Nigeria: Selected Issues
Author: International Monetary Fund. African Dept.
Publication Date:
08 Apr 2016
eISBN:
9781475550559
Language:
English
Keywords:
ISCR; CR; price; firm; Nigeria; monetary policy; rate of return; monetary policy rate; treasury yield; portfolio investment inflow; naira depreciation; Oil prices; Capital outflows; Currency markets; Global; Nigeria securities
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Nigeria: Selected Issues

Abstract

Nigeria: Selected Issues

Capital Flows to Nigeria: Recent Developments and Prospects1

This paper examines recent developments in capital flows to Nigeria, and prospects for flows in the near term. While data on capital flows is subject to limitations, especially on capturing outflows, Nigeria has enjoyed increased international capital flows from a broad array of sources in recent years, though these have declined since 2014. Key drivers of capital inflows have been Nigerian and external interest rates, oil prices, and risk aversion among international investors. Some of these factors, including recent monetary easing, low oil prices expected for a long period, administrative measures inhibiting activity in the interbank foreign exchange market, and market participants expecting the naira to weaken, are likely to weigh on the outlook for capital flows in the near term.

Recent Developments

1. Nigeria has enjoyed increased international capital inflows in the last decade.2 This has been facilitated by a strengthened macroeconomic policy framework, rapid economic growth, high commodity prices, and the conclusion of external debt relief in 2005 and 2006.3 Capital flows have accelerated since 2011, and Nigeria is considered to have joined the ranks of frontier markets—that is, economies with access to international capital markets and domestic financial markets that are deep and open relative to other Low-Income Developing Countries (LIDCs).4

2. Capital has flowed to both the public and private sector, and has been sourced from both international and domestic issuance. Nigeria issued its first sovereign Eurobond in 2011, and two more in 2013. Private sector external debt issuance also ramped up over that period (Figure 1). While data on non-resident investment in domestic markets is subject to uncertainty, available indicators point to inflows to the equity market and both short-term and long-term federal government domestic debt, especially over 2011–13 (Figure 2). Nigeria has also received steady net foreign direct investment (FDI) inflows averaging nearly two percent of GDP over the last decade and been a leading recipient among LIDCs of cross-border syndicated bank loans.5

Figure 1.
Figure 1.

Nigeria: International Bonds Outstanding, 2011-15

(Billion U.S. dollars)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Source: Dealogic.
Figure 2.
Figure 2.

Nigeria: Total Capital Inflows, 2008-15

(Percent of GDP; 2015 includes through Q3 only)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Haver Analytics; and IMF staff calculations.

3. Capital inflows have slackened since 2014. Total capital inflows averaged over 4 percent of GDP over 2011–14 but fell to 1.5 percent of GDP through the first three quarters of 2015 (Figure 2). Both FDI and portfolio inflows declined in 2014 and remained low in 2015, with some offset, especially in 2014, from other investment inflows to the banking and oil and gas sectors.

4. Nigeria has also been characterized by sizable capital outflows, which have also diminished recently. Total capital outflows, which averaged 4 percent of GDP over 2011–14, have mostly consisted of other investment outflows such as trade credits and private sector holdings of currency and deposits. These outflows slowed sharply in 2015, buffering the impact on the balance of payments of the reduction in capital inflows (Figure 3).

Figure 3.
Figure 3.

Nigeria: Net Capital Flows, 2008-15

(Percent of GDP; 2015 includes through Q3 only)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Haver Analytics; and IMF staff calculations.

5. The large magnitude of outflows of other investment assets, and of errors and omissions, highlights the uncertainties faced in analyzing developments and prospects in Nigeria’s capital flows and overall balance of payments. Analysis of Nigeria’s capital flows is subject to limitations in the data, as inflows are generally captured more comprehensively than are outflows. This has in the past been a contributing factor in the large, negative errors and omissions reported in balance of payments data. Net other investment, including both inflows and outflows, averaged about minus 3 percent of GDP over 2010-14. Errors and omissions outflows were of similar size, and highly negatively correlated with other investment flows, suggesting the errors and omissions could reflect unrecorded other investment outflows (Figure 4).6 Supporting this potential relationship is the similarity of Nigeria’s net other investment and errors and omissions outflows, when taken together, with those of other oil exporters, at a level well above most major economies (Figure 5).

Figure 4.
Figure 4.

