Expectation of Higher Portfolio Flows Raises Hope for Strong FX Liquidity

Expectation of Higher Portfolio Flows Raises Hope for Strong FX Liquidity

Expectation of an improved portfolio flows into Nigeria and other emerging markets in Africa raised hope for an improved foreign exchange liquidity in Nigeria in 2021.

In its macroeconomic outlook for the year, ARM Securities Limited report indicates that downside risks to foreign portfolio inflows seems to have subsided.

On that note, projections indicate that the Nigerian market would likely attract more portfolio investment inflow in 2021 than in the previous year.

Analysts noted that the expected improvement in portfolio flows would support the Nigeria’s foreign exchange pillar following year-long pressure on the local currency, naira.

Due to lack of liquidity in the foreign exchange space, the Nigeria’s central bank continues to tighten reins around FX demand.

This has impacted companies and individuals with genuine need for foreign currencies for various transaction purpose.

However, due to low foreign inflow amidst heighten risk in the economy, foreign investors have remained aloof.

In a report, ARM Securities said portfolio flows into Nigeria market was depressed since the inception of the pandemic.

Precisely, the firm explained that non-resident flows into the economy printed at $407.3 million in Q3 from $385.3 million in Q2.

ARM Securities Limited however considered this as a meagre when compared to 2019 where foreign portfolio flows averaged $4.09 billion.

The investment flow breakdown showed foreign portfolio flows to equities market moderated sharply to $53.23 million over Q2-2020 from Q1 $639.7 billion Q1, and $44.1 million in Q3-2020.

“For us, we believe the adverse impact of the pandemic on crude oil prices and other macroeconomic variables resulted in significantly lower flows”, ARM Securities said.

The Nigeria’s gross domestic products (GDP) was contracted by 6.1% year on year in Q2-2020 and 3.6% in the following quarter in the same year.

Rising inflation, supply chain shock and weak foreign exchange position among others were combine to raise domestic investment risks.

Inflation rate rose sharply during the period by 136 bps to 13.710% while monetary policy rate was trimmed twice by 200 bps cumulatively to 11.5% between Q1 and Q3-2020.

On the other hand, foreign portfolio interest in Nigeria’s fixed income securities remained tepid in Q3-2020 as there was no flow to the bonds (same as Q2 20), while flows to money market printed at $363 million as against $332.07 million in Q2.

“To our minds, the tamer interest in Nigeria’s debt reflects depressed yields (-111 bps to 4.03%), lower interest rates significantly below inflation rates”, ARM Securities noted.

Elsewhere, South Africa witnessed a net foreign portfolio outflow of $1.7 billion in Q3-2020, albeit slower relative to the prior quarter reported net outflow of $3.05 billion.

“We believe the moderate pickup in economic activities resulted in a slower outflow as GDP contracted by 6% in Q3-2020”, the firm stated.

Meanwhile, ARM Securities said in the report that over 2021, the firm sees room for possible return of FPI flows to Nigeria.

“Our view is hinged on an expectation of recovery in GDP in 2021 with International Monetary Fund, IMF, forecasting a 1.7% growth in 2021.

“Albeit we think continuous rise in inflation rate, low fixed income yields as well as unstable FX poses a risk to positive flows in Nigeria”.

Similarly, in South Africa, prospects for a rebound in economic growth by 3% year on year according to the IMF against -8% in 2020.

Recall that portfolio flows to emerging markets rebounded in the second half of 2020, following the downward reversals witnessed in the first half of same year.

For context, analysts said while Q1-2020 saw a significant net outflow of $51 billion; triggered by the Covid-19 pandemic, portfolio flows to the emerging market rebounded in Q2-2020, with a net inflow of $54.3 billion.

Hence, net portfolio flows printed at $3 billion over the first half of 2020.

Then, over the second half of 2020, analysts explained that positive COVID-19 vaccine news as well as the resolution of uncertainty regarding the US election boosted positive sentiments that lured non-resident flows toward emerging markets.

In addition, analysts said they believe the extensive liquidity due to stimulus packages from advanced economies gave a boost to portfolio flows during the period.

In the second half of 2020, total net inflow printed at $113.8 billion with 63% ($72.2 billion) of the total flows channeled towards EM debt counters, while equities ($41.6 billion) accounted for 37% of total flows.

Dissecting the quarterly numbers, Q3-2020 saw slower net inflows with a cumulative of $19.3 billion amidst sell-off in the equities market (recording an outflow of $4.5 billion in Q3-2020) while flows to the debt securities totaled $23.8 billion over the period.

However, it was noted that bulk of the funds flowed into Emerging Markets over Q4-2020 printing at $94.5 billion, was spurred by interests across debt ($48.4 billion) and equity securities ($46.1 billion)

Over the first half in 2020, emerging markets equities performance had declined by 10.7%.

This reflects strong selloffs in Q1 2020 (-23.9%) – a fallout of the coronavirus pandemic and oil price shock which rippled through global financial markets, outweighing the rally seen in Q2-2020 (+17.3%).

ARM Securities noted that the adoption of an accommodative stance by the US Fed as well as other monetary bodies to combat the adverse impact of the pandemic sparked positive sentiments across EMs equities over Q2 2020.

In the period, US Fed trimmed rates by a cumulative of 150 bps in March 2020 to 0.25% and pledged to keep interest rates low while simultaneously offering trillions of dollars in credit to spur growth.

As a result, Emerging Markets equities saw a rebound, rising at some +26% over the second half of 2020.

While the positive momentum continued in Q3 with market return at 8.7%, positive COVID-19 vaccine news and the conclusion of the US presidential election which curtailed uncertainties, fueled a rally in Q4 2020 (+15.8%).

Thus, on the fixed income leg, emerging markets government bond spreads tightened more than 15bps and 61bps in Q3 and Q4-2020 respectively over comparable U.S securities.

“This largely reflects investors’ appetite for riskier assets with attractive valuations, in the wake of accommodative monetary policy across most developed markets”, analysts explained.

Nigeria’s Big Banks Withstand 40% Oil Exposure Stress Test

Expectation of Higher Portfolio Flows Raises Hope for Strong FX Liquidity