Nigeria’s negative real yields put off Abrdn after FX reforms

Nigeria will need to allow interest rates on naira bonds to at least double to make them attractive enough for foreign investors to buy and bring in the dollars needed to support its currency reforms, according to fund managers and analysts.

The Central Bank of Nigeria sold one-year treasury bills last week at a yield of 8.2%, which is less than half headline inflation of 22.4% in May and the monetary policy rate of 18.5%. That results in a negative real yield on the notes that will deter foreign investors, Kevin Daly, a portfolio manager at Abrdn Investments in London, said by email.

Abrdn, which sold its short-term naira notes in 2020 after authorities imposed capital controls and pegged the naira exchange rate, said it “would be interested in bringing money back onshore if rates adjust higher in the range of 15-20%, and the naira settles around the 750 a dollar area.”

Nigeria allowed the naira to slump last week, helping to bridge the gap between the official and unofficial exchange rates. Dollar bonds have responded positively to the reforms and the stock market jumped to a 15-year high.

Rates anchor

The changes have re-ignited Abrdn’s interest in Nigeria’s markets, but its investments remain restricted to dollar bonds for now, Daly said.

“We’ve benefited from a big rally on the Eurobonds as spreads have declined by over 200 basis points,” he said. “We expect spreads to compress further.”

Ayo Salami, chief investment officer at Emerging Markets Investment Management in London, also said that local bond yields will need to rise to get foreign investors back into the country. Higher inflation has widened negative real returns on bonds and the policy rate is “substantially adrift of the 1-year T-bill rate at around 8%,” said Salami, whose company has about $40 million in the country’s equities and bonds.

“T-bill yields may have to rise to re-establish the policy rate as the anchor for interest rates before foreign portfolio investors can be confident to reengage with Nigeria,” Salami said.

Africa’s largest crude producer relies on oil exports for 80% of its foreign exchange income. But a lot of that has been missing as the West African nation has been unable to meet its OPEC output quota. Higher fixed-income inflows would help boost liquidity in the foreign exchange market as the central bank allows the naira to find a “fair” exchange rate to the dollar.

Investment flows

In addition to attractive yields, Nigeria needs to smoothen the workings of the currency market to bring back investment, analysts said.

Trading volumes on the single official foreign exchange window have been “very low” so far due to a lack of central bank supply and no influx from fixed income investors, according to Renaissance Capital Africa research.

Salami, whose firm Emerging Markets Investment Management downsized activities in the country after the imposition of foreign currency restrictions in the past, said he was unlikely to make fresh additional investments into Nigeria until he “sees a genuine willing buyer, willing seller foreign currency market.”

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