Our top pick in Nigeria is FGN bonds (a new Buy recommendation). We also now have six Hold recommendations, including sovereign and bank eurobonds, and downgrade our view on T-bills to Hold from Buy.
In the sovereign space, we have one new view and one change of view. We assign a Buy to short tenor naira-denominated government (FGN) bonds, with 1-year yields of 8.5% and 3-year at 10.0%, and we downgrade our view on T-bills to Hold from Buy, given the compression in T-bill yields since October. We maintain Hold on Nigeria’s US$ bonds as “muddle through” becomes the new reality, with a yield on the 7.143% 2030 US$ bond of 6.5% (z-spread 470bps).
Among financials, we now have four Hold recommendations. We downgrade the Access Bank 2021 bond to Hold. We reiterate our Hold on the Fidelity Bank, UBA and Zenith Bank 2022 securities. 2020 may be the year to maintain (rather than add to) existing holdings of Nigerian bank bonds, while looking to the primary market for potential new issues. Within non-financials, the two main corporate bond issuers in US$ of any note – Seplat and IHS – are unrated.
On the macro outlook, President Buhari’s re-election last year just about guarantees the status quo in his second (and likely, final) term. While this year (and next) presents an opportunity to advance more serious structural reform, especially as Buhari now has control of the legislature, before the election cycle begins ahead of the next presidential election in 2023, we doubt this opportunity will be grasped vigorously with both hands. But while the authorities could do more, they would also have to do a lot to mess it up.
We expect moderate real GDP growth, around 2.0-2.5% pa, to continue over the medium term, well below regional peers and the government’s aspirations in its ERGP. We see real GDP growth of 2.5% in 2020. Inflation should remain in low double digits (c12-13% by year-end), as a passive central bank balances pressure to reduce rates to boost lacklustre growth with upside risks to inflation. We expect the CBN to remain on Hold this year (its policy rate is 13.5%).
We don’t foresee any changes to FX policy (unification of the FX rates) or the FX rate (devaluation), as political imperatives will outweigh pressures to adjust the currency coming from the deteriorating external balance and fall in reserves. However, we see downside risks to the naira in a devaluation scenario as less severe now than in 2015-2016.
Nor do we expect any major changes in fiscal policy. While the recent VAT increase is a welcome step towards tackling Nigeria’s chronically low revenue base, more needs to be done and its revenue yield is unclear. Such a seemingly benign outlook may be viewed positively by investors, helped by a low headline budget deficit (1.5% of GDP), stable FX, ample reserves’ coverage, low US$ bonds’ debt service and low but rising public debt burden (30% of GDP).
However, important vulnerabilities remain. The fiscal deficit at the wider general government level is much larger and more persistent (c4.7%), which contributes to large financing needs, while debt dynamics are poor. High debt interest and the low revenue base threaten fiscal sustainability (interest is 60% of Federal revenue). And Nigeria is increasingly reliant on non-resident portfolio inflows into the local market (leaving it vulnerable to changes in investor sentiment and sudden stops) and central bank financing (which threatens monetary policy effectiveness and could be inflationary).
Still, absent lower oil prices/production and/or a flaring up of the domestic or regional security situation, there isn’t anything obvious – this far away from the 2023 election – to upset the outlook, which may be some comfort to investors.