Bond changes: Funds from two bond sales to finance infrastructure development

The latest international bond sale from Nigeria, which was heavily oversubscribed, underscored the bullishness of overseas investors regarding 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, 2013 Nigeria closed the book on two blocks of dollar-denominated bonds worth a total of $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 the construction of pipelines to the western provinces to supply gas to power plants in regions where generation capacity is weak.

POSITIVE OUTLOOK: 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 this will not happen until 2014. 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. At present, its external debt is equal to just 2.5% of GDP, far lower than most other countries in the region, while this figure stands at 18% for domestic borrowing. And the IMF expects this growth to continue into 2014: real GDP is forecast to rise by 7.4% and real per capita GDP to increase from 3.4% to 4.5%.

FLATLINING APPETITE: 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.”

According to Omar Hafeez, the managing director and CEO of Citibank Nigeria, this could be due to several 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,” Hafeez told OBG.

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. In October 2013, Nigeria’s Debt Management Office said the country’s total debt, domestic and external, was about N9trn ($56.7bn) at the end of 2012. Total domestic debt stood at N1.47trn ($9.26bn), a 19.34% rise from 2011 levels.

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