Why FGs borrowing from CBN in 2023 will keep yields in fixed-income market low —Report

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If the Federal Government of Nigeria (FGN) continues to prefer borrowing from the Central Bank of Nigeria (CBN) in 2023, yields in the domestic fixed-income market will not rise as high as economic fundamentals imply.

This is because FGN will not be under pressure to solicit funding from domestic investors, thus limiting the bargaining power of these investors.

This is according to a report from Cowrywise Investment Company.

The report, titled, “The Key Themes Guiding Your Investment Journey in 2023” by Busola Jeje and Basirat Adebiyi, analysts at the company, noted however, that this may not be the case given increased scrutiny from international organisations like the World Bank, which has advised the CBN repeatedly to stop lending to the FGN.

As a result, “We believe the FGN will seek the bulk of their funding from public debt markets, putting the power in the hands of investors and will cause interest rates to rise,” they stated in the report.

Already, the recently released FGN bond auction calendar for first quarter (Q1) 2023 shows that the FGN plans to borrow between N80 and N100 billion for each of the four different maturities, compared to N70 to N80 billion in Q1 2022.

Listing the themes that will guide investment decisions, the firm stated that the Nigerian economy would dance to the tune of global central banks. Others are that the outcome of the presidential elections will be a major inflection point; 2023 fiscal deficit is a catalyst for higher interest rates if CBN stays put; lower liquidity in H2 2023 will give way to higher interest rates and that further devaluation is expected at the official foreign exchange market window.

The analysts noted that there is a clear indication that the FGN will borrow more than expected to supplement its spending plans, adding that preference will be for local borrowing given the higher risk premiums in international markets.

However, how the government chooses to finance the deficit, whether from public debt markets or from the CBN, is critical.

“It is not unusual for the CBN to lend to the Federal Government. In fact, the CBN Act permits it, with the rule that the Central Bank cannot lend more than five percent of the FGN’s previous year’s retained revenue. Using this principle, the maximum amount the CBN was allowed to lend the FGN in 2022 was N305billion.

“Yet, as of October 2022, the CBN had advanced a total sum of N6.3trillion to the FGN, about 103percent of 2021 revenues, a clear breach of the rules.

“This was even more than what was obtained from the public debt markets (N5.9trillion),” the report noted.

To date, the Federal Government has borrowed a total of N23trillion from the CBN, larger than its domestic debt stock of N21trillion.

“From our analysis of supply of liquidity, Q1 2023 is a very liquid period, given the large volume of bond and treasury bill maturities.

“The Debt Management Office (DMO) will also try to take advantage of this and front load borrowing plans in Q1 to enable it to offer lower interest rates,” it stated.

The firm therefore expects interest rates to remain low this quarter, at most, the end of April. It said liquidity will thin out in H2 2023, and thus “we expect interest rates to rise as a response to the tight market conditions, while the DMO continues to borrow.

“As an investor, money market funds and bond funds are a great way to position.”

Mutual funds have become an important way for retail investors to key into markets they previously did not have access to.

The analysts believe money market mutual funds and bond mutual funds are a great way to get access to professional management, as these funds are offered by SEC-regulated asset managers with a deeper knowledge of fixed-income markets and interest rate expectations.

“We cannot close this report, without giving our thoughts on the naira-to-dollar exchange rate.

“2022 was by all accounts, a bad year for the naira, which lost 30percent of its value at the parallel market to N750/$, and seven percent at the official market to N445/$.

“We also closed 2022 with a lower level of foreign exchange reserves, at $37.1 billion compared to $40.5billion at the end of 2021.

“We would have expected that with oil prices rising as high as $123/bbl in 2022, the naira should have been supported strongly by booming FX reserves, but we would have been wrong,” analysts further noted.

In 2023, the report strongly believes the naira will be devalued at the official market to reflect current market realities, as the CBN’s “managed” way of supporting the currency is not sustainable.

Interestingly, the current exchange rate on one year non-deliverable forwards is N525.65/$, which shows that the market is still pricing in a devaluation.

In the parallel market, the analysts expect electioneering activities to cause the exchange rate to remain high.

“We believe the naira at the parallel market is highly undervalued, and we expect a naira appreciation in that market towards the latter part of the year.

“When all is said and done, 2023 carries a lot of risks and uncertainty: unpredictable election outcomes, unanticipated policy changes and a possible global recession.

“We believe the tips to a successful investment strategy this year is to diversify your investments, manage risks and not chase returns. As part of our commitment to democratise the everyday African’s access to credible investments, our strategy has been to offer several regulated investment opportunities for our users, across multiple asset classes. As such, you can build a well-diversified investment portfolio for 2023 directly on Cowrywise, and actively monitor your wealth-building journey,” the report added.

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