1.1 BACKGROUND OF STUDY
The current administration’s commitment to rebuilding Nigeria’s dilapidated infrastructure as a catalyst for economic development has brought to the fore the need for a functional bond market given the developmental needs of the economy. The recent period of economy growth witnessed in Nigeria can only be sustained with continuous investment in infrastructure and the expansion of industrial output. The dearth of adequate financing has been identified as one key factor inhabiting this much needed investment in critical infrastructure such as down and mid stream petroleum distribution, telecommunication and transportation. Additionally, substantial long term financing would be required to rejuvenate Nigeria ailing power sector, it comatose refineries and the provision of socio-economic development in education and healthcare. Moreover, recent effort by the FGN to diversify the economic and make it more market driven means that funds would also be needed to expand existing facilities to meet the increased demand expected of a more efficient economy over the long term.
The Bond Market remains a fundamental financial market as risk pricing and investment valuation models rely on its data. While a functional domestic bond market is necessary for capital investment, monetary authorities also use bonds to define the yield curve and to ensure stability of short-term rates. An active sovereign prevents the economy from overheating as it allows large temporary overflows from the money market. The Bond Market therefore plays such a vital role in ensuring the health of the economy that the monetary authorities must be concerned with its structure and operation.
Internationally best-practice stipulates the existence of a public debt managing agency. Until 2000, no such agency existed in Nigeria. Whilst the Federal Debt Management Office (DMO) may have eventually been instituted, debt relief provided a critical spur, and ensured it was provided with sufficient resources to achieve the country’s goal of debt relief. This meant that a strong, capable debt management agency was created more quickly, and with greater public support, than it otherwise would have been.
Nigerian Bond market is principally regulated by the ISA and the Rules and Regulations of the Nigerian Security and Exchange Commission (SEC). Although the Nigerian Sovereign Bonds have been in existence since the 1970s, but was said to be inactive. Government issued paper was very short-term and limited in scale. Treasury bills had maturities of 91 days and below and this created inconsistencies and irregularities in the federal government’s borrowing costs. The DMO, in a bid to restructure the Federal Government of Nigeria’s deficit funding from shorter to longer tenured borrowing instruments, improve and lengthen the yield curve in the domestic money markets, and to encourage long-term savings, introduced the sale of Federal Government of Nigeria bonds in October 2003, with the launching of four Federal Government bonds of maturities ranging from three years to ten years. The bonds were sold to investors through all licensed banks and discount houses in the country. However, most of the investors adopted a “hold to maturity” approach and therefore little or no secondary trades were carried out.
The DMO extensively restructured Nigeria’s domestic debt portfolio. In 2005, it commenced a textbook bond market development programme. This began with the initial issuance of 2 and 3 year bonds for which there was appetite, and gradually and predictably increased to issues of 5, 7, 10 and now 20 year bonds. However, the regular monthly issuance of the federal government bonds of increasing tenor generates a sovereign yield curve which serves as a benchmark for pricing other securities, including corporate bonds. This is a very powerful strategy to support growth by generating long term funding sources for government financed development projects such as infrastructure, but more importantly, will help to realize the potential of Nigeria’s vibrant private sector to create wealth and jobs by opening this source of domestic funding.
In December 2004, the Nigerian domestic debt stock had an outstanding amount of N1, 370.32 billion, compared to the N1,329.72 billion as at December 2003. This figure had an increase of N40.63 billion or 3.1 percent over the previous year’s figure. This however, was the lowest annual growth in the domestic debt stock for eight years(DMO 2009).
This increase of N40.63 billion in the domestic debt stock was made up of new issues of Treasury Bills valued at N46.52 billion, which was partly offset by repayments of Treasury Bonds and FGN Development Stocks valued at N5.67 billion and N0.22 billion respectively.
As at the previous year (2003), the Treasury Bills remained the dominant instrument, accounting for N871.57 billion or 64 percent of the total domestic debt stock. The balance of the total domestic debt stock was made up of Treasury bond (N424.94 billion or 31 percent), Federal Republic of Nigeria Government Development Stock (N1.25 billion or 0.1 percent) and the first FGN Bonds (N72.56 billion or 5.3 percent).
