Forex regimes and Nigeria’s bond index at JPMorgan

NIGERIA, in January this year, was greeted with a negative investment rating on its bonds listed on JPMorgan’s Government Bond Index – Emerging Markets (GBI-EM).

This index includes selected bonds issued by eligible countries. The situation got worse, when after several months of being on the watch list without improvement, according to the measurement of the operators of the Index, a threat of delisting followed.
   
According to JPMorgan, leading from the negative rating to the planned delisting of the country’s bond on the index are decisions bothering on foreign exchange regime, low external reserve and uncertainty over the accretion of the reserves, given the unending fluctuations in the prices of crude oil in the international market, which gives Nigeria over 70 per cent of its foreign exchange earnings. It also cited difficulties for offshore investors to replicate Nigeria’s allocation in the benchmark.
  
Of course, it was and is still not a good development for the country. For one thing, the investors would now engage extreme cautious trading with the country. On the other hand, investments would be priced higher to cover the assessed risks associated with the uncertainties in the country. For example, at the negative rating put at three steps below investment grade, a typical foreign portfolio investor would ask for higher interest to cover the risk level.
  
Recently, the planned delisting which was due this month was extended by six months. This is perhaps, a new lease of life for the country and for the new administration that already has much in the economy to handle.
  
Still, any possible positive outcome by the end of the period, according to analysts, is to be driven by the extension, which would raise bond returns and may be complemented by duration gains. Also foreign inflows to sovereign debts will likely be underpinned by a more sustainable exchange rate level.
  
However, the continued index inclusion will depend upon improved foreign exchange liquidity and a price-driven trading platform like the Nigeria Interbank Foreign Exchange. This means that foreign accretion is still central to the “cure”.
  
The Head of Market Strategy, Africa, at the Research Unit of Standard Chartered Bank, Samir Gadio, in a not e to The Guardian, said: “The index provider indicated in its notice that Nigeria’s index eligibility at the end of the extension period would be conditional upon a consistent record of a functioning and transparent foreign exchange market. This would require adequate foreign exchange liquidity and two-way flow trading to ensure that benchmarked investors can transact with minimal constraints.
  
“This extension of the review period is broadly in line with market expectations. As Nigeria continues to face challenges from last year’s oil-price shock, it was therefore, expected that the index provider be lenient and allow more time to address market bottlenecks, particularly as the new administration under President Muhammadu Buhari is still settling in after the March 28 presidential election and May 29, 2015, handover.
  
“Furthermore, the Nigerian authorities appear to have maintained a dialogue with the index provider and the investor community on foreign exchange market issues. The Central Bank of Nigeria (CBN) has also prioritised foreign investors on their way out at its special forex interventions.
  
“We expect Nigerian bonds to remain in the GBI-EM indices provided reforms are undertaken to normalise exchange rate conditions and move towards a price-driven FX trading platform in the coming months.”
 
He noted that Nigeria’s potential exclusion from the GBI-EM indices is an avoidable outcome, especially as judging from the government and CBN’s standpoint, it represents a significant setback in the development of domestic financial markets and undermines the country’s external credibility.
  
“For the index provider, it may test the credentials of the GBI-EM inclusion process, while exclusion on account of FX liquidity-related factors is largely unknown territory. International investors would also likely prefer Nigeria’s GBI-EM eligibility to be reaffirmed,” Gadio noted.
  
Nigeria has been described as a high-yielding diversifier in the GBI-EM index, but investors are largely underweight, which may be attributed to risk factors.
  
JPMorgan in an accompanying statement for the extension of the planned delisting noted that Nigeria’s weight in the GBI-EM Global Diversified index- the largest in terms of benchmarked funds, remained marginal at 1.8 per cent as of May.