Oil, reforms make Nigeria top pick in frontier markets

Frontier markets will benefit from the search for yield and, in sub-Saharan Africa, Nigeria is a good pick, according to one emerging markets strategist

Nigeria joined the JP Morgan Government Bond Index-Emerging Markets (GBI-EM) last month, the second African country to join after South Africa, and this is likely to generate “substantial capital inflows, thereby helping deepen the local debt market and boost the naira,” Societe Generale emerging markets strategist Souheir Asba said.

“This should overall be positive for the NGN (Nigerian naira), assuming no major issues in the fiscal calendar of the new government,” she said.

The currency appreciated to the highest level in 2 weeks last week, as portfolio inflows from investors buying fixed-income securities rose.

At the beginning of November, S&P raised Nigeria’s rating by one notch to BB-, with a stable outlook, saying that the fiscal assets in the Excess Crude Account (ECA) rose to about $8.4 billion in October, “which provides a reasonable fiscal buffer” and its external reserve buffers had also been strengthened due to strong exports and high oil prices.

Fiscal assets in the ECA were around $2 billion at the end of 2010.

The West African country is the continent’s top oil producer and Asba said the oil sector is another reason why Nigeria is her favorite frontier market pick.

“While we anticipate an increase in portfolio inflows, the main source of inflows will continue to be FDIs (foreign direct investments), mainly in the oil sector,” she said. 

Nigeria is making “substantial efforts” to enhance its non-oil sector to cure its “Dutch disease,” but it still depends heavily on oil exports, according to Asba.

Reform momentum continues, the S&P said after its recent upgrade, citing measures taken by the government over the past year such as halving the fuel subsidy, overhauling the electricity sector and raising electricity tariffs.

The main source of risk is the fiscal policy, as there has been no agreement on what oil price to include in the budget. They key issue, said Asba, is to find an optimal benchmark that would allow increasing oil revenues to fund the rising government spending on wages and infrastructure.

“We believe that the Finance Minister is right in opposing a high benchmark as it is, in our view, too optimistic taking into consideration high probability of slowing demand of oil in 2013,” she added.