interest rates to be.

 

FX

Last week the exchange rate in the NAFEX market (alsoknown as the I&E Window and the interbank market) weakened by 0.05% toN391.74/US$1. In the parallel, or street market, the Naira slid by 0.42% toclose at N477.00/US$1. Going by the recent data from the Central Bank ofNigeria (CBN), FX reserves dropped to $34.8bn on Tuesday, 15 December from$35.4bn as of Friday, 27 November indicating a loss of $1.7 billion since May29, 2020. The downward trend could continue due to increased dollar sales bythe CBN coupled with depressed foreign exchange earnings from oil and non-oilreceipts. However, with oil surpassing the $50.00/bbl mark, it is possible thatoil receipts will be much better in the coming year. In addition, the approvalof a US$1.5 bn loan facility from the World Bank constitutes a significant FXinflow that will assist to shove up reserves.

 

Bonds & T-bills

Last week, the secondary market yield for an FGN Nairabond with 10 years to maturity rose by 99 basis points (bps) to 6.31% and at 7years rose by 52bps to 4.86% while at 3 years the yield rose by 83bps to 2.77%.The annualized yield on a 314-day T-bill rose by 14bps to 0.65%, while theyield on a 312-day OMO bill rose by 17bps to 0.69%. The Nigerian Treasury Bills(NTB) market started the week on a quiet note and during the week CBN auctionedan NTB offering N7.00 billion ($14.43 million) worth of notes. The 91-day notewas allotted at a 0.05%, while 182-day and 364-day tenor were allotted 0.5% and1.14% respectively. The NTB average yield closed the week at 0.41%. The CBNalso conducted an OMO auction offering N60.00billion ($123.7 million) worth ofnotes. 91- day, 180-day, and 362-day were allotted 1.65%, 4.50%, and 6.44%respectively. The NTB average yield closed the week at 0.47%. Given the rise inyields, increased investor participation is likely. In the bond market, theDebt Management Office conducted a bond auction offering N60bn worth of bonds,however, what was allotted at the end of the auction was N30bn worth of bonds.The 15- year and 25-year papers were allotted at 6.95% and 7.05% respectively.

 

Oil

The price of Brent crude rose by 4.58% last week toUS$52.26/bbl. The average price, year-to-date, is US$42.96 /bbl, 32.97% lowerthan the average of US$64.10 /bbl in 2019. Oil closed last week at over $50/bblas the United States began vaccinating its frontline workers, but prices are onthe decline again as worry about excessive supply outweighs the positive newsabout the vaccines and challenges come to the surface in terms of availabilityand distribution. OPEC revised down its forecast for oil demand for the rest of2020 and 2021 although oil inventories are also declining thanks to strengtheningdemand from Asia, adding to the general optimism about oil prices next year.

 

Equities

Last week, the Nigerian Stock Exchange All-Share Index(NSE-ASI) rose by 7.46% with a gain of 37.12% year-to-date to close at36,804.75. Airtel Africa (+21.00%), Dangote Cement (+14.48%) and GuinnessNigeria (+11.24%) closed positive while International Breweries (-12.67%) andStanbic IBTC (-0.11%) closed negative. The Model Equity Portfolio will be backnext week.

 

Interest rates on therise

Two weeks ago, we asked whether the Central Bank ofNigeria (CBN) wanted to put a floor under market interest rates (Nigeria WeeklyUpdate, Saving Interest Rates?, 7 December). Now we have an answer, namely thatthe effect of the CBN's Special Bills issue (bills granted to banks in respectof their excess cash reserve ratio held by the CBN), with a yield of 0.5%, hasbeen to support interest rates. T-bill rates have been rising for two weeks.This is a change in the way the market sees interest rates rather than a guaranteethat the CBN is in favour of raising them. The market has seen market interestrates crash this year and was wondering whether negative market interest rateswould emerge. The CBN's response was to address the liquidity issues caused byits cash reserve ratio (officially 27.5% but effectively much higher, hence theexcess CRR) by issuing N4.1 trillion (US$10.5bn) of Special Bills to banks. Butits 0.5% rate was, presumably, a signal to the market.

 

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What options are now open to the CBN? 2021 will beanother year of significant deficit financing for the Federal Government ofNigeria (FGN), with the result that, according to the draft budget, N5.2trillion (US$13.3bn) needs to be raised. From the point of view of thegovernment's Debt Management Office (DMO) it is preferable to raise this at lowinterest rates. But, before the question of what rate is going to be achieved,it is probably advisable to ask where the money is going to come from.

 

In 2020 the CBN achieved effects of quantitativeeasing (QE) without announcing a bond-buying program. It did this (starting inOctober 2019) by preventing Nigerian institutions from buying new issues of itsopen market operation (OMO) bills, effectively reducing the size of the OMOmarket over time (e.g., from N9.8 trillion in January to N5.5 trillion inmid-December) and causing these funds to be diverted into the Treasury Bill andFGN Bond markets. At the same time the CRR took liquidity from the bankingsector into the public sector.

 

This can only be done once, in our view. The OMOmarket cannot be run down indefinitely (part of it is foreign-owned, in anycase) and the CRR cannot be raised indefinitely (the CBN has acknowledged thatit causes banks liquidity problems). So, the options for financing the budgetdeficit in 2021 include raising interest rates to attract institutional moneyand, possibly, expanding the CBN's balance sheet (as would happen in aconventional QE program). Meanwhile, while the aim of increasing bank lendinghas been achieved, inflation is rising, with headline inflation at 14.89% y/yand food inflation at 18.30% y/y (November). We doubt that the CBN wants toaddress inflation with interest rates, but it may tolerate a rise in interest ratesover the coming months as a way of stabilizing public finances.


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