Nigeria: Errors and Omissions Correlations, 2008Q1-2015Q3

(Correlation of quarterly data)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Haver Analytics; and IMF staff calculations.
Figure 5.
Figure 5.

Nigeria: Net Other Investment and Errors and Omissions Flows, 2010-14

(Percent of GDP; average 2010-14)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: IMF, Balance of Payments Statistics; and IMF staff calculations.

Drivers of capital flows

6. This section examines the recent behavior of typical drivers of capital flows. The volatility of capital flows during the global financial crisis of 2008-09 and its aftermath spurred a renewed interest in the drivers of capital flows to emerging markets.7 Many studies have distinguished between external “push” factors and country-specific “pull” factors. Push factors would include determinants of the rate of return on advanced economy assets, such as interest rates and economic growth, and the degree of risk aversion by non-resident investors. Pull factors would include determinants of the rate of return on assets in the emerging market, such as domestic interest rates, expectations of the exchange rate, and economic growth, as well as country-specific macroeconomic fundamentals and other risk factors. For Nigeria, given its dependence on oil for foreign exchange earnings and fiscal revenue, the oil price is potentially a key driver of both the rate of return on domestic assets and of country-specific credit and foreign exchange risks.

7. Figures 6 through 9 display some of these factors for Nigeria.

  • Figure 6 shows some pull factors—the ten-year U.S. Treasury yield, the VIX volatility index, and the EMBI Global spread on emerging market sovereign debt, as a measure of investor sentiment toward emerging markets in general.

  • Figure 7 shows the Nigerian monetary policy rate, and yields on one-year and long-term (ten years or more) Federal Government of Nigeria securities, and shows that domestic interest rates have typically exceeded ten percent.

  • Figure 8 shows the spread on Nigerian Eurobonds versus U.S. Treasury yields, and the oil price. The negative relationship reflects Nigeria’s dependence on oil for fiscal revenue, and thus market perceptions of its creditworthiness.

  • Expectations of future exchange rates are shown in Figure 9. Both the Consensus Forecast and the non-deliverable forward (NDF) market have tended to expect the naira to depreciate, with the latter embodying expectations of a larger depreciation.

Figure 6.
Figure 6.

Nigeria: Global Financial Conditions, 2008-15

(Quarterly averages)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Bloomberg; and Haver Analytics.
Figure 7.
Figure 7.

Nigeria: Interest Rates, 2008-15

(Percent; quarterly averages)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Bloomberg; and Haver Analytics.
Figure 8.
Figure 8.

Nigeria: EMBI Spread and Oil Price, 2008-15

(Spread in percentage points; price in U.S. dollars per barrel; quarterly averages)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Bloomberg; and Haver Analytics.
Figure 9.
Figure 9.

Nigeria: Expected Exchange Rate Depreciation, 2008-15

(Expected 12-month percent change in naira per U.S. dollar)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Bloomberg; and Consensus Forecasts.

8. Developments in these underlying determinants appear to have some bearing on movements in Nigeria’s capital inflows and outflows. Overall, the broad stylized facts shown above suggest that total capital inflows, in particular portfolio inflows, lined up with the period of high oil prices and low interest rates in advanced economies, and the associated search for yield by investors. The subsequent downturn in these flows in late 2014 coincided with the decline in oil prices, which also generated higher yields on domestic securities and Eurobonds, and expectations of exchange rate depreciation. Administrative restrictions on foreign exchange market activity imposed around that time, as described in the next section, also likely had a dampening effect on capital inflows.

9. Regressions also point to the importance of these factors for portfolio inflows. Given the short time span of the data, its volatility, and the measurement issues noted above, empirical analysis of Nigeria’s capital flows should be treated with caution. Furthermore, the short time span prevents consideration of some more slow-moving macroeconomic fundamentals such as public debt. Nevertheless some insights emerge from the regressions shown in Table 1, where each category of capital flows was regressed on each of these potential determinants.8 Shaded cells signify statistically significant relationships of the correct sign at the 10 percent level. There were few such relationships for capital outflows, but for inflows, in particular for portfolio flows, relationships were stronger and in line with expectations. Table 2 lists the qualitative findings:

  • Factors increasing capital inflows: Tighter domestic monetary policy, and broader financial conditions, as well as stronger expected growth and higher oil prices, all tended to increase capital inflows, especially of portfolio debt securities.

