JP Morgan recently announced that Nigeria will be phased out of the Emerging Market Government Bond Index (GBI-EM) series over the next two months. According to the bank, lack of transparency and lack of a fully functional two-way foreign exchange (FX) market has led to uncertainty and some challenges for investors buying and selling in naira. Thus, Africa‘s biggest economy would be partially excluded from the index by September end and full exit will occur in October. Nigeria’s current weighting in the $200 billion index is 1.50 per cent.
In a swift reaction, the Federal Ministry of Finance (FMF), the Central Bank of Nigeria (CBN), and the Debt Management Office (DMO) disagreed with J.P. Morgan, saying that Nigeria had taken appropriate measures to improve the market.
“We would like to strongly disagree with the premise and conclusions upon which the decision rests,” a joint press statement by the FMF, DMO and CBN read in part.
This reaction from the highest monetary policy decision making authority in Nigeria quickly throws up some issues which both economic and non-economic analysts have critically analysed. The truth remains that both the CBN and the United States-based lender have their mandates to protect and deliver. But, just like a popular idiom observes, “When two elephants fight, the grass suffers.” The Nigerian economy and its agents may suffer depending on how this matter is handled.
The questions that the clash of two giant elephants from Nigeria and America bring to the front burner are: whose mandate should Nigeria be more concerned about? Who or what is JP Morgan? Who or what took Nigeria to JP Morgan? Analysts from investment banking, corporate finance, public policy and economics have tried to provide insights.
Who is JP Morgan and what is its mandate?
JP Morgan, being an American multinational banking and financial services holding company, is the largest bank in the United States, and the world’s fifth largest bank by assets, with total assets of US$2.6 trillion.
The lender delivers strategic advice and solutions, including capital raising, risk management and trade finance to corporations, institutions and governments. Serving the world’s largest institutional investors, JP Morgan says it supports the investment cycle with market-leading research, analytics, and execution and investor services.
“With over 170 years of experience and knowledge solving the complexities of significant wealth, we offer investments, liquidity and credit management, and tax and estate planning,” the bank boasted in its website.
In summary, JP Morgan’s mandate is to serve the worlds institutional investors and help build economies and communities. In this regard, Nigeria may have approached the lender so as to be an investment partner in building Africa’s largest economy in Gross Domestic Product terms. It’s bond index, which tracks around US$183.8 billion to US$200 assets under management serves as a shop where bonds of nations are displayed for investors/buyers.
In a lay man’s understanding, the bond is a debt instrument issued by a government, with a promise to pay periodic interest and to repay the face value on the maturity date. These bonds are usually in the country’s own currency, in Nigeria’s case, in naira.
CBN and clash of mandates, who blinks first?
The CBN Act of 2007 of the Federal Republic of Nigeria charges the bank with the overall control and administration of the monetary and financial sector policies of the Federal Government. The objects of the CBN are as follows: ensure monetary and price stability; issue legal tender currency in Nigeria; maintain external reserves to safeguard the international value of the legal tender currency; promote a sound financial system in Nigeria; and act as banker and provide economic and financial advice to the Federal Government.
In an attempt to “ensure monetary and price stability and promote a sound financial system in Nigeria,” the apex bank has taken steps which it considers appropriate to keep its mandate. But because in the era of globalisation, no economy can exist without interacting with outsiders, whose actions and inaction affect policy decisions, it has to worry about global players like JP Morgan.
Most economists argue that the global lender has standards set, based on certain models over the years and such models cannot be altered because of a single country. They believe that what Nigeria should do now is taking it as it is, rely on other global fund managers and ultimately diversify the economy away from oil. That way, the economy will no longer depend on a commodity which price is dictated in the international community.
The apex bank has tried to show it has taken the country’s fate the way it is since ‘Mr Morgan’ will not reverse the decision until after one year depending on whether Nigeria satisfies its conditions or not. While JP Morgan is bent on serving the world’s institutional investors and helping them build their economies and investments, CBN says doing what the former requires at this time will lead to massive depreciation of the naira and more hardship for Nigerians.
As if acting the umpire, a Nigeria-based investment banking and research company, Afrinvest West Africa, said in a note to investors: “We believe JP Morgan has its criteria for countries enlisted in its indices and also has the right to delist any country that falls short of its listing requirements. “Nevertheless, we are also of the opinion that the apex bank has its exclusive right to ensure it achieves its primary responsibility of maintaining internal and external price stability. While we observed a knee-jerk reaction in the Nigerian capital market since the announcement, we expect this to stabilise in the medium to long term, as we await policy direction from the Buhari-led administration.”
