‘Liquidity Shortage is the Main Challenge in Nigerian Financial Market’

26 Nov 2012

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Mr. Akinsowon Dawodu

The Nigerian financial market has no doubt been stable this year. This was even bolstered by the recent inclusion of FGN bonds on the JP Morgan Emerging Market Index. President, Financial Market Dealers Association (FMDA), Mr. Akinsowon Dawodu, spoke with Obinna Chima on the opportunities and challenges in the market. Excerpts:

How will you say that the financial market has performed since January?
Well it has been an interesting year as different markets have performed in different ways and different things have happened in different markets. So it is better to take it on a market-by-market basis. The forex market has been stable and the naira has done very well this year in terms of stability. The Central Bank of Nigeria (CBN) defines its target for the naira stability, not necessarily its appreciation. So the stability of the naira represents success from the central banks perspective.

The spread between the official rate and the parallel market rate is narrow and that is really what you can hope for in an environment like Nigeria. So the forex market has done well, it has been one of the better forex years that we have had. The money market has been relatively consistent with the central bank’s policy. Central bank has tightened monetary policy as a means of controlling inflation and to protect the currency or to get it sequentially correct. 

The central bank has been protecting the currency and has been controlling inflation, and the money market has reflected that bias. So apart from sometimes in August when things got a bit out of control and interest rates went very high probably because of the disequilibrium in terms of the policy implementation on the part of the central bank and some panic on the part of the market, the market has been stable and has been in double-digits which is more or less where it should be in a country where inflation is at about 11 per cent and the Monetary Policy Rate (MPR) is at 12 per cent.

So the money market has been fine. The bond market has been very active, but of recent, quite volatile. The bond market is dominated by the Federal Government. Corporate bond just started a couple of years ago. But unfortunately, the tightening policy by the central bank led to an increase in rates and it was not economic for corporates to issue bonds, so that slowed the market down. The FGN bonds has been active as it started the year relatively high but ultimately dropped from about 15-16 per cent to about 12-13 per cent in the later part of the year across the curve.

The curve is very flat and that is because of aggressive monetary policy at the short-end. So, overall bond yields came down driven also by the inclusion on the JP Morgan Index and the increase in demand that it created. The way bonds work is that the bond price is a function of its yield. If the yield goes up, the price goes down and if the yield comes down, the price goes up. The JP Morgan’s inclusion increased demand for Nigerian bonds because it brought in a bunch of offshore investors who traditionally were not big players in the Nigerian market. They were investors who were buying treasury bills but very few foreign investors were buying Nigerian bonds until JP Morgan’s inclusion.

So that increased demand and as the bond prices went up, the yields came down. So now we see yields settling at about 13-13.5 per cent on the average. So the bond market has been volatile, but bond prices have gone up. But liquidity in the market has been difficult sometimes because of the extreme volatility. Fixed income is a risky and tough market. When you buy a 10-year bond, you are buying 10 years of price risk. So it is different from the forex or money market and sometimes liquidity can be a challenge in terms of volatility.
That is why one of the key challenges for us as market people is to deepen the bond market and ensure that the periodic lack of liquidity is eliminated altogether so that the market will be deepened and the financial system can work much better. Also, the equities market has done very well, the stock market has also appreciated. There have been a lot of foreign interests in the market and some returning local institutional investors.

I think from a relative distance, the only shoe yet to drop in the equities market is the retail investors. Most retail investors are still a bit wary but a few of the savvy investors are going back there. The index has gone up by over 35 per cent year-to-date which is strong. Again the sustainability of that next year will be very important. So overall, markets have been healthy and there have been exciting developments like the JP Morgan Inclusion which highlights the increasing connectivity of the Nigerian market with the global market.
It shows that Nigeria is no longer an outpost where something is happening and the rest of the world is doing something else. Increasingly, the Nigerian market is being plugged into the global market or one can say that the global market is plugged into Nigeria and so we will start to behave like other emerging markets.

Earlier you said the forex market has enjoyed relative stability this year. But there are concerns that the plan by the CBN to stop the sale of dollar cash to Bureaux De Change operators (BDCs) may distort the stability we have seen in the market if implemented. What is your take on that?

Well, there are different segments in the forex market. There is the central bank market; there is the interbank market and the parallel market. Fortunately, the three have been stable this year. The central bank action you referred to may be more impactful at the parallel market. If it comes to pass, you may see the spread widening a little bit. The central bank has a point. The central bank’s point is that the parallel market is a market for BDCs and they do invisible transactions. Most invisible transactions don’t require cash.

Here we are talking about school fees, medical fees, credit card payments and other retail types of transactions. Even BTA technically you don’t have to carry cash. So, most retail users really don’t require huge volume of cash. The central bank’s concern is that the volume of dollar cash being imported is not commensurate with the profile of a typical retail forex user and is concerned that the parallel market is funding other activities. So it is not impossible that it may affect the relative stability of the market in terms of the parallel market.

But most retail users have access to dollars officially from the interbank market and anybody who has a bank account can walk into any bank. Most legitimate users are covered by the manual. The central bank is concerned that some of the cash is really capital flight which technically is not eligible for forex. Perhaps their view is that legitimate transactions do not require such heavy cash and by clamping down on it, it will not affect legitimate dollar demand but the grey market. So I think the objective of the central bank is laudable.