  • Factors reducing capital inflows: Higher U.S. yields and increased risk aversion either in general or toward emerging markets in particular reduced capital inflows, with the relationship again tighter for portfolio flows. Higher expected depreciation of the naira also tended to reduce capital inflows, but the results were not statistically significant.

Table 1.

Nigeria: Coefficients from Univariate Regressions, 2008Q1-2015Q3

article image
Source: IMF staff calculations.Note: The sample period is 2008Q1 to 2015Q3. The independent variables are the first two lags for domestic interest rates, and the contemporaneous term and first lag for the external factors and survey variables. The coefficients shown are the sum of these two terms. Shaded cells are statistically significant at the 10 percent level, as measured by p-values of Wald F-statistics, which are robust to autocorrelation and heteroscedasticity and test the joint significance of the independent variables.
Table 2.

Nigeria: Broad Impact of Push and Pull Factors on Capital Inflows

article image
Source: Regressions in Table 1.

Prospects for Capital Flows

10. This section examines some factors that could affect the outlook for Nigeria’s capital flows. Nigeria’s increasing reliance on market sources of financing warrants a closer examination of portfolio investment inflows. Building on the results in the previous section, each category of portfolio flows was regressed on a subset of variables of particular importance for forecasting and policy analysis. These variables are the Nigerian monetary policy rate, the expected depreciation of the naira, the U.S. Treasury yield, and the oil price. This model was chosen to maximize the applicability to the outlook for portfolio inflows, controlling to the extent possible for key factors identified in the univariate regressions, while mindful of the limited degrees of freedom due to the short time span of the data. The contemporaneous value of each variable is included except for the Nigerian monetary policy rate, where the first lag was used.

11. Table 3 shows the results of these regressions, which are of the expected sign. The regressions explain between 20 percent and 70 percent of the variation in portfolio inflows, with the best fit for government debt securities. The effects of the various explanatory factors on capital inflows are in line with those of the univariate regressions above. In particular, higher oil prices and tighter monetary policy tend to raise inflows, while higher U.S. yields and higher expected depreciation tend to lower them.9

Table 3.

Nigeria: Portfolio Inflows Regressions, 2008Q1-2015Q3

article image
Source: IMF staff calculations.Note: The sample period is 2008Q1 to 2015Q3. The dependent variables, capital flows, are expressed in million U.S. dollars. The independent variables are the first lag for the monetary policy rate and the contemporaneous term for the other variables. Asterisks denote statistical significance at the 5 percent (**) and 1 (***) percent levels, respectively, using test statistics robust to autocorrelation and heteroscedasticity.

12. These findings point to risks that capital inflows to Nigeria will be lower in the near term than in the recent past. As an illustrative calculation, the coefficients estimated in Table 3 were used to calculate the potential impact of a one standard deviation shock to each of these drivers of portfolio inflows. The magnitude of these shocks would be a tightening of Nigeria’s monetary policy rate by 250 basis points, an increase in expected depreciation of the naira by 4 percent, a rise in U.S. Treasury yields by 70 basis points, and a fall in oil prices by $23.10 Figure 10 shows the potential impact on portfolio inflows of such shocks as well as the combined impact if all shocks were experienced simultaneously.11 The total impact would amount to over half a percent of GDP, with the largest contributions from the U.S. Treasury yield and the oil price. The magnitude is not large relative to GDP, but the results highlight the drag that external conditions could exert on capital inflows and reserves, particularly in the current environment characterized by recent monetary easing, market expectations of a devaluation, and low oil prices for a long period. Given the role of oil in Nigeria’s external accounts, the impact on the balance of payments could be offset to some extent by lower outflows of other investment assets and of errors and omissions, as seen in the first three quarters of 2015.

Figure 10.
Figure 10.

Nigeria: Portfolio Inflows Sensitivity to Shocks

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Source: IMF staff calculations.

13. The recent implementation of administrative measures adds uncertainty to the outlook for capital flows. Measures have been taken recently that could lower both inflows and outflows. In December 2014, the Central Bank of Nigeria (CBN) reduced the daily foreign exchange trading exposure limit for commercial banks and required customers to utilize funds purchased on the foreign exchange market within 48 hours, or return them to the CBN for re-purchase. These measures significantly reduced liquidity on the interbank foreign exchange market, an impact that persisted despite the subsequent partial relaxation of these limits. Citing this reduction in liquidity of the foreign exchange market, J.P. Morgan and Barclay’s decided to remove Nigeria from their global indexes of domestic currency bond markets, which are widely tracked by non-resident investors. In June 2015, the CBN enacted a restriction on obtaining foreign exchange for outward portfolio investment by Nigerian residents.

