Managing Risks in Nigeria's Political and Economic Landscape
While local and international media are transfixed with Nigerian political risk following what they consider flawed elections, Nigerian assets continue to rally, including a tentative move south in the US dollar/Nigerian naira (NGN) exchange rate. Nigerian market participants clearly concur with our long-held sanguine election risk view. More important than the security risk generated by the elections is the economic policy risk associated with a potentially new leadership. Here again we are constructively pricing in continuity and possibly policy reform acceleration. In fact, our key concern remains the lack of clarity on monetary policy and the likely response to an eventual up-tick in inflation towards the end of 2007. In the meantime, we can see further compression along the length of the bond curve, especially as foreign participants become more comfortable taking up exposure to potential US$/NGN downside via the higher yielding bonds.
Our core scenario for the Nigeria presidential elections was that the ruling People’s Democratic Party (PDP) candidate Umaru Yar’dua would easily win. And it proved accurate. According to INEC data, he received 24.78 million votes, or some 70% of the votes cast. The All Nigerian Peoples Party (ANPP) candidate, General Muhammadu Buhari, took 6.6 million (18.7%), while the Action Congress (AC) candidate, Atiku Abubakar, received 2.57 million votes (7.2% of the vote). The three main candidates took 95.7% of the vote while the remaining votes were shared between the other 21 candidates.
At the time of writing we only have the results for 251 of the 360 House of Representative seats and 82 of the 109 Senate seats. Each of Nigeria’s 36 states is allocated three senate seats and the Federal Capital Territory is allowed one seat. The House of Representative seats are determined by the state’s population. From the numbers to date, it is clear that the PDP will enjoy almost a two-third majority in both houses.
Like the state and local elections the week before, the National Assembly and Presidential elections were far from orderly. Both EU and US observers called the elections process deeply flawed, but both stopped short of calling for the elections to be re-run. However, some local observers are arguing that the polls are so flawed that they should be re-run.
Not surprisingly, both opposition candidates are in agreement with local observer groups calling for the elections to be re-run. However, runner up Buhari will be cautious of taking legal action, as he spent two years unsuccessfully contesting the 2003 presidential poll. Instead he has called for demonstrations. Abubakar is unclear on what action he intends to take to make firm on his promise that the results will not stand.
We continue to subscribe to our long-held view that it is business as usual following the elections. In many ways the situation feels very similar to the 2003 elections, which were deemed to be broadly in line with the will of the people. The PDP has again won massive majorities in most of the country and across most of the various polls, suggesting that the power of incumbency is still arguably the dominant determining variable. Certainly, the size of the victory would appear to suggest that, like in 2003, either the results were broadly the will of the people or there was election fraud on a huge scale. To our knowledge, no one is seriously arguing that the PDP and its presidential candidate only won because of systematic fraud.
It is also extremely unlikely that the courts are likely to allow the elections to be meaningfully contested and thus hold up the transfer of power due on the 29 May. Senior Nigeria leaders are very well aware of lessons from the 1993 elections, when election uncertainty sponsored military intervention. However, Nigeria is in a very different political space to the one prevailing in 1993, especially in terms of the relative civilian/military power balance. Another potential security risk comes from the argument that the disquiet over the election will further undermine Yar’dua’s fragile power base. Once again we place limited importance to this argument. While Yar’dua will certainly have to build his own power base going forward, at present he still enjoys Obasanjo’s support and thus, assuming there is no personal falling out with Obasanjo in the near term, he has plenty of time to assert his own political authority. Firstly, Obasanjo remains in power until 29 May. Secondly, he will still be in a position of significant authority as PDP Chairman for some time to come.
In the same way that we have been relatively sanguine on security risks surrounding the elections, we have also been relatively happy that the reformist policies of the last four years will continue. Indeed, we fully anticipate that they will accelerate under Yar’dua. There are several interesting litmus tests to watch:
As we have argued consistently in the run up to the elections, our willingness to hold domestic rates unhedged has been more tempered by monetary policy risk than security or policy risk surrounding the elections. These risks stem from two sources. Firstly, our expectation that inflation is not as under control as the present figures suggest. Secondly, we are uncertain of the likely policy response of the CBN to a sharp increase in inflation.
