JP Morgan last week announced its decision to delist Nigeria from its Government Bond Index-Emerging Markets (GBI-EM). On the back of this announcement, investors in Nigeria’s equities market lost over $1.2 billion in two days of trading. Various analysts and economists have expressed concern about this announcement and what it portends for Nigeria’s growing economy. Should Nigerians and foreign investors really be concerned? What are the effects of this announcement and the eventual delisting of Nigeria from the index on the economy?
Launched in 2005, the GBI-EM is a comprehensive emerging market debt benchmark that tracks local bonds issued by Emerging Market governments. Nigeria became the second African country after South Africa to join this index which comprises of 18 emerging market economies.
On the 8th of June 2015, J.P Morgan threatened to delist Nigeria from its GBI-EM, except the CBN restored liquidity to the Foreign Exchange market before the end of 2015. Following failure to comply, it was announced that by the end of October 2015 all Nigerian bonds on her index would have been delisted, that Nigeria would not be eligible for re-inclusion for a minimum of 12 months, and only after meeting its liquid currency criteria. According to JP Morgan, “Nigeria’s index eligibility after this period is contingent upon a consistent track record of satisfying the index inclusion criteria.”
The Naira has lost between 15% and 20% in 2015 and had to be devalued in November 2014 and February this year. At that time the CBN adopted various measures to defend the naira against the dollar, including the use of Nigeria’s dollar reserves. However, this became unsustainable after the reserves dipped precariously low, forcing Nigeria to adopt other measures. The particular measure that is behind this brouhaha is CBNs decision to restrict the supply of dollars to certain classes of persons and businesses. This decision was taken to safeguard the naira against the whims and caprices of speculators and round trippers.
The Central Bank of Nigeria, Debt Management Office and Ministry of Finance in a joint statement disagreed with the premise on which the decision was taken. In the statement signed by CBN’s Director of Communications Ibrahim Mu’azu, the three agencies stated, “While we respect the right of the J.P. Morgan to make this decision, we would like to strongly disagree with the premise and conclusions upon which the decision rests.
“ It would be recalled that Nigeria was included in the index in October 2012, 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 2015, 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 our continuous bid to strengthen the Nigerian financial market and enhance our status as a preferred destination for investors, we took measures to improve the market. Despite the fact that oil prices have fallen by nearly 60 per cent in one year, which should expectedly reduce the amount of liquidity in the market, the CBN ensured that all genuine and effective demand were met, especially those from foreign investors. On transparency, the CBN mandated that all FX transactions were posted online in the Reuters Trading Platform so that all stakeholders can easily verify all 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.
“It is important to note that a functional two-way FX market already exists in Nigeria. However, given the high propensity for speculation, round tripping, and rent-seeking in the market, it became imperative that participants are not allowed to simply trade currencies but are only in the market to fulfil genuine customer demands to pay for eligible imports and other transactions. In the light of this, we introduced an order-based, two-way FX market, which has resulted in the stability of the exchange rate in the interbank market over the past seven months and largely eliminated speculators from the market. “Despite these positive outcomes the J. P. Morgan would prefer that we remove this rule; even though it is obvious that doing so would lead to an indeterminate depreciation of the naira. With dwindling oil prices, we believe that an order-based two-way market best serves Nigeria’s interest at the moment…..”While we would continue to ensure that there is liquidity and transparency in the market, we would like to note that the market for FGN Bonds remains strong and active due primarily to the strength and diversity of the domestic investor base.”
With dwindling global oil prices, increasing interest rates in the US and the economic slowdown in China, the last thing Nigeria needs is anything negative that will hamper her recovery process after sixteen years of misrule. However, after this announcement by JP Morgan Nigeria is set to lose over $2 billion dollars of foreign investment in her bond market. This may seem like bad news as it would raise Nigeria’s borrowing costs and increase the already existing volatility in the bond market. However, it is worthy to note that in the last twelve months foreign holdings of Nigerian bonds declined from around $8billion to its present level today without too much effect on the economy. If the remaining $2billion dollars is withdrawn, local banks and Pension Fund administrators would easily close the lacuna created.
With a more stable economy and a better government in power, will foreign investors be able to resist the lure of higher returns? In my opinion these foreign investors will eventually return, after President Buhari has named his Minister’s, economic team and charts a course of recovery for Nigeria’s ailing economy. With the exit of these investors the price of Nigerian government bonds will reduce thereby leading to an increase in the yields.
Various analysts have advised the CBN to toe the line and abide by the rules drawn up by JP Morgan, an American institution, and adopt a more market-determined exchange rate, which will inevitably lead to the devaluation of the naira. The Governor of CBN, Godwin Emefiele believes the naira is “appropriately priced” and few pundits doubt the government will change it stance. But even if they bow to pressure and allow market forces to play in the forex space, so as to abide by the rules drawn up by a foreign corporation, at what cost will this act of obedience come? Nigeria is principally an import dependent nation, with very little leaving her shore to other countries, devaluing the naira or allowing the market forces to control the price of the Naira will only make importations more costly, thereby increasing the cost of living for the average man on the street.
The important question however is, what do these bonds finance? Can Nigeria afford to lose $2billion at this time with dwindling revenues? Will this hamper her ability to undertake capital projects? Only time will tell.