The year 2023 proved to be another rollercoaster year for Nigerian fixed-income markets. Indeed, the year was going to be another inflexion point as the general elections marked the end of the eight-year presidency of Muhammadu Buhari.
The incoming Tinubu administration moved to change things quickly with big increases in petrol prices, the dismissal of the erstwhile CBN governor (Godwin Emefiele) and the removal of the hard peg on Naira trading within the official FX market, which led to a 40% weakening of the currency in June.
In the months that followed, the Naira would lose over 57% of its value in nominal terms (around 20% in real terms) to post its worst year since 1995 and inflation would accelerate to 28%, the highest since 2005.
In terms of fixed income markets, rates across the Naira yield curve climbed on average around 128bps in 2023, driven by sell-offs across the entire curve: front-end (+175bps), middle (+80bps), and long-end (+170bps).
The lift-off in rates was driven by a strong repricing on the one-year +350bps) which followed the sale of OMO bill sales by the CBN at yields of 20-21% beginning in Q3 2023.
However, yields retraced strongly in December with the 1-yr trading at effective yields of 12-13% after rising to 17.5% levels in November reflecting a pull-back in CBN liquidity management and as the Debt Management Office closed out its 2023 borrowing cycle after reaching its targets in early December.
From a price perspective, total returns on Nigerian bonds using the S&P/FMDQ bond index came in at 8.1% (2022: 7.8%) with most of the price gains concentrated in December.
Figure 1: Naira Yield Curve
Source: Bloomberg
• Despite policy tightening, Naira depreciation drives above-target expansion in money supply: Looking at monetary aggregates, available data through September reveals strong growth in Broad Money (M3) (+38.4%, annualized) relative to CBN’s target of 28% (2022: +19%) despite the pursuit of contractionary monetary policy.
If anything, the tightening stance over H2 2023 merely helped dampen the robust pace of monetary expansion in the first half of the year when M3 expanded as high as 49% in June 2023.
The rapid increase in money supply reflects a surge in net domestic assets, NDA (up 52%, annualized), relative to a contraction in net foreign assets, NFA (down 86%).
The growth in NDA largely reflected strong credit growth across the public sector (+51% annualized to NGN34.1trillion) and private sector (+54% to NGN58.6trillion) driven by the record fiscal deficits in the former and the translation impact of the NGN depreciation on USD loans in the latter.
Despite stronger oil prices and improving oil production, the steep declines in net foreign assets relative to more modest declines (down 12% to USD32.8billion) in Nigeria’s FX reserves reflects the huge overhang of external foreign liabilities comprising large cross-currency swaps (USD21billion) and USD forwards (USD7billion).
The expansion in money supply comes in the face of higher direct liquidity sterilization via CRR debits as cumulative CRR debts stood at NGN16.7 trillion at the end of September 2023, up from NGN13 trillion at the end of 2022.
• CBN returns to liquidity sterilization but balance sheet matters complicate efficacy of tightening measures: In terms of actual securities supply, after three years of reducing the size of its ‘public’ Open Market Operations (OMO) bill portfolio, the CBN returned to active liquidity management with net issuance of OMO bill to the tune of NGN658billion which compares with the pattern of large redemptions in the prior three years (2022: NGN1.3trillion, 2021: NGN4.5trillion and NGN6.03trillion in 2020) which left the total outstanding stock of public OMO bills at NGN1.2 trillion, the lowest level in nine years.
I use the distinction between public and private OMO bills as following the release of the long-delayed CBN audited financials, it was revealed that the CBN had a much larger OMO bill stock (NGN10trillion) which reflects off-market OMO bills issued to banks and other counterparties instead of the famous cross currency swaps.
The huge liabilities running at elevated interest rates appear to have been the main confounding factor to effective monetary policy as the associated costs raised the risk that the CBN would run a loss.
As I flagged in my note on Nigeria’s central banking, this is the main drawback to asset-driven central banks as effective sterilization of excess liquidity required a profitability trade-off which underpinned CBN’s preference for reserve requirements as the key tool for monetary policy.
How the CBN navigates this trade-off, in my view, will be key in viewing policy credibility over 2024.
• This leaves elevated government borrowings as the main driver of higher yields: The relatively tame CBN liquidity sterilization implied that something else pushed Nigerian yields to record levels in September-November 2023.
In my view, this reflects a return to aggressive borrowing by the DMO late in the year with a ramp-up in sales of Nigerian Treasury Bills (NTBs) where gross issuance climbed to NGN5.8 trillion (compared to NGN4.7 trillion in 2022).
Adjusted for maturities, the DMO effectively borrowed NGN1.3 trillion largely over November 2023 reflecting a desire to hit borrowing targets. In a similar vein, gross bond sales climbed 103% to another annual record of NGN6.2 trillion, including NGN350 billion in sukuk sales.
Adjusted for the April 2023 bond maturity, net bond sales were a record NGN5.5 trillion (compared to NGN2.6 trillion in 2022).
A point to note is that these borrowings were largely financed by domestic investors which speaks to the understated depth and scale of Nigeria’s local debt markets.
In line with rising interest rate trends, the average stop rates on bond sales during 2023 climbed to 15.3% compared to 13.05% in 2022.
However, despite the rise in nominal yields, the acceleration in inflation means that NGN bond yields remain expensive, given the persistence of wider negative real yields (-1273bps compared to -760bps at the end of 2022).
Figure 2: Monetary policy and market interest rates
