On 29 May, President Bola Ahmed Tinubu was inaugurated as the 16th President of Nigeria. As with the usual practice, President Tinubu addressed the nation, highlighting some of the policy actions Nigerians should expect from his administration. We highlight several talking points, including (1) PMS subsidy removal, (2) exchange rate unification, and (3) interest rates cap as he deemed the current interest rates as too high. Asides from that, President Tinubu also signified the end of current capital control measures as he assured foreign investors that they will be able to repatriate their profits and dividends with ease. In this report, we examine some of these talking points, and also give our views on the expected impact on the equities and fixed-income markets.
Exchange rate unification: We believe exchange rate unification is a very good initiative to pursue. This should essentially see the official and unofficial exchange rates eventually trade within a close margin which is considered to be optimal, holding FX liquidity constant. In the near term, we expect to see some panic selling at the unofficial market, leading to some appreciation of the local currency at the parallel market. However, if the official exchange rate is eventually realigned, we would probably see the exchange rate depreciate again at the unofficial market, if there are no immediate plans to drive FX inflows. In essence, what then happens afterwards in terms of FX supply will determine how the exchange rate dynamics in the unofficial FX markets play out. Overall, we expect volatility in the FX market until the coast is clear on FX supply after the official exchange rate is realigned.
PMS subsidy removal: We also like this given that subsidy removal frees up government resources for other productive uses. Indeed, the President stated that his administration shall re-channel the funds into better investments in public infrastructure, education, healthcare and jobs that will materially improve the lives of the average citizen. Also, given the potential positive impact of PMS subsidy removal on government revenue, we expect to see an improvement in the debt-service-to-revenue ratio (11M-22: 89.5%). Fiscal deficits are also likely to reduce over time if aggregate expenditure does not grow more than the increase in revenue. However, we expect the PMS subsidy removal to aggravate near-term inflationary pressures given the dependence on gasoline for almost all aspects of our lives amid an epileptic power supply. Nonetheless, we expect the road to full PMS subsidy removal to be bumpy as organised labour and citizens are unlikely to let a full PMS subsidy removal be implemented without any furore.
Interest rates level: In the President’s speech, he stated that “interest rates will come down” as they are “too high, anti-people, and anti-businesses”, implying a lower interest rate preference. While some individuals can find logic in reducing interest rates, for now, we think it will be disastrous when activities eventually normalise. Thus, we think the statement suggests a preference for low interest rates even when low rates are not warranted, likely leading to capital outflows, exchange rate pressures, and worsening inflationary pressures. Perhaps, the country might end up with interest rate bifurcation such that interest rates for government securities are low but private sector lending rates are high.
Market Impact
Equities: Considering that we have previously argued that the new administration’s stance and intent to resolve key policy issues, particularly around the current FX framework and oil subsidy payments will be key catalysts for a better-performing equities market, we view the new President’s speech as positive for the equities market. Particularly, we believe the President’s statements on resolving current issues around multiple exchange rates and rectification of the current FX repatriation sit well with investors, evidence of which is the positive showing in today’s session (+5.2% | YTD: +8.8%).
However, we note that policy reforms from the new administration have to be overarching to have a lasting impact on the local bourse over the long term. Indeed, the NGX ASI is currently undervalued, trading at a P/E of 9.3x, a 13.9% discount to its 5-year average of 10.8x, and a 30.1% discount to the frontier market peers – MSCI FM (13.3x). We think this is unjustified, given its higher RoE (19.2% | MSCI FM: 16.2%; 5-year average: 16.7%) and dividend yield (5.3% | MSCI FM: 4.9%; 5-year average: 5.3%).
Fixed income: In our view, we see no movement in fixed income yields on local bonds as we remain convinced that the FGN’s high borrowing needs for the current fiscal cycle amid the tight liquidity picture would keep yields tethered northwards. However, given the positive signals to foreign investors on key policy issues such as FX framework revamp and subsidy removal, we expect a positive reaction from the Eurobonds market.
Final Thoughts
On the surface, the speech is positive and contains some bold reforms pronouncements, which would improve both local and foreign sentiments in the near term. However, how long the sentiments will persist will depend on actually acting on those reforms, given the lessons learnt from the previous administration.
That said, we think proper linkage of some of the reforms is lacking, servicing as a source of concern when the administration eventually embarks on acting on them. For instance, we are unclear on how exchange rate unification will be efficiently done alongside interest rate caps, annual expansionary fiscal policies, and likely continued usage of CBN’s monetary financing.
