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‘Absence of near to mid-term solution to Nigeria’s FX problems may stall foreign capital’

By Femi Adekoya
22 July 2022   |   2:42 am
Stephen Osho is a Co-Managing Partner at Comercio Partners Limited, an investment banking firm. In this interview with FEMI ADEKOYA, he talks about major developments in the global and local economy

Stephen Osho

Stephen Osho is a Co-Managing Partner at Comercio Partners Limited, an investment banking firm. In this interview with FEMI ADEKOYA, he talks about major developments in the global and local economy in the first half of the year, with projections for the second half of the year, with caveats on the likely consequences he specifically warns that Nigeria’s foreign exchange challenges will have implications for the ability to attract foreign capital.

What is your assessment of the economy in H1’22 vis-a-vis global development, and monetary and fiscal policy decisions?
In the first half of the year, the global economy and market unenthusiastically hosted a barrage of headwinds, bordering on geopolitical tensions and inflationary pressures, as well as the ensuing drastic policy reactions to such occurrences. Essentially, Covid-19 was dethroned as the leading global economic disruptor, as policymakers raced to manage the fallouts of the Russian – Ukraine war while struggling to tackle the unyielding trend of inflation triggered by the accelerated cost of commodities such as food and energy. The Eastern European war exacerbated the already worrisome global trend of inflation that trailed the Covid-19 induced policy dovishness and supply-chain bottlenecks, hence, forcing monetary authorities across major economies to embrace aggressive contractionary policy measures to assuage these inflationary forces.

Because of the far-reaching impact of the geopolitical conflict in Eastern Europe and the aggressively hawkish monetary policy response to skyrocketing inflation, the global economy struggled with the growing probability of a recession, while the financial market dramatically nosedived. On Wall Street, the S&P 500 index lost 20.58% in H1’2022, while the yield on the U.S. 10-year Treasury note crossed the 3.00% psychological level for the first time since 2018. Likewise, digital currencies plummeted in the half-year period, with bitcoin hovering around its two-year low.

Nonetheless, the resilient economic growth seen in the first half of the year offers a seemingly paradoxical image of the Nigerian economy, given the deteriorating state of the macroeconomic framework.

For context, Nigeria’s oil sector has defied the elevated price of crude oil to extend its stay in the contractionary region, due to factors like oil theft and vandalism, and low oil output. Also, the move by major central banks to raise interest rates has joined the existing legacy drivers spurring the repatriation of foreign capital, as we saw capital importation in Q1 2022 dip by 28.10% quarter-on-quarter, Q/Q and 17.50% Y/Y to $1.57 billion.

Regarding foreign trade, the conflict in Eastern Europe has caused the ballooning of Nigeria’s import bill, as imported petrochemicals like diesel and imported food products like wheat have soared in price. (Total imports rose by 21.04% Y/Y in Q1 2022 to N5.90 trillion).

Consequently, the soaring import bill, negative net foreign flows, and the failure to efficiently leverage the elevated price of crude oil in generating FX earnings have caused FX liquidity to stay tight in H1 2022, impelling the weakening of the local currency.

In the Nigeria Autonomous Foreign Exchange Market, NAFEX window, the exchange rate of the Naira to a Dollar has moved from an average of N414.88/$ in December 2021 to N420.98/$ in June 2022, representing 1.45% depreciation, while the parallel market has moved from about N575/$ to N622/$, representing 7.56% depreciation.

Nigeria’s inflation is another aspect of the domestic macroeconomic landscape that waned significantly in H1 2022, as global headwinds worsened inflationary pressures in the local economy. Due to the surge in energy and food prices, headline inflation surged by 2.08% from the level in December 2021 to 18.6% in June 2022. On the policy end, the monetary authority has joined the bandwagon, hiking interest rate by 150 basis points to 13.00% in response to the threat of inflation. This rate was upwardly adjusted to 14 per cent during the week.

So, even with the encouraging divergence between local and global growth, challenges pertaining to inflation, foreign exchange liquidity, capital importation, and oil production, among others, have strained Nigeria’s macroeconomic landscape in H1 2022.

Rising inflation and increased government borrowing were prominent features in H1’22. How did these two factors influence the fixed income and equity markets?
High inflation and elevated government borrowing are twin forces that typically nudge both local equities and fixed income markets into a bearish region. This year, inflation has climbed to a 5-year high in June, while the government has set out to fund its revised budget deficit of N7.35 trillion. However, the equity market was able to shrug off these negative drivers in the first half of 2022, on the back of the impressive full-year 2021 and Q1 2022 financial results and interesting corporate actions. Hence, the local bourse posted a gain of 21.31% in the first half of the year, relying on the performance of underlying sectors like Oil and Gas (58.06% uptick in H1 2022), Industrial (7.17% uptick in H1 2022), and Consumer Goods (5.89% uptick in H1 2022).

For the local fixed income market, the impact of elevated inflation and high government borrowing has been hushed this year. The government has become increasingly reliant on the CBN Ways and Means Advances, with the borrowings from the CBN totalling N19.01 trillion in June 2022 from N17.46 trillion in December 2021. Hence, local bond sales for the first half of 2022 stood at N1.84 trillion, reflecting a growth of 29.58% when compared to the sales in the corresponding period of 2021, but relatively low when compared to the hefty budget deficit. Also, the Pension Fund Administrators (PFAs) have bolstered demand at the bond auctions, as the total asset under management (AUM) rose to a record N14.19 trillion in May 2022, with investments in government securities accounting for 62.10%. This implies that the growing AUM of the PFAs has slightly improved the liquidity in the fixed income market this year. Also, the selling pressure that typically succeeds a hike in the benchmark interest rate has been limited, as the PFAs, which hold roughly 63.00% of the bond market value, have about 60.00% categorised as “Hold to Maturity” (HTM).

