Nigeria’s Macroeconomic outlook 2020: Analysts advise investors on Eurobond auctions to mitigate risk of Naira depreciation against U.S dollars

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Global Economy
International Monetary Fund projects global output to grow by 3.4% in 2020, higher than 3.0% forecast
for 2019.

The Bretton Woods institution predicated its global growth forecast on increased output in
emerging and developing economies, especially in Asia and Europe, which are currently witnessing strong
domestic demand and rising wages amid monetary and fiscal stimuli.

This is in spite of the ongoing global trade tensions, especially between the U.S. and China as well as economic and trade uncertainties over the Brexit saga – in deed, the IMF projects slower growth rates for U.S. and Chinese economies of 2.1%
and 5.8% respectively in 2020 (from 2.4% and 6.1% projected for 2019).
To support economic expansion in their respective economies, major central banks in advanced
economies adopted accommodative monetary policy measures even as central banks in several emerging
market and developing economies have also cut policy rates – a stance that is expected to be sustained
in 2020.

Meanwhile, amid a relative weaker U.S. dollar, resource rich economies are expected to benefit from
expectations of increased global demand for their exports.

Specifically, Opec anticipates a 1.08 mbpd
increase in global oil demand to average 100.88 mbpd in 2020 is anticipated to (up from 99.80 mbpd),
with significant demand coming out of Asia (particularly from India and China).

On the other hand, non-Opec supply in 2020 is forecast to grow by 2.17 mbpd to average 66.46 mbpd while Opec supply in 2020 is expected to keep the market in balance, via the instrumentality of the output quota agreement, in order to ensure favourable crude oil prices in 2020.

Nigerian Economy
The IMF projects Nigeria’s economy to grow by 2.5% in 2020 (higher than 2.3% forecast for 2019). We
expect the Nigerian economy to benefit from solid crude oil revenues which should support economic
growth in 2020 as well as provide boost to its external buffers.

Sustained expansionary fiscal policies should, especially from the angle of infrastructural development around the country should also provide at least minimal support to growth giving lag effects due to their long gestation period. However, growth expectation is also subject to risks of possible Naira depreciation occasioned by foreign portfolio exits on account of any disincentive to remain invested in the domestic financial markets, weaker consumption activities due to increased indirect taxes and significant economic leakages due to recurring petroleum subsidy.
Inflation
We expect general price level of goods and services to be upbeat in 2020, mainly as a result of structural factors and less of consumer demand.

Continued border closure by the fiscal authority, premised on the need to support local industries, is expected to exacerbate cost push inflation – although there are expectations that the protectionist measure should stimulate domestic output and improve the balance of payments.

Inflation could be further aggravated in the event of deprecation of the Naira relative to the
U.S. dollar triggered by external shocks, especially foreign portfolio outflows. There is also the upside risk of an upward review of electricity tariffs statutorily expected during the year.

Fiscal Sector
The Federal Government budgeted N10.59 trillion for 2020, comprised of N4.84 for recurrent (non-debt)
expenditure; N2.73 trillion for debt service; N2.47 trillion for capital expenditure and N560.47 billion for statutory transfers.

The budget (an increase over N9.12 trillion in 2019) was predicated on crude oil production of 2.18 million barrel per dollar (mbpd); crude oil price benchmark of USD57 dollar per barrel; exchange rate of N305/USD; GDP growth rate and inflation rates of 2.93% and 10.81% respectively.

While the projected N4.84 trillion recurrent expenditure is expected to gulp about 57.5 per cent of
projected N8.41 trillion revenues, N2.72 trillion in debt servicing is expected to claim 32.3 per cent while N0.56 trillion in statutory transfers should absorb a further 6.6 per cent; thus necessitating borrowings to
fund its N2.47 trillion capital expenditure plan of, albeit inefficiently.
We however feel that the revenue projection is quite optimistic given that actual revenues in the
preceding years underperformed forecasted revenue at 54% and 52% in 2018 and 2017 respectively. Thus,
assuming 55% (or N4.62 trillion) revenue performance for 2020, the projected recurrent (non-debt)
expenditure, assuming 90% performance (or N4.36 trillion) based on average performance of 2018 and
2017, should gulp over 94% of revenues; hence, we anticipate a much higher borrowing rate in 2020. On
a positive note, however, the Federal Government’s debt is expected to refinanced at lower interest rates.
In its attempt to shore up government revenues, the fiscal authority presented its finance bill for 2019 to the legislature. The Senate also introduced a new bill which to aims take the responsibility of road
construction, rehabilitation and maintenance away from the Federal Government and place it in the hands
of local and foreign investors once passed into law.