14. Non-deliverable forward (NDF) prices are another indicator that can be used to assess the impact of administrative measures on capital flows. NDFs are foreign exchange derivatives in which a net payment in a convertible currency is exchanged based on the difference between the contracted forward exchange rate and the realized spot exchange rate at the end of the contract.

Covered interest parity would imply that the forward rate should be equal to the spot exchange rate adjusted for the interest differential:12

F = S* (1 + i)/(1 + rt$)

Where F is the forward exchange rate, S is the spot exchange rate, i is the onshore interest rate on a naira-denominated instrument, and r$ is the U.S. dollar interest rate. For an NDF, this condition would be:

NDF = S* (1 + i*)/(1 + rt$)

The only difference is that i*, the implied offshore interest rate in naira, is unobserved. Rearranging terms, the implied offshore interest rate can be expressed in terms of observable indicators:

i* =NDF  * (1 + rt$)/S − 1

A key concept for analysis is the gap between the implied offshore interest rate and the onshore rate, i* − i, which is a measure of the degree of effective segmentation between the onshore and offshore markets. A positive gap is an indication of higher returns offshore, suggesting that potential capital outflows are being inhibited in some way.

15. A sizable gap has opened between implied offshore and onshore rates. Figure 11 shows one-year interest rates in naira and in U.S. dollars, plus the NDF-implied offshore rate as calculated above. Onshore and offshore-implied rates were generally close from 2011–14, with some tendency for the onshore rate to be higher, signifying the potential for more inflows. This situation reversed in late 2014, when NDF contracts began pricing in substantial amounts of naira depreciation not reflected in the prices of financial instruments onshore, suggesting the administrative measures on foreign exchange market activity implemented around that time were binding for capital outflows. The NDF-implied offshore interest rate averaged 27 percent in 2015, compared to an onshore rate of 14 percent. This 13 percent offshore premium—which increased to an average of about 30 percent in the first two months of 2016—is substantially higher than for any of the countries analyzed in a similar recent study covering a number of emerging Asian economies, plus Korea and Brazil.13 While covered interest parity may fail to hold completely due to market illiquidity or time-varying country or credit risk premia, the large offshore-onshore interest rate gap for Nigeria suggests that capital flows are unlikely to pick up in the near term due to investor expectations of naira depreciation and the higher expected returns of investing offshore.

Figure 11.
Figure 11.

Nigeria: NDF-Implied Interest Rate, 2011-15

(Percent)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A003

Sources: Bloomberg; and Haver Analytics.

16. Overall, the analysis points to both exogenous and policy-related factors as drivers of capital flows. In the long run, removing structural impediments to growth and enhancing the business environment and governance would be the ideal way to increase capital flows. In the short run, Nigeria’s room to maneuver in an environment of low oil prices and rising external interest rates may be limited, especially with NDF-implied interest rates suggesting that in an unrestricted setting, Nigeria could experience capital outflows. Nevertheless, the authorities may be able to counterbalance these factors to some extent through tighter monetary policy and avoiding exchange rate misalignment. These findings are in line with other recent work on capital flows to LIDCs, which find a substantial role for the macroeconomic fundamentals of this group of countries in the access to and pricing of external funding.14

1

Prepared by Andrew Swiston, with research assistance from Marwa Ibrahim.

2

Total capital inflows are defined here as net non-resident investment in Nigeria (see International Monetary Fund, 2015, “Macroeconomic Developments and Prospects in Low-Income Developing Countries: 2015 Report,” IMF Policy Paper. Similarly, total capital outflows are defined as the net investment of Nigerian residents abroad. As such, the values taken on by both concepts can be either positive (increase in liabilities or assets) or negative (decrease in liabilities or assets).

3

In addition, a rule that required foreign investors to maintain their government bond holdings for at least a year was removed in 2012.

4

The set of LIDCs and frontier markets are as defined in International Monetary Fund, 2014, “Macroeconomic Developments in Low-Income Developing Countries: 2014 Report,” IMF Policy Paper.

5

See International Monetary Fund, 2015.

6

Some of these outflows could be illicit flows, as discussed in Annex II of Nigeria: Staff Report for the Article IV Consultation.

7

For a recent review, see Koepke, R., 2015, “What Drives Capital Flows to Emerging Markets? A Survey of the Empirical Literature,” Institute of International Finance Working Paper.

