However, as I consider today's double-digit yields against credit fundamentals and recent policy developments, I think Nigerian hard currency sovereign bonds and some corporate bonds offer a compelling investment proposition. Perhaps most importantly, there's a new government in Abuja that's demonstrating a commitment to advancing economic reforms. If sustained, these could have a transformative impact – for the country and investors.

Relatively stable credit fundamentals

On the fundamentals side, Nigeria has long been differentiated from many of its African and emerging market peers thanks to its relatively modest public debt which is below 40% of GDP, less than a quarter of which is external. Being a major oil producer also critically supports exports and the current account, which has been in surplus over the past several years. There should also be a beneficial impact from the new Dangote refinery, that should in time eliminate the need to import refined oil. Additionally, foreign exchange reserves are fairly comfortable at around $34 billion, equivalent to over five months of goods and services. Given all this, there seems to be little near-term risk of Nigeria either being unable to service its debts or seeing a balance of payments crisis.

Key drivers of Nigeria's country risk premium

So the reasons for Nigeria's elevated country risk premium, reflected in its high bond yields, clearly must lie elsewhere. Perhaps the most notable area of concern has been political risk. This includes traditionally poor governance and a track record of weak policymaking. Progress on structural reforms has also been limited. A key indicator of this is a weak tax base. At around 7%, Nigeria has one of the lowest tax revenue/GDP ratios in the world. Indeed, for years I've been saying that Nigeria doesn't so much have a debt problem as a revenue one.

Aside from the inability to make effective policies to raise tax revenues, Nigeria has also traditionally lacked discipline on the government spending side. In some cases, politicians have been guilty of pursuing outright wrong policies. On the spending side, this was reflected in a costly and highly distortive fuel subsidy. This, in turn, reduced the availability of funds for more productive outlays on things like education, health, and infrastructure. Another longstanding concern has been the policy of multiple exchange rates. These reduced transparency, increased currency volatility, supported black-market activity, and generally hindered Nigeria's business and investment climate.

New Tinubu government quickly improving policy

However, the good news is that, since his election victory in May, President Bola Tinubu has rapidly improved policy. One of his first acts as president was to remove costly fuel subsidies, which had grown to around 3% of GDP in 2022. This was perhaps not surprising as Tinubu had been promising this in the pre-election period. Less expected was the speed at which the government pushed through this unpopular but key reform.

Just a few weeks later, on 14 June, came the more surprising decision to remove restrictions on the official exchange rate – this caused a drop of over 30% in the Naira to a new low of around NGN750/1USD.¹ Crucially, this move brought the official exchange rate into line with the black-market exchange rate. The resulting significant devaluation of the Naira, which brings it much closer to its fair level, in my view, should benefit the economy. In particular, the weaker Naira should help the fiscal account and boost export competitiveness, which coupled with more restrained import demand, should support both the current account and the growth contribution from net exports.

Maintaining reform progress will be key

The new administration's drive to quickly and decisively tackle two of Nigeria's main longstanding distortive issues has certainly been welcomed by bond investors, with spreads tightening considerably (see Chart 1 below), Nigerian bonds returning nearly 19% in the three months to end-July, outperforming the broader hard currency sovereign index by 15%.² However, while the Tinubu government has gotten off to a flyer, there's still much more to be done. Raising tax revenues and increasing oil production should be priorities.

Source: JP Morgan, 31st July 2023

Ultimately, continued and sustained reform progress will be needed for Nigeria to realize its undoubted potential. In this regard, Tinubu's successful track record of raising tax revenues when he was governor of Lagos state from 1999–2007 is a good omen.

Putting everything together

It should hopefully be evident why I'm bullish on the outlook for Nigerian hard currency bonds. The 10-11% yields for government dollar bonds, and a touch higher for corporate bonds, look attractive given key credit fundamentals, but I feel the investment case becomes compelling when we also factor in the improved prospect of significant reforms under the new government.

¹ Since late June, the official exchange rate has ranged between NGN750-800 per USD
² JPM EMBI Broad Diversified Global Index

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