Part of the reasons CBN took the measures it took recently was revealed by the Director, Financial Markets Department, CBN, Mr Emmanuel Ukeje, who said most of the people being branded Foreign Investors (FIs), who JP Morgan referred to when it announced the removal of Nigeria from its Government Bond Index for Emerging Markets (GBI-EM), were mere traders.
Calling the bluff
On those who want to exit, the director said: “The apex bank has advised Deposit Money Banks to actually allow them to go because there are people who are also willing to come in. The fundamentals of the Nigerian economy are very, very good and people are willing to come into Nigeria and invest.”
He further said that JP Morgan was just a fraction of investors that are in Nigeria and that a lot of them had gone out before the 2015 election, because they never thought Nigeria would have a successful election.
Ukeje said the CBN had been in contact with Deposit Money Banks and that initial panic which greeted the news had died downed after they sat back and analyzed the market. He said there was calm in the market and everything was returning to normalcy.
Corroborating the fact that there are alternative investors and indexes to JP Morgan, Afrinvest observed that the “financial market sentiment is still likely to continue to feel the impact of this news flow as the domestic investor sentiments will seem to be the new major force driving the Nigerian fixed income market while the equities market may still continue to enjoy a mix of foreign and domestic sentiments as Nigerian equities still remains in the MSCI (Morgan Stanley Capital Index) for frontier markets.” It added that with a weight of 1.5 per cent (out of US$183.8bn) in the index, the US$2.8 billion worth of foreign holdings of Nigerian government bonds expected to exit the market, is significantly lower than a total of US$8 billion that exited in September 2014.
“We have seen some buying interest at the secondary market in spite of the auction of JP Morgan to remove the country’s bond from its index,” a trader said.
The initial reaction to the JP Morgan move led to an increase in yields across the board on Nigerian local debt, but later moderated after regulators introduced a new spread to stem volatility.
Voices from abroad
Responding to JP Morgan’s decision, Mr Jurgen Hecker, a France-based financial expert and media trainer, said: “It has happened.” He expressed surprise at the early timing of this move, but said he was not surprised at the reasoning behind it.
Hecker, in an e- mail to the Nigerian Tribune, expressed worry that three months into his term, President Buhari had not appointed a full cabinet, and especially, a finance minister.
He believed that if the naira was devalued, credible finance minister appointed and rapid measures to diversify the economy and fight corruption announced, investors would be demanding Nigerian bonds again.
“This is a real worry for international investors. Expectations that the naira should already have been devalued are another reason,” he stated.
From the Economist’s intelligence unit, the United Kingdom-based magazine wrote that “The decision to remove Nigeria from the index of local-currency government bonds is a blow to its fledgling capital markets, which have benefited from large inflows of foreign monies in recent years. More generally, the expulsion of Nigeria from a major emerging-market index is a blow to the country’s reputation in the international capital markets and a setback to its ambition to achieve greater integration into the global financial markets.”
Major impacts
Is there any way this will affect a Nigerian on the street looking for daily bread? Some analysts explained that though there is no direct impact of JP Morgan’s decision at the moment on low income earners, there is always a long-term effect of anything that happens to the naira on household income and expenditure.
“If the naira is reduced in value, it means a loaf of bread you buy at N100 will now cost you N250 to N300, that is one side of the argument,” some analysts have noted in simple terms.
Also, for the fact that listing the bond is a way of looking for borrowers or buyers of government bonds, another impact is that when the government gets the money it needs, it can finance a lot of activities in the economy.
Essentially, the government borrows to enable higher spending without having to increase taxes. Experts have explained that when tax revenues are less than predicted, borrowing means the government can meet a temporary shortfall by borrowing, rather than having to immediately cut back on spending. Like an overdraft facility, the government borrowing gives the government more flexibility and means they can maintain wages and spending commitments without having to keep cutting spending.
Also, the government may invest in public sector investments lie roads, health care among others for the benefit of citizens. This investment can give a return on the investment which helps to boost productive capacity and increase economic growth. In this case, the government is acting like a firm who takes out a loan to finance investment but where there is revenue shortfall like Nigeria is experiencing now, life becomes difficult, experts explain.
