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Nigeria faces removal from JP Morgan bond index

By on February 18, 2015

The likelihood of Nigeria being removed from the JP Morgan Emerging Market Bond Index has increased as liquidity concerns in the nation’s foreign exchange market linger.

The plunge in global oil prices since June 2014 has put pressure on the foreign exchange and bonds market, leading to the devaluation of the naira by eight per cent in November and tightening of trading rules to curb speculation.

Analysts said the removal from the index would force funds tracking it to sell Nigerian bonds from their portfolios, potentially resulting in significant capital outflows and this in turn would raise borrowing costs for the country.

The Head of Economic Research, Ecobank, Mr. Angus Downie, in an emailed response to questions from our correspondent, said, “It is looking increasingly likely that Nigerian bonds could be removed from the JP Morgan EMBI given the US dollar shortage in the local market, which makes it difficult for foreign investors to repatriate funds from Nigeria.

“If Nigerian bonds are removed, this will only have a limited impact in the short term because many foreign investors have already liquidated their Nigerian bond holdings; so, the level of capital outflows from this event will be relatively small.”

The EMBI is JP Morgan’s index of dollar-denominated sovereign bonds issued by a selection of emerging market countries, and the family of the EMBI is the most widely used and comprehensive emerging market sovereign debt benchmark, according to Financial Times.

JP Morgan on January 16 said it had placed Nigeria on a negative index watch on its Government Bond Index.

The bank, which runs the most commonly used emerging debt indexes, said it placed Nigeria on a negative index watch and would assess its place on the GBI over the next three to five months.

Downie, however, said looking further ahead, assuming Nigeria was not swiftly re-admitted to the EMBI, the level of portfolio inflows would remain relatively low, which would undermine the naira and weaken growth prospects.

JP Morgan added Nigeria to the index in 2012 when liquidity was improving, making it the second African country after South Africa to be included. It added Nigeria’s 2014, 2019, 2022 and 2024 bonds, which make up 1.8 per cent of the GBI-EM Global Diversified index.

“If we are unable to verify sufficient liquidity in Nigeria’s spot FX and local treasury bond market … it will trigger a review … for removal,” JP Morgan said.

“Conversely, if liquidity improves and investors are able to transact with minimal hurdles, Nigeria will be removed from index watch negative,” the bank said.

A financial analyst at the WSTC Financial Services Limited, Mr. Olutola Oni, said the removal of Nigeria from the JP Morgan bond index would trigger a massive sell-off of Nigerian fixed-income assets by foreign investors tracking the index, stressing this would have a significant downside implication on the naira.

“It will further increase risk premium investors will require to hold the FGN bond securities,” he said.

Oni said the decision of the Central Bank of Nigeria to stop banks from selling dollars sourced from the CBN among themselves was expected to further increase the pressure in the foreign exchange market.

“While we view the increase in the net open position of banks to 0.5 per cent as a positive step in easing liquidity pressure in the FX market, we believe that the recent development (ban of two-way quotes) will further narrow liquidity in the interbank segment of the market (and impliedly restrict easy movement of capital by foreign investors).

“We believe that this will rather increase the likelihood of the removal of Nigeria from the JP Morgan bond index,” he added.

In the year after Nigeria joined the index in October 2012, foreign holdings of its bonds jumped from $1.2bn to $5.4bn, but JP Morgan said last month Nigeria’s inclusion was under review because of a lack of market liquidity.

 

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