Nigeria Calls Time on One of World’s Most Rewarding Carry Trades

(Bloomberg) -- Nigeria’s central bank is preparing an end to an era of debt sales that handed foreign investors some the best carry returns in Africa.

Offerings to non residents of so-called Open Market Operations bills -- introduced to help stabilize the naira following the oil-price collapse in 2015 -- are to be phased out “once current obligations have been redeemed,” Hassan Mahmud, the bank’s director of monetary policy in Abuja, said in an interview aired during an online conference on Tuesday. He didn’t give a time frame.

Though the sales helped to shore up the currency, the debt has become too burdensome to sustain as foreigners snapped up securities that offered carry traders -- who borrow in low interest-rate markets to invest elsewhere -- returns of as much as 30% in dollar terms in recent years. The market for OMOs had grown to about $40 billion by the end of last year, according to Cairo-based investment bank EFG Hermes, with foreigners holding about a third.

The cost of liquidity management is getting too high and issuance of OMO bills should be a transaction between the central bank and commercial lenders, Mahmud said.

“It’s not supposed to be for the public, but along the line the transition broke and investors who were non domestic were investing in OMO,” he said.

The central bank has reduced OMO issuance by 61% in the first two months 2021 compared with the same period last year, according to data compiled by Bloomberg.

OMOs, which have maturities of less than a year, were created to mop up excess liquidity in the banking system, but had been opened to foreign investors to attract dollars since the 2015 oil-market crash. In October 2019, the Abuja-based lender restricted OMO sales to banks and offshore investors, barring participation of domestic institutional investors and non-banking firms. That distorted the market for Nigeria’s short-term debt, with yields on Treasury bills collapsing.

OMOs maturing in February 2022 yielded around 8.5% on Tuesday, compared with 3% for one-year Treasury bills in the secondary market.

Naira Pressure

Repatriation of returns by offshore OMO holders has been putting pressure on the foreign-exchange market, Mahmud said. The central bank has settled more than $2 billion of OMOs to foreign investors, “but the pile-up is still more than that,” he said.

“The goal is to get that off, and if inflows are going to come, they should come in through the normal channels of the capital market,” Mahmud said.

Moody’s Investors Service warned as far back as 2019 that the cost of keeping the naira stable using OMOs would be prohibitive and leave the country vulnerable to outflows. Non-residents held $13.2 billion of the securities as of September, according to Omotola Abimbola, a fixed-income analyst at Chapel Hill Denham in Lagos.

It is unlikely that the central bank will increase lenders’ loan-to-deposit ratio, which is at 65%, until there is stability and signs of consolidation and economic growth, Mahmud said. The CBN is also maintaining the forbearance given to lenders to restructure loans in the sectors affected by the pandemic.

“We want this recovery to consolidate before we start reversing those things,” he said. “Assessment is going on and the bank-examination report will determine whether some of those will be rolled over or not.”

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