Bond index: Nigeria risks N800bn capital flight as JP Morgan, CBN bicker

In from Success Allantee …
Nigeria might be at a risk of enormous capital flight as JP Morgan has said it would delist the country from the JPMorgan Government Bond Index-Emerging Markets Indices (JP Morgan GBI-EM Index) by the end of October.
The announcement has created a panic in the financial market.
Nigeria immediately responded strongly to the announcement by JP Morgan. In a statement signed by the Ministry of Finance, Central Bank of Nigeria (CBN) and Debt Management Office, the Nigerian financial services authorities said they “strongly” disagreed with the index expulsion, noting that foreign exchange market’s liquidity was improving.
The CBN said it has continuously met the dollar demand of foreign investors, describing the exclusion as unjustifiable.
JP Morgan hinged its decision on the management of the Nigerian currency exchange by the CBN. “Foreign investors who track the GBI-EM series continue to face challenges and uncertainty while transacting in the naira due to the lack of a fully functional two-way FX market and limited transparency,” JP Morgan noted.
CBN had to devalue the naira and pegged it at a fixed rate against the dollar, turning trading into a one-way quote currency market whose lack of transparency upset investors and businesses.
JP Morgan said Nigeria would not be eligible for re-inclusion in the index for a minimum of 12 months. To get back in, it would have to establish a consistent record of satisfying the index inclusion criteria, such as a liquid currency market.
Nigeria might be at a risk of enormous capital flight over the announcement of exclusion.
The JP Morgan GBI-EM Index serves as benchmarks for local currency bonds issued by emerging market governments. The index was launched in June 2005 and is the first comprehensive global local emerging markets index.
The JP Morgan GBI-EM Index is widely regarded as reference point for foreign investors seeking to diversify their portfolios by investing in sovereign bonds issued by emerging market countries.
Nigeria celebrated its admission to the JP Morgan GBI-EM Index on October 1, 2012. Nigeria was the second African country after South Africa to be included in the widely followed index.
JP Morgan had earlier in January 2015 downgraded Nigeria to “index watch negative”, a decision the global financial services company said resulted from policies by the CBN, which limited liquidity in the spot foreign exchange market and local treasury liquidity market. The CBN had on December 17, 2014 reduced the net open position (NOP) of commercial banks from one per cent to zero per cent of shareholders fund, before subsequently revising it to 0.1 per cent in January 2015.
JP Morgan had stated that this measure effectively resulted in a lack of liquidity in the spot foreign exchange market and domestic bond market thus hindering the ability of foreign investors to replicate Nigeria’s exposure to the GBI-EM Index.
Analysts at CardinalStone Partners Limited had said Nigeria is at risk of capital flight involving about $3.9 billion (N800bn).
“Nigeria’s inclusion in the GBI-EM index was generally seen as a big step forward in its integration into global financial markets, opening the market to new investment and raising its profile worldwide. That will now be reversed,” said Alan Cameron, an economist at Exotix.
Foreign holdings of Nigerian government bonds stood below $2.75 billion, said Samir Gadio, the head of Africa strategy at Standard Chartered Bank. They had been around $8 billion in September 2014.
“This will initially trigger excess volatility in the market as exiting offshore accounts and onshore investors may push yields higher,” Gadio said. “A potential exclusion from the GBI-EM indices would make it more difficult to attract foreign portfolio flows in the future as Nigeria will need to rebuild its market credentials.”
According to analysts, possible reactions and impact of the downgrade and eventual removal on the local bond market could lead to significant capital flight.

Read also: CBN, Banks move to avert JP Morgan’s axe

Analysts noted that the total value of investor money benchmarked against the whole JP Morgan GBI-EM suite of indices is about $217 billion. The GBI – EM Global Diversified Index is the most frequently used local emerging market index and Nigeria accounts for 1.8 per cent of its value, about $3.9 billion. “Hence, Nigeria’s removal from the Index would trigger capital flight at a time when the country needs to attract capital inflow. Bond yields will also spike in reaction to the significant exit by funds which mirror the composition of the index and may subsequently lead to the exit of Nigeria from the Barclay’s Bond Index as well,” CardinalStone Partners stated.
Global Head of Sales and Trading, Dunn Loren Merrifield (DLM), Mr. Malcolm Gilroy, had in 2012 estimated that the listing of Nigeria’s sovereign bond in the JP Morgan GBI-EM could result into a total inflow of $1.5 billion in the first year of listing.
According to him, there were indications that the upward weight review due to the listing would attract as much as $1.5 billion into the domestic bond market before the end of the first listing year.
Gilroy had noted that in spite of current conditions of the global financial markets, the inclusion has helped the capital inflow into the Nigerian bond market pointing out that the market has witnessed increased flow from offshore investors since the announcement in August 2012.
He had noted that with the inclusion of the country in the JP Morgan Government Bond Index, interest rate would likely continue to go down.

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