Conclusively, inflation and increased government borrowing have not had a significant impact on both local equities and fixed income markets this year, as several other drivers have partly insulated the financial market from such local headwinds.

Citing low liquidity in the Nigerian foreign exchange market, the MSCI recently indicated its intention to reclassify the MSCI Nigeria Indexes from Frontier Markets to Standalone Markets status. What does it portend for the economy and for investors?
The contemplated reclassification of MSCI Nigeria Indexes is a warning alarm to foreign investors, as the situation in the FX market has deteriorated to the point where foreign investment appetite should understandably weaken. Due to Nigeria’s abysmal oil production level and slowing foreign inflows, the supply of foreign exchange has been tight this year, with the World Bank estimating the FX backlog at $1.7 billion, while the Investors and Exporters’ net flows stood at just $273 million from January 2022 to June 2022.

Should the MSCI go ahead in downgrading Nigeria’s frontier status on or before the set deadline of August 31, 2022, the impact on the local bourse would likely be limited, as foreign investors have been the net sellers for over a year, hence, have a limited presence in the equity market.

The last NGX Domestic and Foreign Portfolio Investment Report for May 2022 revealed that foreign transactions accounted for just 7.46% of total transactions in the review month, and the foreign quotient used to be well above 60.00% in 2019. However, there are long-term consequences of the MSCI reclassification, as the absence of a near to midterm solution to Nigeria’s FX problems could translate to a sustained apathy of foreign capital.

As an investment banking group, what were the major challenges for Comercio Partners in H1’22 and how did you navigate these challenges to deliver value for your stakeholders?
As with many other investment organizations, the turbulent market posed a key challenge, particularly, with dollar-based assets like Eurobond and U.S. equities plummeting significantly. However, local equities were low-hanging fruits in the first half of the year, as the local bourse remained in the top five best-performing markets globally for a significant part of the review period.

Particularly, names in the telecommunication, industrial and agricultural sectors offered decent returns. Also, the aggressive selloffs in the Eurobond market created attractive long-term entry opportunities for the business, as yields on specific Eurobond sovereigns offered dollar returns that match and exceed the yields on corresponding maturities in the local bond market.

Basically, we maintained a nimble approach this year, leveraging in-depth research to garner unfolding insights into the economy and market, which has in turn informed our strategy and kept us ahead of the curve, irrespective of the headwinds and uncertainties.

We have also kept to the catchphrase of “following the money and making cash kings.” In a time of extreme volatility, it is preferable and smart to keep cash and play a lot on the short end of the curve.

What is your outlook for the economy, financial markets in H2’22 and your advice to investors in terms of opportunities and challenges in H2’22?
In the global space, there is a growing probability of a recession over the next two years, as drastic policy efforts to tame inflation could significantly squeeze the economy. Also, the unabating conflict in Eastern Europe remains a major caveat for the global economy in H2 2022, as the sustained progression or escalation of the war could further dampen global growth prospects for the rest of the year. Meanwhile, policymakers should continue to prioritize efforts aimed at lowering inflation, leaving the global financial market susceptible to a prolonged bearish dominance.

Back at home, we maintain a positive outlook for GDP growth, as Service-related sectors like Information and Communication, Finance and Insurance should continue to buoy overall growth. However, we recognize the limiting impact of the spiralling inflation trend, as this could increase the cost margins of businesses at large. For the oil space, there appear to be no major tailwinds, as sectoral ills pertaining to security concerns and debilitated infrastructure remain unaddressed. Hence, Nigeria’s low crude oil output would limit the expected positive impact of soaring prices in the international oil market.

In addition, the upside risks to the trend of inflation in the coming months remain predominant, as tensions in Eastern Europe continue to run amok, while the local economy stays structurally susceptible to such headwinds.

Regarding the foreign exchange market, the impact of the Russian-Ukraine conflict on energy and agricultural commodities should mount pressure on the import bill, while the hawkish policy posture of developed nations, ravaging insecurity, and election fears should act as deterrents to foreign capital inflows. Also, Nigeria’s low oil output level significantly undermines the economy’s ability to leverage the elevated price of crude oil to improve FX earnings. Putting all these together, the local currency is likely to weaken further this year, with the possibility of the parallel market exchange rate falling past N650/$ by year-end.

For the financial market, a progression of the contractionary policy efforts by the monetary authorities could force yields to trend upwards, albeit aggressive, as PFAs’ long-term investment approach denies the market adequate liquidity to sell significantly.

Elsewhere, local equities are expected to be largely steered to earnings releases and corporate actions, as investors shrug off the worries concerning Nigeria’s deteriorating macroeconomic framework to focus on stocks with impressive fundamentals and positive catalysts. However, elevated fixed income yields could partly stifle the stock market performance, as activities on the local bourse are largely dominated by institutions that would typically turn to fixed income instruments when presented with attractive yields.

On a broader stage, the electioneering campaign activities towards the next year’s general elections will go into full swing in the second half of this year and could play a huge impact on the currency and inflation that have already been battered. It is no less fact that the Nigerian economy is in a precarious state and cannot afford the ‘typical’ excessive electioneering campaign that would lead to a serious economic shock, which could suppress the last gasp of breath the nation needs for survival out of stagflation.