WED, JULY 12 2023-theGBJournal |The perennial question for investors is whether to save in Naira or US dollars, assuming, of course, that the choice is possible from a purely regulatory perspective. Nigerian savers typically have a bit of both.
Clearly, it is best to hold US dollars ahead of a devaluation. By contrast, and after a major Naira devaluation (such as that in 2017) investors can take the view that:
a) a further major devaluation is unlikely for a while;
b) Naira fixed income yields beat US dollar yields; so it is best to invest in Naira.
The outlook for currency stability, combined with the superiority of Naira fixed income yields over US yields, after August 2017 led to the influx of Foreign Portfolio Investment which we saw in 2018 and 2019.
On this point, we have received many questions as to exactly where the Naira/US$ exchange rate will settle. Our answer is that these are early days (foreign exchange rate liberalisation is only a few weeks old) and that trades are taking place at a variety of prices, though we expect the market to reach a consensus over a month or two (as opposed to the several months it took from January to August 2017).
And we advise people to put the difference between a putative N750.0/US$1 and a N800.0/US$1 exchange rate into perspective, because the difference (in US dollar terms) is 6.02%. 6.02% is a small difference when considering a currency that has devalued from N475.1/US$1 to N750.0/US$1 (37.3% in US dollar terms).
Yet 6.02% is a big deal when comparing fixed income yields, so it makes sense to wait for the exchange rate to settle.
The carry trade, again?
This raises the question of the carry trade and the potential for a repeat of the very high levels of foreign portfolio investment seen in 2018 and 2019.
US dollar rates have changed significantly since the heyday of the carry trade four years ago, so conditions are unlikely to repeat themselves.
For example, in September 2017 US Libor was 1.7% per annum which enabled US, UK and other hedge funds to borrow US dollars at low rates. A 1-year Naira T-bill yield was 20.1% pa, so a hedge fund could borrow in US dollars, buy Naira at close to N360.0/US$1, invest in a Naira T-bill (or similar securities) and even hedge Naira currency exposure with a non-deliverable forward (NDF).
The principal risk was Naira/US dollar liquidity but this was not an issue while the CBN was supplying the foreign exchange markets with significant sums of US dollars during 2018 and 2019.
Today the arithmetic is very different. US dollar Libor is 5.9% and a 1-year Naira T-bill recently yielded 7.70%. Without a significant uplift in Naira T-bill rates and a lowering of US dollar borrowing rates it is unlikely that foreign investors will return to the carry trade in significant volumes.
Value in Eurobonds
As we argued in Coronation Research Investment Opportunities from Fuel Subsidy Removal, 9 June, the. first beneficiary of fuel subsidy removal is the Federal Government of Nigeria (FGN).
In 2022 the FGN’s budget for fuel subsidy was N4.0 trillion (US$8.6bn at the exchange rate immediately before June this year), which represented 22.1% of its total budget of N18.1 trillion.
The subsidy swallowed up 40.1% of budgeted aggregate FGN revenues of N9.97 trillion Doing away with fuel subsidy clearly has positive implications for Nigeria’s fiscal deficit, which was budgeted at N8.17 trillion in 2022.
The government-owned NNPC’s purchases of petroleum products take the form of swaps, of the NNPC’s crude oil for imported products, with petroleum (until 31 May 2023) sold at subsidised Naira prices.
Given the nature of the swaps, it seems that the NNPC is saving itself the equivalent barrels of oil, with the value accruing to the government (its shareholder).
Removing fuel subsidy is therefore a US dollar saving for the FGN. Eurobond markets were quick to spot this, with yields tightening across the curve almost immediately after the announcement of fuel subsidy removal on 29 May.
We think FGN Eurobonds still represent good value in the context of a government whose finances are improving and which has embarked on a path to reform another subsidised sector of the economy, the power sector.
Does foreign exchange liberalisation itself have implications for FGN Eurobonds? One could argue that a fully-liberalised Naira/US$ exchange market would remove the strain on the Central Bank of Nigeria of providing US dollar liquidity to it.
The published foreign exchange reserves of the CBN have fallen from US$37.1bn to $34.0bn so far this year, though only part of that decline is likely attributable to interventions in the foreign exchange market.
In our view the argument goes some way to suggest that FX liberalisation supports the US dollar reserve position of the nation, but we recognise that central banks routinely intervene in their foreign exchange markets, so the effect may be limited.
Banks upside potential persists
Nigerian banks routinely record gains/losses depending on their balance sheet exposure to foreign exchange.
Following the recent FX liberalisation which has seen the value of the Naira dropped by circa 40% against the US dollar, we expect banks with net long US dollar balance sheets to book significant FX revaluation gains.
Note that the exposure of each bank may not be adequately expressed in the above chart. Each bank may hold off-balance sheet and derivative positions that either decrease or augment their net foreign exchange positions. Predicting revaluation gains from the above table alone, therefore, is not possible.
On average, foreign currency loans for banks under our coverage account for 40% of their combined total loan book. In contrast with revaluation gains, we also expect a degree of elevated foreign currency non-performing loans (NPL) and associated impairment charges going forward.
Shifting focus, we expect a breather for the banks from the tight regulatory regime imposed on them over the past four years.
Nigerian banks have had to pay the 32.5% Cash Reserve Requirement (CRR) imposed by the CBN. There is market comment about possible CRR refunds which would result in a reduction in the cash reserve positions. This would in turn improve banks’ margins.
Recently, changes were made to the rates at which the Naira inter-bank market could trade. Previously, the rate at which overnight NIBOR could trade had been linked to the lower band set around the Monetary Policy Rate (MPR) at 18.5%, effectively putting an 11.5% floor to interbank rates. With this limit removed, NIBOR rates have reduced drastically.
Typically, tier-2 banks are frequently at the receiving end of the inter-bank market, and so, this is likely to translate to reduced cost of funds fortier-2 banks.
We expect significant buying interest including from institutional investors as well as from foreign investors following FX liberalisation and we believe Nigerian banks look attractive in comparison with banks from comparable markets.
In 2017, we saw the Importers and Exporters Window (I&E window) market introduced, and this resulted in improved FX liquidity in the market.
This ushered significant increases in banks’ share prices with the banking index gaining 73.3% in 2017 compared to a 42.3% return of the broader index.
We have upgraded our earnings for the six banks under our coverage, and today we publish these along with new target prices (TP).
We see value in Access (BUY; TP: N22.05), FBNH (BUY; TP: N22.59), GTCO (BUY; TP: N44.31), Stanbic (HOLD; TP: N62.08), UBA (BUY; TP: N18.45), Zenith Bank (BUY; TP: N45.79).-Concluded.
This Special Report is written by Coronation Research and made available to theGBJournal
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