Nigeria latest index accession significant says Investec

Nigeria has just been admitted as the 15th member of the JP Morgan Global Diversified Index, the most-followed emerging market debt index, a significant move for the local market and for international investors, according to Investec Asset Management.

The firm’s emerging market team noted that Nigerian bonds reacted “very aggressively” to the news, returning up to 17% (2022 bonds) in price terms over two weeks.

Yields between 12% and 14%, make Nigeria the highest yielding bond market in the index (the second highest is Brazil at 8.54% while the index’s yield stands at 5.83%).

“In a world characterised by historically low returns, such yields, coupled with a highly managed currency, are very likely to attract growing investor attention,” Investec said.

Nigeria offers a good growth story. As Africa’s most populous country (160 million) it has an estimated GDP of $375bn (the second largest on the continent). Over the past five and ten years, the country’s average economic growth has been 7% and 8% respectively. Its stellar growth rate firmly places it among the world’s ten fastest growing economies.

Investec Asset Management has actively participated in the Nigerian fixed income market for the past seven years. “More recently, it has been positive structural changes, marked by political, policy and regulatory developments that has pushed the country into the emerging market universe,” the strategy note said.

Requirements for inclusion into the JP Morgan index are twofold. First, a country needs to attain a minimum classification as a lower-middle income country for two years by the World Bank. The second, more challenging prerequisite, is the need to have sufficiently liquid bond markets.

A key factor underpinning Nigeria’s impressive growth trajectory over the last decade has been the ending of a protracted civil war and the holding of democratic elections, despite some local clashes, in 1999.

Oil, while not the main driver of growth performance, has played a definite role in the country’s impressive growth over the past 10 years. Restoring a much greater degree of peace and stability to oil production in the historically tumultuous River State is seen as a big win for the country.

Some of Nigeria’s growth has arguably come from a credit boom in 2007/2008 when private credit extension grew by more than 100% year-on-year. This lead inevitably to bust in 2009/2010, when non-performing loans increased to near 40% of gross loans.

“However, the ensuing restructuring and cleaning up of the banking system is one that a more advanced emerging market and even developed market can learn from,” Investec noted.

“This extensive exercise included the sacking of several boards of financial institutions and the criminal prosecution of past directors. Furthermore, the authorities increased required capital to prudential limits that led to a very healthy consolidation in the industry and created a ‘bad bank’ that cleaned up viable banks’ balance sheets by buying up doubtful debt”

Monetary authorities won further respect for their successful defence of the Nigerian naira during 2011. In part, this contributed to creating the recent high yield investment opportunity for global investors.

The aggressive open market operations of the central bank at the end of 2011 to mop up excess liquidity in the banking system pushed short-term yields as high as 19%, attracting an estimated $2bn of offshore investment into the money market.

However, Investec said Nigeria faces further macroeconomic challenges beyond the need for a continued democratisation

The country still relies heavily on oil, which accounts for 75% of government revenue and 95% of exports. Vested interests in several key industries, including the oil and gas sector, pose a challenge to the successful implementation of much needed reform.

Implementing prudent fiscal policy is more difficult because of the three-part (federal, state and local authorities) nature of government, where goals and priorities differ. The country’s infrastructure especially electricity generation and distribution, is struggling to keep up with Nigeria’s rapid expansion.

Finally, Nigeria’s language and cultural diversity does at times lead to unrest and outbreaks of violence by dissident groups such as Boko Haram and MEND.

But overall, Nigeria’s inclusion in the index is “well-deserved”, Investec said. Investors are already familiar and “to some degree comfortable” with the country’s credit.

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