Economic Update

The latest international bond sale from Nigeria, which was heavily oversubscribed, underscored the bullishness of overseas investors in the country’s sustained if uneven growth. However, the yield level on the offering also highlights the looming challenges that Nigeria, along with other emerging markets, could face when seeking to raise capital in the future as the US economy begins to pick up.

On July 2, Nigeria closed the book on two blocks of dollar-denominated bonds worth a combined $1bn, with the offer being oversubscribed four times its face value. Of the two issuances, the 10-year $500m bond attracted bids of $2.26bn, while the five-year instrument, also worth $500m, drew bids of $1.77bn. Initial yields were set at 6.375% and 5.125% on the 10- and five-year bonds, respectively.

The government has said the funds will be used to finance infrastructure development, particularly in the power sector. Planned projects include an upgrade to electricity distribution systems, as well as the construction of pipelines to the western provinces to supply gas to power plants in regions where generation capacity is weak.

The finance minister, Ngozi Okonjo-Iweala, said the result of the offer was pleasing, especially given the turbulence in international capital markets.

“The coupon shows confidence in the Nigerian economy,” she told journalists. “Appetite for our paper was strong.”

The positive outlook may be due in part to Nigeria’s continued economic expansion. By some accounts, the country has surpassed South Africa as the region’s largest economy, though other estimates suggest that it will not achieve this until next year. With the IMF projecting that GDP will rise by 7.2% in 2013, the country is better placed than most to support higher borrowing levels. Its external debt is equal to 2.5% of GDP, far lower than most other countries in the region, while this figure stands at 18% for domestic borrowing.

Although demand for the latest bond offering was strong, Okonjo-Iweala warned that appetite for emerging market debt is likely to wane if the Federal Reserve scales back its bond buying programme, pushing up interest rates in the US.

“If the strength of the US recovery holds and quantitative easing ends in 2014, we will certainly see higher treasury yields and that will impact emerging markets,” she told the Financial Times in an interview on July 3. “If we look down the road we might see liquidity flow out of emerging markets.”

The cost of financing Nigeria’s debt has already started to climb, with the yield on 10-year bonds issued in 2011 rising from 3.64% in January to 6.24% as of the end of June 2013.

According to Omar Hafeez, the managing director and CEO of Citibank Nigeria, this could be due to a number of factors, such as spending on domestic security, general inflationary pressures and lower oil production levels, which could have a fiscal impact. “Banks are still likely to be attracted to government paper, at current levels and even with slightly lower returns than previously seen,” he said.

Hafeez added that foreign investors now have greater access to Nigerian sovereign debt with very few restrictions. “At the same time, news of a tapering in the quantitative easing programme in the US has already caused a shift in capital away from emerging markets. Many factors are at play simultaneously, and we have witnessed the ramifications of the fluidity of portfolio flows,” he told OBG.

How much further external borrowing costs may rise will depend in part on the degree to which the US economy recovers. Closer to home, however, the ability of Nigeria’s economy to cope with various domestic and foreign challenges will likely have an impact on returns on its bonds.