Since the London Interbank Offered Rates (LIBOR) scandal involving Barclays Bank in England this year, there has been doubt over the credibility in fixing the Nigerian Interbank Offered Rates (NIBOR)?
Well, there are two things there. The first thing is that one of the reasons why the scandal was so devastating was because of the centrality of the LIBOR fixing to economic activities in the developed world. Everything there is LIBOR-driven: mortgages, commercial loans, corporate loans, all type of loans, uses LIBOR. Unfortunately, despite the efforts by the FMDA, NIBOR is relatively less used in Nigeria. So it is not systemically significant, even though we would like it to be systemically significant. That is one point.
The other thing is that I do not believe that same is happening here. What we are doing presently with the NIBOR committee is that we are  looking at the process of how NIBOR is determined and see what lessons we can learn from what happened in the United Kingdom in terms of how LIBOR is set and how essentially the potential for abuse can be eliminated. There is no evidence of abuse of the NIBOR in Nigeria historically, so what we want to do is to learn from what happened in abroad, improve our process of getting the NIBOR rates and use systems more rather than surveying people. Those are the things we are looking at and fortunately, because it is not widely used like LIBOR, the incentive to abuse it has not been there. The challenges we have are things like liquidity and depth.
We need to find a way to make sure there are more activities here so that the rates that are quoted reflects what is going on in the market because Nigeria is a very short-term market, there are not much activities in the longer tenors. As an association we plan to deepen activities in those tenors so that the rates that are produced by the NIBOR process will be much more reflective of economic realities. Those are the kind of things we are worried about in particular.  So we are putting in place measures to ensure that it doesn’t happen in the future.

So how does the association fix the NIBOR tenors?
Essentially, a survey is made of banks. Somebody from the NIBOR committee at the FMDA will call 10 banks daily and get their deposit rates for Overnight (Call), 7-day, 30-day and others, work out the average. The panel is reviewed from time to time, but presently there is a particular panel of 10 banks. It is reviewed periodically. What we do when we get from the 10 banks is to eliminate the top two and bottom two and the average is worked out from the middle six. The removal from the 10 is to eliminate skewness and abuse.
But what we want to do is to acquire systems that have the capability to bring out data of trading so that you can look at what people trade and work out the average from that rather than from a survey, so that, that element of subjectivity can be further removed. But we don’t have the capability now, but we are looking at investing on it as a market. If we can automate it, we can eliminate the possibility of collusion. Again I must stress, we have never had that (abuse) in this market. It has never happened and we monitor closely for that.

How far has the association gone in its quest to get an Over-the Counter (OTC) trading platform?
What we are trying to do is to get the Securities and Exchange Commission (SEC) to formally approve an OTC for the market.  What we have now is an OTC for government bonds, so what we are trying to do is to get a formal approval from SEC for an OTC platform where different products such as forex, money markets, fixed income (sovereign and corporates), derivatives and in the future, maybe commodities.
But for now, what we have is a platform for just money market instruments and commercial papers. As part of that process, there is a capital requirement to be met and we have gone through that process. Part of that process also requires that we invest in technology and trading platform or systems that will automate and improve trading process across all products. There is already OTC activities going on, but the aim now is to put it under one umbrella, with standards and professionalism as well as guidelines for people to adhere to, which if they don’t, they will not be allowed to trade  on the platform.

We have worked with the Bankers’ Committee on this and we have the support of the central bank. We are currently in the final stage of getting the approval from SEC so that we can start operation. Data has been a challenge in the market. We have been trying to work with regulators and the National Bureau of Statistics (NBS) to try and get a better handle of market data. As the market continues to open up to the world, that culture of transparency and data availability has to be enshrined because the market is changing, risks  are being added and so people need to have as much information as possible, which is also part of the reasons why we are going for the OTC platform.

So what is your forecast for the market for the rest of this year?
I think that the currency market will be stable for the rest of the year. There might be one two activities and there may be some volatility as portfolio investors may come in or move out towards the end of the year. But basically the central bank, with the reserves up by $10 billion year-on-year, will comfortably be able to defend the currency. So I see exchange rates being stable. Interest rates too will remain stable.
People feel the central bank has to start easing monetary policy and that could happen next year. But I know that the CBN is focused on price stability and they are very convinced of the efficacy of using forex to achieve that. So they believe that forex stability is very key to price stability and that will always be a factor when they think of easing monetary policy rates because they will definitely consider the possible impact of that on the current exchange rate situation and ultimately on inflation. 

Akinsowon Dawodu


Akinsowon Dawodu started his professional career with Unilever Nigeria as a Management Associate before joining FSB International Bank Plc in 1998. He joined Citibank Nigeria’s Treasury Department in June 2000 as a Foreign Exchange Dealer responsible for risk taking and market activity on the FCY desk. After a spell on the Local Currency desk, he became Chief Dealer in 2003 overseeing all trading and mark-to-market activity by the Treasury department. He was also responsible for the management of regulatory relationships and market development initiatives.

Akin left Citibank Nigeria in 2005 and subsequently became the first Treasurer of MTN Nigeria. He returned to Citibank in July 2007 as the Head Trader/Deputy Treasurer and resumed his leadership role within the bank’s Treasury function. He was then subsequently appointed Fixed Income Currency and Commodities Head and Country Treasurer in October 2007.

Akin attended Kings’ College Lagos before obtaining a B.Sc in Accounting from the University of Lagos. He also holds an MBA from Manchester Business School (MBS) and became a holder of the Chartered Financial Analyst (CFA) designation awarded by the CFA Institute in 2003. He is the current President of FMDA.

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