The headline consumer price index increased 1% month-on-month in March compared to 0.8% month-on-month in February and 2.8% month-on-month in March 2006. The larger base influence fostered a sharp decline to 5.2% year-on-year in the headline CPI from 7.1% in February. If the month-on-month rate is annualised we would be looking at inflation of 12.6%. Moreover, core inflation, which strips out food and fuel, actually rose 2.6% month-on-month (or an annualised rate of 36%). The result was the core measure jumped to 10.2% year-on-year from 9% in February. The underlying story in Nigerian inflation remains the same, food inflation, which is 64.4% of the basket, is holding down the aggregate measure. The headline rate is also being assisted by base influences. Interestingly, last April saw 2.2% month-on-month growth and so it is reasonably likely that we will see another moderate decline in the headline inflation rate to 4.8% in April 2007. However, after that we have two very benign months of 0.1% and -0.2% month-on-month in May and June, which will place upward pressure on the headline rate. Despite this, it is not until we see the big negative month-on-month base influence between October and January that there will be sufficient pressure to take the headline rate back into heavy double digit figures, assuming a reasonably modest change in food prices.
With the headline rate remaining relatively sanguine, it is extremely unlikely that we will see a concerted change in the CBN’s relatively new policy rate corridor. The new system sets a 300 basis points (bps) corridor on either side of a reference rate. The reference rate is presently 10% and the CBN will accept funds on deposit at 7% and lend at 13%. In its 7 February 2007 monetary policy committee (MPC) meeting, the CBN decided to leave its MPR on hold at 10%. We suspect that the MPC will similarly decide to leave rates on hold at 10% at its May meeting, albeit the mechanism for deciding interest rates remains less than clear. At present, it appears to be some blended target derived from money supply goals and an inflation goal. It is unclear to us at present, whether the MPC places more emphasis on a core measure or merely keeping the headline rate in single figures on a 12-month moving average. Presently around 7.3% year-on-year, this 12-month moving average measure has been under 10% since October 2006. It now looks like this target may not be challenged until the end of 2007.
The introduction of the MPR in December has been successful in holding up the short end of the Nigerian rates curve, with three-month money being relatively stable at around 7.3%. The past few months has also seen some further yield compression, with the bulk of the compression occurring in the one-year sector of the curve, fostering a moderately upward sloping curve. With the short-term inflation environment likely to foster a relatively constructive background for the bonds, we could see further yield compression along the length of the curve, especially if we see additional post-election foreign interest in Nigerian bonds. Certainly with this week’s three-year bond auction yielding around 9%, we would not be surprised to see the longer dated seven-year paper trade another 100 bps tighter to 9.5%. Importantly, with the ability to short the bonds extremely curtailed by the present constraints on the repo-market, duration risk is somewhat minimised by the overriding demand and supply mismatch. This is set to get even greater as foreign investors get comfortable with holding the longer dated bonds in order to add some yield pick up for what is essentially still a carry trade. The clamour to be involved in any potential move south in the US$/NGN will clearly pick up if the recent move down to 127.20/50 is allowed to hold by the CBN, pointing to a potential willingness to use the currency to assist in the effort to sterilise the country’s considerable FX inflows.
We have been relatively sanguine on election risk in Nigeria for some time. The process has panned out broadly in line with our core scenario, which has been limited security and economic policy risk. We remain more interested in monetary policy risk and how the CBN will respond to increased inflation pressures. That said, these look unlikely to materialise until towards the end of 2007. In the meantime, we are likely to see a further concerted rally along the length of the bond curve, as international participants become happy with taking their desired exposure to potential US$/NGN downside via higher yielding bonds.