At around NGN400/$, the naira currently offers a 5% discount to our estimated fair value (this discount will likely disappear due to inflation over 2017), while we think equities and naira bonds are cheap.
After spending most of the past fortnight in Nigeria, at Renaissance Capital’s 8th Annual Pan-Africa 1:1 Investor Conference in Lagos and the 10th African Finance Corporation’s (AFC) infrastructure-focused conference in Abuja, we believe we have learnt enough to justify a more optimistic stance towards Nigerian assets. In February, we argued that when greater FX flexibility came to Nigeria, investors might only enter the market at an exchange rate of NGN450-500/$. We assumed there would be no Egyptian style float of the currency.
We thought investors would need a ‘Nigeria FX risk premium’ of at least 10-20% to compensate for the potential risk that FX flexibility might be short-lived. But we were wrong to only look at investing in Nigeria through the FX prism. We should have also considered whether bonds and equities were cheap or expensive. What has become evident in recent weeks is that naira bonds yielding 18% and equities are cheap enough that investors are prepared to buy the naira even with just a small discount to the NGN375/$ fair value estimate of our 22-year REER model. Note due to inflation we estimate that fair value will depreciate to NGN410-415/$ by mid-2018.
The ‘I&E’ FX window was clearly the catalyst of change
The catalyst of this was the introduction of the new investor and exporter (I&E) FX window on 24 April, which finally gave portfolio investors a currency market they could access after two years of market-destroying FX illiquidity. After a hesitant start, foreign inflows began to pick up, and the stock market reacted sharply at the time of our Lagos conference. Media reports suggest $600mn has flowed into Nigeria over four weeks (a fair amount has flowed out too).
The I&E rate varies from bank to bank, with recent estimates putting the exchange rate range from around NGNG370/$ to NGN425/$. The large range is because so far banks are barred from trading with each other in this FX window. Comments last week from Vice-President Yemi Osinbajo, that “the market should determine everything”, imply we may see all Nigeria exchange rates converge to a market-determined rate.
But for now, we think investors should cautiously assume the I&E window remains the only accessible window until the 2019 elections. The most obvious threat to the I&E window is a collapse in oil production and/or oil prices; in that scenario, we cannot be sure the Central Bank of Nigeria (CBN) would continue supplying FX to this window. But potentially, investors would meet their own supply and demand needs, presumably at a much weaker exchange rate. Whatever scenario unfolds, the key point is that the FX barrier to investing in Nigeria has now been removed. As a consequence, investors can now focus on the reform priorities of the government.
This is (mostly) a reform-minded administration
Nigeria’s per-capita GDP has fallen to around $1,740 in 2017, from over $3,000 in 2014. This year the IMF forecasts Nigeria will have the third-fastest GDP growth acceleration of any Frontier market, and it expects this to repeat in 2018. Investment spending in the 2016 budget reached perhaps NGN600bn, and the government aims to push this to NGN2,240bn via the 2017 budget. Railway investment will be funded by China’s Eximbank, similar to what we have seen in Kenya.
The Ministry of Trade and Investment is focusing on special economic zones to boost manufacturing, under advice from former World Bank chief economist Justin Lin. That should be supported by the Power Sector Recovery Programme, partly funded by the World Bank. The ministry is also advancing Ease of Doing Business reforms. The anti-corruption campaign continues, and the Ministry of Finance should soon unveil a tax amnesty plan to gather revenue and encourage future tax collection. Reform is under way.
We think most metrics in Nigeria will be demonstrating improvement in 2017, providing oil prices/production do not plunge. We are cautiously positive on equities and bonds at an exchange rate around NGNG400/$.