Sule: Cost of Debt Service May Soon Equal Oil Revenue

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The Executive Director, Apertus Capital, an investment firm, Mr. Leke Sule in this interview with Nume Ekeghe and Nosa Alekhuogie, expressed concern over the high cost of debt service in the country. He also spoke on the Nigerian capital market as well as other investment opportunities. Excerpts:

Taking a look at the market last year, what were the factors responsible for the downturn?

Mainly it was because people did not really expect the level of depreciation we saw in the currency. That was the first disappointment. We all expected currency depreciation to some level, but we did not expect the level to be as high. We saw the parallel market move from around N300 to N350 then it galloped to N400 then to N450 and before we knew it, we were seeing N500. So that fuels inflation in the first place, because we are mainly a consuming economy so most of what we consume, we import. So that also transited into the market and before we knew it, investors started selling.
Looking at fixed income securities, if inflation is going up, you expect that the returns on treasury bills and bonds should also be higher. So, if it is not high enough, investors would start selling. Another thing is the oil price and of course that affects how the currency performs because we are mainly an oil dependent economy. The performance of oil price would definitely affect the currency. So, as oil price stayed stable between $45 and $55 per barrel, the currency wasn’t performing so well. The budget targets oil production of about 2.2 billion barrels per day. So if we hypothetically end up producing less than that, government’s projected revenue would be in jeopardy.
On the currency, some investors were optimistic about 2016. The naira appreciated slightly at the parallel market late December 2015 to about N270 to a dollar and people were really optimistic about 2016 until it jumped to about N300 in January. Surprisingly, between January and December 2016, we all saw that it declined further by about N220 which is about 81 per cent depreciation and we do not have that kind of movement in revenues or prices. So when you have one of the major determinants of prices in the market depreciating, every other thing would fall.
On inflation, investors earning in foreign currencies have a better opportunity to invest here. There is so much pressure on the naira. Foreign portfolio investors are existing, only few of them are still left. For local investors, it made sense to buy government securities. It is no longer enticing to do businesses that require one to import raw materials anymore.

Are you saying those who opted out of the stock market invested their monies in treasury bills?

Yes from July last year, it made so much sense to invest in treasury bills than to do any other business. The yields were around 22 per cent last year and already 23 per cent by middle of January 2017.

Do you see that trend still happening this year?
We see that trend still happening this year. Last week we had one of the highest yields on federal government bonds. We had about 17 per cent yield at the primary auction. There was an auction last week and the results were fantastic especially for new investors in those offered maturities and not too good for those who had positions in them earlier.

What is your outlook for the market for 2017?
First, on oil prices, we think it would remain stable.  That is, below $60 per barrel because once it goes above $60 dollars per barrel, it is going to be more profitable for shale oil producers. So they are going to ramp up production and prices would come down again. So we think oil prices would remain low despite the production cut the Organisation of the Petroleum Exporting Countries (OPEC) have been announcing. When they started with the production cut, oil prices went up but before we knew it, it started coming down again because the shale producers who are not OPEC members anyway, quickly cashed in on it and they ramped up their productions. So, it means oil price would remain low and if it happens, government revenues would remain low. If revenue is low, that means the federal allocation that is being shared monthly is going to be quite low. It means states would still be owing salaries unless they increase their internally generated revenues. It means economically, purchasing power would still be low, people are still going to be poor.
In terms of currency, we are currently seeing about N495 to N500 to $1 at the parallel market. It is likely that the N500 ceiling would be broken this year if situations do not improve. We think inflation would keep going up but once the budget is approved, we expect that spending would commence and once we start spending, employment is likely to improve and government would start paying contractors again.
For interest rates, it is going to remain high as well though. We are in a recession and normally in a recession; we expect the central bank to reduce interest rates. Whenever there is recession, interest rates should go down so as to expand the economy and encourage people to borrow money from banks. But that is not going to happen because banks were not even lending when rates were high. So they would not lend if the rates are low. It is not likely that the central bank would reduce its MPR as well.  Because if they reduce rates, the federal government may not really be able to borrow money competitively and looking at the size of the budget and the deficit, they need to borrow a lot of money and they have not been finding it easy to borrow offshore. And for the federal government to borrow significant amounts locally, rates have to be high or at least competitive. So they would likely keep the rates high enough to encourage borrowers to give them money. We can safely conclude that interest rates are going to remain high this year. Exchange rate – naira is going to remain most likely above N480 to $1 at the parallel market although the CBN has started selling dollars to Bureau de change (BDC) operators. But we don’t really think they can do so much. It is still likely that on the exchange side, the outlook would remain negative.
We expect inflation to also remain high because of the weak exchange rate although it has been increasing but lately at a reducing rate when compared to what we experienced last year. It is currently at 18.55% but it would likely increase further but the pace would be slow and it should begin to drop gradually due to base effects. Probably as we move towards the pre-election year when we think the federal government would spend more, we should probably start looking ahead for better times but getting the economy out of recession would be challenging. Purchasing power is reducing, people that are really going to bear the burden are the salary earners because salaries are not likely to increase. Employers are not likely to increase salaries because earning power has not really improved for companies, so there is no point increasing salaries. Even the labour associations cannot really clamour for higher salaries because even the N18,000 minimum wage, a lot of states have not been able to pay, they are still owing, so if you increase salaries again, it is just going to make things worse.

If government is not able to borrow externally, do you think they would be able to raise debts from the domestic market?