Meanwhile, we view the speedy passage the N10.59 trillion 2020 appropriation bill in December 2019 –
an increment of N264 billion from N10.33 trillion originally presented – and its enactment into law by the President in the same month as a positive, paving the way for early implementation of the budget, as early as January 2020, which should stop the late implementation which in the past resulted in a vicious cycle of underperformance by the fiscal authority.

Foreign Sector
Nigeria’s foreign exchange market should witness stability in 2020. We expect CBN to sustain its OMO
sales at high interest rates in order to attract foreign portfolio investors and maintain foreign exchange rate stability as OMO interest mature.

This is because anticipated liquidity glut will depress interest rates and result in negative real returns on investment – a situation that could lead to a reversal of foreign exchange flows as well as speculative attacks on the Naira.

Furthermore, we anticipate favourable global crude oil prices which in addition to sustained crude oil output – on account of relatively stability in the Niger Delta – should lead to sustained crude oil dollar revenues, boosting Nigeria’s external buffers.

Monetary Sector
Events in the financial sector in the year 2020 will be shaped by a central theme – Liquidity Creation. We
know that the apex bank plans to increase the Loan-to-Deposit ratio further to 70 per cent in 2020, up
from 65 per cent in December 2019. This is expected to boost liquidity in the financial system as a result
of increased money creation. Other potential sources of liquidity include matured bills and FAAC
disbursements. Hence, the resultant effect would be the reduction in interest rates to allow the real sector
obtain much needed financing more cheaply and hence, support economic growth. By the same token,
the anticipated reduction in interest rates amid increased money supply would help reduce the cost of
financing the N2.18 trillion Federal Government fiscal deficit. In managing liquidity in the financial system, we expect the monetary authority to engage in Open Market Operations to mop up created liquidity at attractive interest rates, in part, due to the need to maintain foreign exchange stability and to forestall speculative attacks on the local currency.

Interest Rates
We believe the monetary authority will remain aligned with the fiscal authority’s economic growth
objective by seeking to create and sustain conditions that will boost liquidity in the financial system in order to drive down interest rates to single digit. Thus, we expect interest rates to remain suppressed in 2020.

In a complementary move, we suspect the Monetary Policy Rate may be adjusted downwards from
13.50% to 13% in order to further signal its expansionary monetary policy regime. This should result in a downward spiral of deposit rates as well as lending rates of commercial banks.

Furthermore, we expect the monetary authority to continue to perform OMO auctions at attractive interest rates above the prevailing inflation rate in order to retain foreign portfolio investors, and hence, ensure exchange rate stability.

Fixed Income
We expect to see increased government and corporate debt issuances in 2020 as cheaper interest rates
provides opportunities for refinancing. According to its borrowing plan for 2020, Federal Government is
expected to issue at least N850 billion worth of domestic debt – although we expect an increase in actual borrowings to finance its capex plan as revenue forecasts appear quite optimistic.

We expect the Federal Government to seek more foreign borrowings, preferably from multilaterals at
concessionary interest rates, although Eurobond issuance remains a viable option even at relatively
cheaper cost.

Given the ratio of external debt to total debt of 32% as at June 2019 (see Table O2), it has enough legroom to borrow up to 40% of its total debt stock. We also anticipate more T-bill issuances both for funding its budget deficit and for refinancing maturing short term debt at lower cost.

We also anticipate more corporates to take advantage of the relatively low yield environment by issuing
corporate bonds, especially short-term commercial papers as well as long term domestic debt
instruments, in order to refinance existing debts more cheaply and to finance new projects.

Equities
We expect 2020 to be a favourable year for equities against the backdrop of low interest rate
environment. This is because companies would be able to access funds at cheaper cost, thus reducing
their interest expense and positively impacting their bottom lines.

Also, investors are expected to make a switch from fixed income securities yielding negative real returns to equities presenting positive real returns both in terms of dividend yields as well as possible capital appreciation especially in the first quarter of 2020.

