Nigeria’s return to JP Morgan’s Index imminent as NAFEX attracts $45bn in 1yr

By Babajide Komolafe 

The  readimission  of Nigeria  into the J.P Morgan Government Bond Index-Emerging Market (GBI-EM) is imminent following the successful operation of the Investors and Exporters (I&E) window for one year with turnover of $45 billion. Citing lack of liquidity and transparency in the country’s foreign exchange market, due to restrictions imposed by the Central Bank of Nigeria (CBN), J.P Morgan in October 2015 ejected Nigeria from its GBI-EM, which tracks local currency bonds issued by emerging market governments This prompted foreign investors to sell off their holdings of Nigeria’s  bonds. 

Nigeria According to J.P Morgan, Nigeria would be eligible for re-inclusion if it could establish that it had upheld the inclusion criteria for at least 12 months. This means the authorities must restore liquidity to the forex market in a way that allowed foreign investors tracking the index to conduct transactions with minimum hurdle. This week marks one year of the successful operation of the I&E window introduced by the CBN on April 21, 2017, to boost liquidity in the foreign exchange market and ensure timely execution and settlement for eligible transactions. Transactions commenced on Monday April 24, while the FMDQ introduced the Nigeria Autonomous Foreign Exchange Rate (NAFEX) as reference rate for the window. In a circular issued on April 21, 2017 introducing the window, the CBN stated that eligible transactions in the window include: Invisible transactions (excluding International Airlines Ticket sales’ remittances), Loan repayments, loan interest payments, dividends/income remittances, capital repatriation, management services fees, consultancy fees, etc; Bills for collection and; Any other trade-related payment obligations (at the instance of the customer).” 

The apex bank further stated that “the supply of foreign currency to the window shall be through portfolio investors, exporters, authorised dealers and other parties with foreign currency to exchange to Naira. The CBN shall also be a market participant at this window to promote liquidity and professional market conduct.” Performance of the I&E window Since transactions commenced on April 24, 2017, the window has gained recognition and confidence from foreign investors, with transaction hitting $45 billion at the end of last week. Financial Vanguard analysis of data by FMDQ revealed that the market recorded turnover of $26 billion in 2017, while it has so far recorded $18.84 billion turnover this year. 

Last week, turnover in the market rose by 10 percent to $1.29 billion from N1.17 trillion the previous week. The naira, however, depreciated in the window by 10 kobo last week, as the exchange rate rose to N360.42 per dollar from N360.32 per dollar the previous week. A month after it was  introduced, Fitch Rating agency commended the operation of the I&E window, saying: “The Nigerian Autonomous Foreign Exchange Rate Fixing, NAFEX, mechanism, commonly referred to as the “Investors’ and Exporters’ FX Window,” appears to be boosting Foreign Currency (FC) supply and the flow of FC liquidity into the banking system. “NAFEX provides investors and exporters with a more transparent mechanism through which they can sell FC to willing buyers. Authorised banks act as intermediaries, clearing funds supplied by portfolio investors and exporters and ensuring timely execution of settlement for buyers. 

“Despite their short records, volumes transacted through NAFEX are growing. In our opinion, NAFEX offers a more transparent alternative to accessing FC than is available through the other foreign-exchange markets in the country” With the I&E operating successfully without hitch for one year, Nigeria seems to have met J.P Morgan’s criteria for liquidity and transparency in the foreign exchange market and hence its re-admission into the GBI-EM. Thus, analysts at Lagos based Vetiva Capital Management Limited were optimistic that the country could make a return into the GBI-EM as early as this quarter (Q2’2018). 

This, they observed will be a game-changer for the fixed income market this year and could potentially depress yields even further. Impact of I&E window on Nigeria’s economy Reviewing the impact of the  I&E window on the economy, they said: “The NAFEX fixing has proved to be a game-changer in the foreign exchange (FX) story, and almost a year to the date of its conception (April 21, 2017), we explore the most significant differences it has made to the Nigerian economy. “The NAFEX fixing has been a boom to Nigeria’s FX market, boosting liquidity and price discovery, but also fostering investor confidence in the economy. 

The improvement in the FX market has been a critical element of Nigeria’s economic recovery. “After an average 52 percent spread between the official and parallel market rates in 2016, and a peak spread of 70 percent in February 2017, the introduction of the NAFEX fixing triggered a convergence in rates. 

The improvement in market liquidity and transparency drove the parallel market rate from its peak of N520/$  in February 2017 to N390/$ by the end of April 2017. “Promisingly, although the naira continues to be priced at a discount in floating segments compared to its official levels, we have observed a sustained near-parity between the NAFEX and parallel market rates, providing more clarity on the market price of the naira and reducing arbitrage in the economy. “Average monthly foreign exchange turnover recorded by FMDQ stood at $12 billion, $7 billion, and, $10 billion for 2015, 2016, and 2017 respectively. Furthermore, H2’17 average was $13 billion, compared to $7 billion in H1’17, indicating the impact the NAFEX window has had on boosting dollar liquidity. 

Estimates of autonomous inflows into the “I&E” window are imprecise, but conservative guidance is at least $10 billion since inception, a far cry from Nigeria’s capital flight experience of 2014-2016. “The improvement in the FX picture can also be seen in the evolution of Nigeria’s external reserves. External reserves almost doubled from its trough of $24 billion in October 2016 to $46 billion in March 2018. A significant portion of this increase can be attributed to Federal Government external borrowing (c.$7.3 billion), currency swaps with commercial banks, and higher oil earnings, but also reflects higher autonomous dollar inflows into the economy. “The most obvious effect of the NAFEX fixing has been on the Nigerian Stock Exchange (NSE). 

The introduction of the NAFEX fixing encouraged foreign investors to return to the space, spurring a market rally that earned the NSE a podium finish on the global equity markets league table in 2017. “We recall that having been placed on a watch list and considered for a standalone status following illiquidity challenges in 2016, Morgan Stanley Capital International (MSCI) retained Nigerian equities in its index following the introduction of the  I&E window as the operators deemed window to satisfy its FX market requirements. 

“The Nigerian economy is already benefitting from the NAFEX fixing through improved dollar liquidity and investor confidence, with the dark days of currency crisis looking like distant history. Should Nigeria be re-included in the J.P. Morgan Emerging Market Bond Index, it would provide another boost and almost bring us full circle to a pre-currency crisis period.”