Demand For FG Bonds Falls On Oil Price, Naira Pressure | Independent Newspapers Limited
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Demand For FG Bonds Falls On Oil Price, Naira Pressure

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Posted: Mar 18, 2016 at 1:00 am   /   by   /   comments (0)

Kirk Leigh, Lagos

Demand for Federal Government bonds have slowed in the last five months, leading to a spike in yields on the back of falling oil prices, rising inflation and dropping naira value.

Yields of Federal Government 10-year bond fell to 11.94 percent on Thursday March 17 from 11.99 percent the previous trading day. Historically, however, yields reached an all time high of 102.26 percent in January of 2016 and a record low of 2.06 percent in November of 2015, according to Trading Economics, a global economic data base.

Oil revenue as the nation’s mainstay serves as security for bonds, which is government debt or obligation to investors while the national currency is a secondary investment for investors who take a bet on a country’s debt instruments.

Senior macroeconomist at Ecobank, Gaimin Nonyane, says it’s a question of confidence linked to government’s ability to repay its debts, shrinking reserves and the outlook for inflation, which has climbed to 11.4 percent in February.

“In the case of Nigeria, lower oil prices and dwindling FX reserves have raised investor concern over the government’s ability to repay its debt in the future and over the outlook for inflation and the NGN. The country has also been removed from the JP Morgan Government Emerging Market index, further weakening investor confidence in the country.

“As a result, we have seen demand for Nigeria’s assets fall as investors shy away from the market into less risky assets. Undoubtedly, the fall in investor demand has reduced bond prices, while yields have increased as investors price in the risk associated with the impact of the weak oil price outlook on inflation and the NGN”, Nonyane told Independent from London.

Ajediran Omololu, Asset Manager at SCM Capital, agrees that “to foreign investors, the FGN bond may not be attractive because of high inflation rate, scarcity of foreign exchange, uncertainty about the government policies on necessity to devalue naira.”

He also says that the implication of rising bond yields for Nigeria “is that it will make our bonds risky to the investors and most especially, the foreign investors will rather sell their holdings instead of buying more. This in essence will reduce capital inflow and increase capital outflow from our system. When this happens, there will be pressure on our foreign exchange and reserves with CBN. As the selling pressure continues, naira will continue to lose value in exchange to other foreign currencies”.

Higher yields have implications for servicing the country’s debt, says Nonyane. But the country’s low debt level may be something to cheer about in the circumstance.

“Higher yields on FG bonds will increase the Federal Government’s debt servicing costs.

“But at present, Nigeria has a low level of debt distress and as such ample room to manoeuvre; therefore, the country’s debt level should be manageable for now,” she said via an email response.

Nonyane, however, posits that a combination of low oil price and unwieldy expenditure could spell doom for the government security.

“However, if oil prices remain low in the medium term against a backdrop of high government spending then the debt level is likely to climb to unmanageable levels. This will undermine investor confidence in the economy even further and put more downward pressure on the NGN”.

Nevertheless, there remains appetite for FG Bonds, Nonyane clarifies.

“There is still appetite for FG bonds, but the numbers have dwindled compared with recent years. This is due to concern over the impact of low oil prices on the economy – the collapse in global oil prices and hence Nigeria’s oil receipts have reduced the country’s FX reserves, and as a result, the CBN has had to intervene in the FX market to prop up the value of the naira (which has been undermined by oil price shock against a backdrop of significant import demand). Inflation has also increased, reducing the real value of assets.”

In that regard, Omololu insists that local players in the bond market continue to purchase the debt instrument.

“But to local investors especially the financial institutions and PFAs, FGN bond still remain attractive due to lack of alternative investments which is relatively profitable with less risk of losing the investment”, he said.

According to Omololu, factors responsible for high yields of FGN bonds include: high inflation figure. “Our current inflation figure stands at 11.4% which is higher than the MPR. A rational investor will want to exit as the inflation rate continues to rise. Investors will begin to exit from a market with high inflation rate to a low inflation rate market. Another factor is the riskiness of the bond.”

When investors are of the opinion that the risk associated with a given bond is high (i.e. the ability of the issuer is in doubt to pay both the coupon and the principal as at when due), they will price it higher to accommodate the higher risk associated with the bond, Omololu noted.

Meanwhile, the opposite to the Nigerian situation seems to be laying out in emerging markets where a combination of waning US dollar strength, high absolute yields and the prospect of lower benchmark interest rates have made Indonesia’s sovereign bonds attractive, driving the government to unload more debt papers to capitalize on the factors.

Debt paper (SBN) issuance has reached a third of the target set in the 2016 state budget, with interest from foreign investors remaining high. The government has so far issued SBN worth Rp 102.2 trillion (US$7.81 billion) by the third week of February, according to data from the Finance Ministry.

The figure accounted for 31.2 percent of the net SBN issuance target, which was set at Rp 327.22 trillion within the budget. About Rp 66.2 trillion of the SBN is in the form rupiah-denominated paper and about Rp 36 trillion is foreign-denominated.