Why FGs Borrowing From CBN In 2023 Will Keep Fixed Income Market Yields Low – Report

If the Federal Government of Nigeria (FGN) continues to favor borrowing from the Central Bank of Nigeria (CBN) in 2023, returns in the domestic fixed income market will not rise as high as economic fundamentals suggest.

This is because FGN will not be pressured to seek financing from domestic investors, limiting the bargaining power of these investors.

This is evident from a report by Cowrywise Investment Company.

However, the report, titled “The Key Themes Guiding Your Investment Journey in 2023” by Busola Jeje and Basirat Adebiyi, analysts at the firm, noted that this may not be the case given increased attention from international organizations such as the World Bank, which has advised the CBN several times to stop lending to the FGN.

As a result, “We believe the FGN will get most of their funding from government debt markets, putting power in the hands of investors and driving up interest rates,” they stated in the report.

The recently released FGN bond auction calendar for the first quarter (Q1) of 2023 already shows that the FGN plans to borrow between N80 and N100 billion for each of the four different maturities, compared to N70 to N80 billion in Q1 2022.

While listing the themes that will guide investment decisions, the company stated that the Nigerian economy would dance to the tunes of global central banks. Others are that the outcome of the presidential election will be a major turning point; The 2023 budget deficit is a catalyst for higher interest rates if CBN stays in place; lower liquidity in H2 2023 will give way to higher interest rates and further devaluation is expected on the official currency market window.

The analysts noted that there is a clear indication that the FGN will borrow more than expected to supplement its spending plans, adding that local lending will be preferred given the higher risk premiums in international markets.

However, it is critical how the government chooses to fund the deficit, whether through the government debt markets or the CBN.

“It is not unusual for the CBN to lend money to the federal government. In fact, the CBN law allows it, with the rule that the Central Bank cannot lend more than five percent of last year’s withheld income from the FGN. Under this principle, the maximum amount that the CBN could lend to the FGN in 2022 was N305 billion.

“Yet, as of October 2022, the CBN had advanced a total amount of N6.3 trillion to the FGN, approximately 103 percent of 2021 revenues, in clear violation of the rules.

“This was even more than what was obtained from government debt markets (N5.9 trillion),” the report said.

To date, the federal government has borrowed a total of N23 trillion from the CBN, exceeding its domestic debt stock of N21 trillion.

“Our analysis of the liquidity supply shows that the first quarter of 2023 is a very liquid period given the large volume of bond and Treasury bill maturities.

“The Debt Management Office (DMO) will also look to take advantage of this and advance borrowing plans in the first quarter to allow it to offer lower interest rates,” it stated.

The company therefore expects interest rates to remain low this quarter, at most by the end of April. It said liquidity will decline in the second half of 2023, which is why we expect interest rates to rise in response to tight market conditions as the DMO continues to borrow.

“As an investor, money market funds and bond funds are a great way to position.”

Mutual funds have become an important way for retail investors to access markets they previously could not access.

The analysts believe that money market funds and bond funds are a great way to access professional management, as these funds are offered by SEC-regulated asset managers with a deeper understanding of fixed income markets and interest rate expectations.

“We cannot close this report without expressing our views on the naira to dollar exchange rate.

“2022 was a bad year by all accounts for the naira, which lost 30 percent of its value on the parallel market to N750/$, and seven percent on the official market to N445/$.

“We also ended 2022 with a lower level of foreign exchange reserves, at $37.1 billion compared to $40.5 billion at the end of 2021.

“We expected that with oil prices rising as high as $123/bbl in 2022, the naira would be strongly supported by booming currency reserves, but we would have been wrong,” analysts further noted.

In 2023, the report strongly believes that the naira will be devalued in the official market to reflect current market realities, as the CBN’s “managed” way of supporting the currency is not sustainable.

Interestingly, the current exchange rate on one-year non-deliverable forward contracts is N525.65/$, showing that the market is still pricing in a devaluation.

In the parallel market, analysts expect election activity to keep the exchange rate high.

“We believe that the naira in the parallel market is heavily undervalued and we expect a naira appreciation in that market by the end of the year.

“All things considered, 2023 brings a lot of risk and uncertainty: unpredictable election results, unexpected policy changes and a possible global recession.

“We believe the tips for a successful investment strategy this year are to diversify your investments, manage risk and not chase returns. As part of our drive to democratize the everyday African’s access to credible investments, our strategy has been to offer a variety of regulated investment opportunities to our users, across multiple asset classes. As such, you can build a well-diversified investment portfolio for 2023 directly on Cowrywise and actively track your wealth-building journey,” the report added.

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