8

Tests found that the explanatory variables did not display a unit root over this sample period. For external factors, the contemporaneous value and first lag were used. To avoid potential endogeneity, the regressions used the first and second lags of Nigerian interest rates. For the two variables from the Consensus Forecasts survey, expected Nigerian growth and exchange rate depreciation, the contemporaneous value and first lag were used, using the survey taken early in the first month of each quarter.

9

Tighter monetary policy was found to lower portfolio equity inflows, but the estimated effect was not significant.

10

The fall in the oil price is close to the expected price decline from 2015 to 2016 based on average prices in futures markets.

11

The impacts of monetary policy and expected depreciation on equity flows were excluded since the coefficients were not statistically significant.

12

See, for example, G. Ma, C. Ho, and R. McCauley, 2004, “The Markets for Non-Deliverable Forwards in Asian Currencies,” BIS Quarterly Review, June 2004, pp. 81-94.

13

See R. Bi, 2016, “How Open is India’s Capital Account? An Arbitrage-Based Approach,” in India—Selected Issues, SM/16/27 (1/29/2016).

14

See International Monetary Fund, 2015, “Macroeconomic Developments and Prospects in Low-Income Developing Countries: 2015 Report,” and Presbitero, A., and others, 2015, “International Sovereign Bonds by Emerging Markets and Developing Economies: Drivers of Issuance and Spreads,” IMF Working Paper WP/15/275.

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Cover IMF Staff Country Reports
Nigeria: Selected Issues
Author: International Monetary Fund. African Dept.
Volume/Issue:
Volume 2016: Issue 102
Publisher:
International Monetary Fund
ISBN:
9781475550559
ISSN:
1934-7685
Pages:
59
DOI:
https://doi.org/10.5089/9781475550559.002
  • View in gallery

    Nigeria: International Bonds Outstanding, 2011-15

    (Billion U.S. dollars)

  • View in gallery

    Nigeria: Total Capital Inflows, 2008-15

    (Percent of GDP; 2015 includes through Q3 only)

  • View in gallery

    Nigeria: Net Capital Flows, 2008-15

    (Percent of GDP; 2015 includes through Q3 only)

  • View in gallery

    Nigeria: Errors and Omissions Correlations, 2008Q1-2015Q3

    (Correlation of quarterly data)

  • View in gallery

    Nigeria: Net Other Investment and Errors and Omissions Flows, 2010-14

    (Percent of GDP; average 2010-14)

  • View in gallery

    Nigeria: Global Financial Conditions, 2008-15

    (Quarterly averages)

  • View in gallery

    Nigeria: Interest Rates, 2008-15

    (Percent; quarterly averages)

  • View in gallery

    Nigeria: EMBI Spread and Oil Price, 2008-15

    (Spread in percentage points; price in U.S. dollars per barrel; quarterly averages)

  • View in gallery

    Nigeria: Expected Exchange Rate Depreciation, 2008-15

    (Expected 12-month percent change in naira per U.S. dollar)

  • View in gallery

    Nigeria: Portfolio Inflows Sensitivity to Shocks

    (Percent of GDP)

  • View in gallery

    Nigeria: NDF-Implied Interest Rate, 2011-15

    (Percent)

Nigeria: International Bonds Outstanding, 2011-15

(Billion U.S. dollars)

Nigeria: Total Capital Inflows, 2008-15

(Percent of GDP; 2015 includes through Q3 only)

Nigeria: Net Capital Flows, 2008-15

(Percent of GDP; 2015 includes through Q3 only)

Nigeria: Errors and Omissions Correlations, 2008Q1-2015Q3

(Correlation of quarterly data)

Nigeria: Net Other Investment and Errors and Omissions Flows, 2010-14

(Percent of GDP; average 2010-14)

Nigeria: Global Financial Conditions, 2008-15

(Quarterly averages)

Nigeria: Interest Rates, 2008-15

(Percent; quarterly averages)

Nigeria: EMBI Spread and Oil Price, 2008-15

(Spread in percentage points; price in U.S. dollars per barrel; quarterly averages)

Nigeria: Expected Exchange Rate Depreciation, 2008-15

(Expected 12-month percent change in naira per U.S. dollar)

Nigeria: Portfolio Inflows Sensitivity to Shocks

(Percent of GDP)

Nigeria: NDF-Implied Interest Rate, 2011-15

(Percent)