Christian Debt Recovery

Debt To Capital Ratio Average

January 8th, 2008 |

Author: Gavin

Global economic meltdown, Crude Oil and the Nigerian capital market

It is interesting to note that the word “meltdown” is used to describe what happened in the global financial markets but the word “crash” which is more severe, is used when referring to what happened in the Nigerian capital markets.

Sadly, I cannot disagree with the contrasting description of what happened globally and what happened locally which resulted in the Nigerian capital market earning the unenviable accolade as one of “the world’s worst performing stock market in 2008, after losing N5.2 trn in market capitalization and 54 percent in the All Share Index” just a year after it had emerged as the world’s best performing the stock market in 2007 with a return of 74.9 percent.

Curiously, it was the seeds that were sown when the Nigerian stock market emerged the best performing market in 2007 that was harvested when it emerged one of the world’s performing markets in 2008 losing 67 percent of its value.

Soaring global economic growth, led by China averaging 10 percent per annum growth rate in gross domestic product (GDP) on the back of rising exports, fuelled by the insatiable demand for consumer goods by Americans, whose appetites were sustained by easy credit from a financial institutions drunk with exotic financial products riding on crazy expectations and dreamy valuations that had little or no fundamentals. That was the world in 2007.

With easy credit at their finger tips, American financial institutions represented by their hedge funds set their eyes on emerging markets, looking for ways and means to further meet the high return expectations created back home. Nigeria was fortunately, as at the time it happened and unfortunately, with the benefit of hindsight, ripe for the picking.

Nigeria had just emerged from a comprehensive write off of its external debts totaling $32 billion after paying about $12 billion cash to the Paris Club. The write off saw Nigeria’s debt to GDP ratio drop to highly attractive levels of less than 5 percent one of the lowest globally. Debt service to revenues ratio also dropped to new lows.

Nigeria’s attractive external picture was complemented by a stable macroeconomic environment, a clear economic policy direction and most importantly rising prices of crude oil which was hitting new highs in the international markets. Finally, the high profile fight waged by the EFCC against corruption ensured Nigeria was soon delisted from the black list of the Financial Action Task Force (FATF), the global anti money laundering task force. Then Nigeria got an investment grade rating from Standard and Poors as well as FitchRatings placing the risk of investing in Nigerian in the same class as Brazil and Turkey which are major destination of foreign investment.

Not surprisingly, Nigeria suddenly emerged as a major destination of hedge funds in search of our bonds and equities attracted by the high yields on Nigerian bonds and potential returns on equities.

However, as the saying goes “Nothing good lasts forever.” The bubble blew up. Excessive credit to people who had no capacity to pay soon resulted in massive defaults. Exotic financial products built around these faulty credit valuations soon realized that the returns are never going to come. Valuations started collapsing. Holders of these financial products which has been framed as derivatives and securitized debts soon found out that their values may not be worth the paper they are written on. The financial market panicked. AIG collapsed. The global financial world was shaken. Hedge funds skewed for short term investments, were the first to take a flight for safety.

Nigeria, as a major part of the emerging markets that was exposed to hedge funds was among the first to take a hit. Before the global financial crisis took shape in early 2008 in the Nigerian capital market, there was already the feeling that Nigerian stocks were overvalued. Banking valuations were going as high as 25 times earnings compared to about eight times earnings in other leading markets. In the face of the panic in the global markets, it is suspected that hedge funds may have withdrawn more than a trillion Naira from the market.

The flight of hedge funds happened when Nigerian banks were estimated to have been heavily exposed to the Nigerian capital market through several share linked loans to individuals, institutional and other types of investors. The sudden withdrawal of hedge funds created panic among exposed banks which also panicked in a bid to cut their losses from the exposure to the capital market.

Banks panic in the capital market was compounded by the fact that most of them were also exposed to foreign banks through international credits and guarantees. The foreign banks hit by the global meltdown suddenly recalled these loans and dropped their guarantees. This created a liquidity challenge for Nigerian banks, further compelling them to sell down their stocks to boost their liquidity.

This cocktail of crisis was further compounded by the sudden steep drop in crude oil prices from a high of about $145 pb to an average of $35 pb. In a country where the economy is 70 percent dependent on public sector spending and where 95 percent of public sector revenues is dependent on crude oil earnings which are basically channeled through the banking system, the steep drop in crude oil prices further compounded the liquidity position of Nigerian banks forcing most of them to further cut down their exposure to the capital market in a bid to boost their liquidity position and remain in business.

It must also be noted that in the midst of this crisis, over N700 billion of investors funds were tied down in private placement which could not be sold as most of the companies were unlisted. The non existence of a liquid over the counter market for these securities also compounded the liquidity position of all players in the capital market.

With so much selling pressure on the market and little or no demand from any source, it was not surprising that the Nigerian stock market plunged 67 percent in 2008 earning it one of the worst performing markets in the world. It must also be noted that several anti market initiatives by the regulatory authorities like the one percent minimum fix on downward movement of share prices helped deplete investor confidence in the capital market and accentuate the fall.

The dwindling fortunes in the capital market continued into early part of this year until May 2009 when the market rebounded strongly. Note that this rebound coincides with the restoration of a level of confidence in the global financial system which has seen a resurgence in crude oil prices in the international markets from an average $35 to $40 to about $69 before slipping to its current average of $60.

The Nigerian Stock market made a strong 38.3 percent gain in May coinciding with the same month when crude oil prices high a new high of $70 in the international markets. This shows the strong relationship between crude oil prices and the performance of the Nigerian stock market. This relationship may not be surprising considering that though oil constitutes just about 30 percent of our GDP, it drives Nigeria’s formal economy 95 percent. Manufacturing contributes less than five percent of export earnings and is largely comatose thanks to the huge infrastructural challenges faced by the nation.

The link between the global financial meltdown and the Nigerian capital market collapse is real. The transmission vehicle is obvious, crude oil. As long as Nigeria remains a mono product export economy, with crude driving productivity in the formal sector of the nation’s economy, the Nigerian capital will continue to respond negatively to any “meltdown” in global economy with a “crash”

About the Author

Finance and communication specialist with experience in banking, research and financial analysis and media. Academic qualifications include an M Sc in Banking and Finance, a Bachelor’s Degree in Finance and professional affiliation to the Chartered Institute of Stockbrokers (CIS level I) and the National Investor Relations Institute (NIRI) United States. Good computer skills- Microsoft Excel, Access and Word-. Won four different merit awards in financial journalism

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