Finally, with the ongoing insurance industry recapitalization exercise, extended to December 2020, we anticipate a flurry of public offers by insurance companies. We also note the possibility of commercial banks approaching the capital market to raise funds to boost their tier one capital in line with their growing risk assets in order to safeguard depositors’ funds. Meanwhile, the pension fund managers, balanced fund managers and even retail investors are expected to patronize equities market given the low fixed income yields.

Investment Strategy for 2020
Premise for our 2020 investment strategy include:
• U.S. Fed Rate to be retained at the current band of 1.50% and 1.75% as given the need to sustain
economic growth and favourable labour conditions in the U.S.
• Federal Government to embark on foreign borrowings in 2020 while taking advantage of the low
yield environment due to excess liquidity to raise more local borrowings.
• CBN to attract foreign portfolio investors using OMO auctions. It is expected to mop up liquidity
at higher rates. Currently, CBN has maintained relatively high OMO yield environment (361DAY
OMO bills traded at 13.28% as at 27-12-2019)
• Above CBN strategy to keep FPIs on our shores and increase US dollars inflows, although slight
depreciation of the foreign exchange rate is expected at the I&E Window in 2020. Nevertheless,
with the proposed large foreign borrowings, likely shocks in foreign reserves would have at least
been taken care of.
• Expectation of improvement in consumer spending as govt scales up capital projects and
implements minimum wage; albeit, unemployment will continue to be a concern.
• Inflation rate to climb in 2020 as federal government embarks on tax reforms, especially VAT, and
leaves the country’s border closed.
• Economic growth rate to remain flattish in 2020, at around 2.3% (moderating IMF’s 2.5% 2020
forecast) as increased consumer spending may be hobbled by expected increase in VAT.

Possible minimal involvement of private participation in viable public projects due to unfavorable
government policies. Instead we see government spearhead investments by aggressively
borrowing, taking advantage of the low rate environment. The fact is that CBN has successfully
created liquidity for federal government short term securities.
• CBN could reduce the MPR to accentuate the permanency of low rate regime, at least in the medium term. Hence, we see rates, especially T-bills, to stay below double digit in the first quarter
of 2020.

Equities Market

Generally speaking, the easy access to cheap credit even at the commercial banks would have positive
impact on companies listed on the local bourse.

We expect the equities market to give better performance
this year as the increasing number of capital projects to be undertaken by federal government, and private sector building projects, would rub off on the performance of some quoted companies – especially those in building and construction.

We therefore suggest investments in currently undervalued building and construction stocks – such as Dangote Cement and CAP – which have potential for growth and have good
to decent dividend yields.

We suggest investment in shares of FMCGs which we expect to give a better performance in both revenue
and their bottom lines.

This is partly due to the implementation of the new minimum wage of state and
Federal Government which should increase disposable income and therefore spending activities of
households, especially for fast moving consumer goods.

In addition, the recent land border closures by
the Federal Government should help boost turnover of certain FMCG such as Okomu and Presco.
However, advise to trade shares of banks cautiously in 2020 due to dwindling capacity of banks to
generate income amid low yield environment and lower non-interest bank charges.

Thus, we will beam our search light on banks with efficient securities trading capacity.
Any surprises for oil and gas stocks in 2020?

In his New Year address, President Buhari, while not specifically mentioning deregulation of the
downstream industry, proceeded to give a hint on his plans by his administration to deliver a more
competitive, attractive and profitable oil and gas industry, operating on commercial principles and free
from political interference.

Notwithstanding, the National Assembly has given assurances that it was
working on the Petroleum Industry Bill which it believes would be passed this year, perhaps in the second quarter. We therefore keep our fingers crossed about investing in downstream oil and gas stocks;
although shares of upstream players might be favoured in light of a positive global oil outlook.

Fixed Income
We advise investors to participate in Eurobond auctions as this will help mitigate the risk of possible
depreciation of the Naira against the U.S dollars.

In the local fixed income space, we expect yields to generally moderate. Nevertheless, for short-term
securities such as treasury bills, we expect slight improvement as it trades within the band of 5% and 8%.

The long-term securities are expected to be within the band of 9% to 12%.
In the near future, navigating the low single digit yield environment amid double digit inflation rate will be a challenge; requiring a risky active trading strategy in order to beat inflation.

However, given the possibility of an upward reversal of interest rates, we suggest holding 91-day treasury bills especially in early 2020 and abstaining from higher maturities in order to mitigate against interest rate risk.

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