“This move by JP Morgan will oblige many fund managers to sell Nigerian bonds, as they can only invest in securities included in the index,” Hecker explained. The France-based financial expert reiterated that it would put additional pressure on the naira, and the government would do well to react decisively this time.
“But now it will probably have to devalue by more than it would have had it acted earlier. It is a pity that it has come to this, and now it’s going to be more difficult than before to regain investors’ confidence. There is a lesson here for the future.
“What President Buhari needs to do is now even clearer: devalue the naira, appoint a credible finance minister, and announce credible and rapid measures to diversify the economy and fight corruption. If all of this is swift and credible, investors will be demanding Nigerian bonds again,” Hecker, who was in Nigeria two weeks ago to honour an invitation by Sterling Bank, advised.
According to Afrinvest, private sector investments would reduce due to high borrowing cost and this removal would further pressure the external reserves as these funds, which have been gradually exiting since 2014, would be expected to leave the financial system; although the effect might not be noticeable on interbank FX rate given the CBN’s managed peg of N199.00/UD$1.
“A further impact is expected to be felt as the exit of foreign investors is expected to increase government’s dependence on domestic investors, thereby narrowing the pool of funds in the bonds market. Ultimately, this may increase the risks of government borrowing crowding out private sector investment due to higher borrowing cost.”
JP Morgan will remove Nigerian debt from its main indices by the end of October, raising fears of a fire sale of government securities. However, many foreign investors have already abandoned the country. Bankers estimate that overseas holdings of local currency debt have fallen to approximately $3 billion, from $11 billion in 2013.
It’s not that investors aren’t hungry for Nigeria’s hefty yields, which are among the highest in the JP Morgan index, but many are growing increasingly worried about the CBN’s management of foreign exchange reserves. In June, CBN banned the import of some 40 products – from rice to wheelbarrows – in an effort to prevent currency from leaving Nigerian shores. The restrictions have settled the naira into a tight band between N198 and N199 to the dollar.
Countries within and without the JP Morgan index
According the Financial Derivatives Company (FDC) of Nigeria Limited, India and China are also excluded from the index gauge due to the capital controls that limit access to a majority of foreign investors. Russian bonds are also going to be removed from emerging markets indexes but will remain in other J.P. Morgan indexes that don‘t require a maximum credit rating. Malaysia, Pakistan and Ukraine have been taken off the MSCI index as a result of capital restrictions.
Nigeria was, in 2013, listed among the 18 emerging market economies, who were part of the GBI-EM Broad index. It became the second country in Africa, after South Africa, to join Mexico, Peru, Philippines, Poland, Romania, Russia, Thailand, Brazil, Chile, China, Colombia, Hungary, India, Indonesia, Malaysia, and Turkey.
Background
In October 2012, Nigeria was included in the JP Morgan Emerging Market Government Bond Index (GBI-EM). The GBI-EM indices consist of regularly traded liquid fixed-rate domestic currency government bonds. Nigeria was expected to have a 0.59 per cent weight of the $170 billion of assets under management of the index. At the time Nigerian bonds were offering yields of up to 16 per cent compared to the GBI-EM Index yield of 5.8 per cent. Bond Yield is the amount of return an investor will realize on a bond. When inflation expectations rise, interest rates rise, bond yields rise and bond prices fall.
The CBN, in December 2014, reduced the Net Open Position (NOP) of Deposit Money Banks (DMB) to 0 per cent from 1 per cent of shareholders fund, before revising it up to 0.1 percent in January 2015. These measures reduced foreign exchange and bond trading making it difficult for foreign investors to replicate the gauge or predict how the market operated. Naira daily trading volumes fell to just $20-$30 million compared to $300- $500million six months before. Nigerian bonds became the worst performers after Russia, with dollar investors losing 16 per cent.
Then, Nigeria was placed on the negative index watch in January 2015. In June 2015, Nigeria was given a six-month deadline to restore (dollar) liquidity, taking into account the arrival of a new administration before finally deciding earlier last week to exclude Nigerian bonds from the index.
A circular released by the Central Bank of Nigeria (CBN) in response to JP Morgan‘s announcement suggests that Nigeria‘s removal from the index may not be unrelated to the forex system adopted by the CBN- which JP Morgan disagrees with. Despite the relative stability in the exchange rate, JP Morgan believes this current forex system has been less than adequate in resolving the challenges of liquidity and transparency in the forex market.
Culled from the Tribune.
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