They are going to issue bonds. There is a bond auction calendar where they have the amounts to be issued and the respective tenors. They have a projected volume. At the last FGN bond auction, they offered N130 billion but they sold about N210 billion. That is unprecedented. Basically, when an individual or corporate body invests in treasury bills and bonds, what they are doing is lending money to the federal government. You have given them a loan so to speak. The difference between that and raising money offshore is that you are giving them your money in naira. When you take money from abroad, you take it in dollars. When you have more dollars coming in, it will have positive impact on your exchange rate because it is a positive flow of foreign exchange. If the oil price goes up, you have more revenue coming in dollars in so fa as oil production does not decline. If you have foreign direct investment in a very big chunk, the naira would strengthen. High level of local borrowing by the government is not always good for the economy because it crowds out private investments. If I can lend to the government at let’s say 20 – 23%, why would I (as a bank) lend to any SME? If banks buy treasury bills at 22% yield, they are not going to pay taxes or make provisions for bad loans, they do not have to run after you to repay. It makes so much sense to invest in Treasury bills instead.

What can be done to revive public offering of shares in the market?

The economy has to first come out of recession because stock prices are low generally. For instance, if you have a company and you know the worth of your company is N5 per share and it is currently trading at N3.50 a share; you wouldn’t want to issue more shares at a discount, this is not the time to issue more shares to raise money. You would rather raise a bond or borrow money. You would want to raise more equity at N6 if you think your stock is worth N5 for example. So even if you decide to raise a corporate bond right now, you would have to bench mark it to the federal government bond so it means you would be looking at around 18% to 20% so as to be at a premium to FGN bonds. If the economy doesn’t come out of recession quickly and stock prices remain low, it is not likely that any company is going to come out for a public offer. And if any company comes out for a public offer right now, it would likely be poorly subscribed unless it is a blue-chip company and they are issuing at a discount. Informed people don’t usually want to take risk during times of economic downturns, they would rather go for risk-free instruments like treasury bills and bonds because equities have higher risk than government securities. You can buy a stock at N10 and within a month or two it can go to 50 kobo whereas if you buy treasury bills even if situation goes bad in the market, the government would still pay you your money at maturity. So that is the reason why we are not likely to have numerous public offers soon, unless the economy booms and the market turns around.

The 2008 crisis scared a lot of investors into Nigeria, what do you think can be done to woo them back into the market?

Firstly, corporate governance; I think a lot has been done between then and now and the stock market is stronger now in terms of corporate governance and reporting. In banks, CEOs can’t spend more than 10 years, they have fixed tenures unlike before where you could spend 10 to 15 years as CEO and the board keeps going for you. In terms of reporting, banks now have uniform accounting period. Before we could have situations were some non-reporting banks would help some other reporting banks shore-up their books, now all banks have uniform accounting year so you can compare their results and books easily. Then again, our markets have become more open to foreign investors so foreign investors can partake in the market. However to attract people there has to be more transparency in the market as well as financial literacy.

What do you think can be done to broaden investment in the market?

Fixed income is also a significant part of the capital market and retail bonds trading has been included in the NSE. But that has not been very successful probably because they have not created enough awareness. A lot of people are not really aware that they can buy and sell bonds on the exchange. So I think they need to create a lot of awareness. A lot of people aren’t aware. They believe once they buy N5 million worth of bonds today, they would have to hold it to maturity and that is not the case. There is actually a retail market but it has not been very active because most people are not aware that it exists. So there is need for investor education.

What advice would you have for investors scared to dabble into the stock market?

Well it all depends on the individual’s risk profile and preferences. Before you give advice to anyone, first you need to understand the person’s risk profile and returns expectations. For a low risk investor, let’s say someone who is above 50years old, I wouldn’t advise the person to go heavily into the stock market, I would advise fixed income.  Because at that point, the person is close to retirement and doesn’t need uncertainties. So for older people it would be better for them to do more fixed income or treasury bills. But for young people, maybe university students, and anyone between 30-40 years, they can do equities. And it also depends on what plans they have for their money. With good analysis, you can actually double your money by investing in a stock with good fundamentals within a few months or lose almost all your money on a bad call. If you buy treasury bills on the other hand, it is not likely that your money is going to double but you are not going to lose it.
For example if you look at stock X and it is currently trading at N10 and then you think it has a good probability of going up by 25% over the next year. That probability may not be enticing enough so instead of being uncertain about the return on this stock I might as well invest in treasury bills. If Treasury bills and bonds yields are high, it is not likely people would be looking at equities. But when interest rates are low, people look more at equities. So, it is not likely that the stock market is going to improve significantly as long as treasury bills rates remain high.
High level of outstanding government securities is also risky for the government. If everyone continues to look at FGN securities because of the high returns and the DMO also keeps selling more than it offers at auctions, there would be a significant risk on debt servicing. After some time, debt servicing will crowd out other expenses. Debt servicing projection in the 2017 budget is 23% of the total expenditure; that on its own is high. However we don’t have any foreign currency denominated sovereign instrument maturing until July 2018. From the proposed budget you can see that the expected total revenue is N5.029 trillion, total expenditure is N7.298 trillion and the deficit is N2.269 trillion; more importantly, 23% of total expenditure is debt servicing. If Nigeria is not able to borrow money externally and we continue to see lower oil revenues, the projected amount they need to borrow would go up. Oil revenue projection is N1.985 trillion and debt serving is N1.66 trillion so if oil revenue doesn’t go up, and the non-oil revenue doesn’t go up as well, Nigeria would have no choice but to borrow more. And when we borrow more, considering present conditions, it would have to be higher rates.
So a time may come when the whole of oil revenues would be equal to the amount used for debt servicing. As it is today, our debt servicing is almost equal to our non-oil revenue. The fiscal authorities need to do more to diversify our revenue base and we need to have stability in the Niger Delta so that oil revenues can grow.