In the year 2004, the DMO made plans to build on the success of the first FGN Bonds floatation that were first issued in 2003. The DMO embarked on the arrangements to commence the issuance of bonds on a regular basis in small tranches that market could accommodate.
The DMO commenced the smoothening and restructuring of the Treasury Bills in 2004. The restructuring entailed extending the maturities of the existing Treasury Bills by issuing tenors of 6, 12, 24, and 36 months, to refinance part of the existing 91-day Treasury Bills.
The 2005 bonds issuance programme which had a floatation of N140 billion over the period July to December 2005, had the objectives of restructuring the existing stick of Nigerian Treasury Bills into longer-tenured bonds, and to help sustain the momentum of reviving, deepening and developing the Nigerian capital market (DMO, 2005).
The debt deal in 2005 not only removed a significant financial burden from the government, allowing it to spend its resources on public service delivery and social sectors, but it enabled the DMO to refocus its energy on the core business of public debt management – “establishing and executing a strategy to manage the government’s debt in order to raise the required amount of funding, pursue its cost and risk objectives, and to meet any other public debt management goals the government may have set, such as developing and maintaining an efficient and liquid market for government securities” (IMF and World Bank, 2002).
The next landmark in the development of the bond market occurred in August 2006, when a primary dealership/market maker network was established. The Primary Dealers/Market Markers (PDMMs) are the only institutions authorized to deal directly with the DMO in bond auctions. The establishment of this system was to facilitate the emergence of a liquid and vibrant secondary market for government securities, in line with global best practices (DMO 2006).
Prior to the establishment of the of the system, DMO requested for expressions of interest (EOI) to the PDMMs in the FGN Bonds from financial institutions, of which a total of thirty-two (32) EOIs were received (DMO 2006).
The purpose of the PDMM system is in two-fold:
- To ensure the total take up at primary auctions of government bonds.
- To provide liquidity in the secondary bond market.
Apart from underwriting every bond issue, the PDMMs, are also required to make two-way price quotes on the bonds to their customers and other PDMMs in all market conditions upon demand. This means there has been viable and vibrant secondary market trading in FGN bonds issued by the DMO since August 2006.
The strategy for the development of Nigeria’s bond market from 2008-2012 is organized on a medium term basis with an annual securities issuance work plan. In developing this work plan, the Federal Government conducts wide consultations with market participants through regular monthly meetings held with Primary Dealer Market Makers (PDMMs), usually before each FGN Bond auctions. (DMO, 2008).
Bond issuance in 2008-2012 will continue to aim at developing the bond market and creating a benchmark for the issuance of other instruments. This will be achieved through the issuance of long-tenured instruments. It also aim at providing low cost funding for the FGN, subject to the control of risks within acceptable limits, and developing the market for long-term debt instruments, thereby creating a benchmark yield curve for other financial instrument in Nigeria.
The Work Plan for the bond issuance programme in 2008-2012 will include advertisement of Offer Circulars, conduct of auctions, post allotment activities and development of indicators for domestic debt sustainability.
The 2008-2012 Bond Issuance will include the following features:
- Following the continued sophistication of the appetite of the market, a variety of instruments such as floating rate and index-linked securities may be introduced;
- With growing sophistication and capacity in the market and also in order to optimally allocate government resources, the multiple pricing auction system may be introduced;
- The FGN Bonds auctions, which are presently conducted monthly, may be made more frequent as demand for the bonds continues to soar, particularly with limitations on re-openings; and
- The submission of bids will be done on the day and within a specified timeline or duration while settlement takes place on T+2.
- The restructuring of short-term debt instruments to long-term will continue until the ratio of 25:75 short-term to long-term debt ratio is achieved. (DMO, 2008).
The curve of tenors on debt instruments has increased sharply and impressively in the six years since the launch of the Access Bank government bond index. Today, the government has issued bonds with a 20 year tenor. This reflects the growing confidence in the market’s capacity to absorb Government bonds and in the sophistication of the instrument to serve as a key conduit for state funding. While investors’ search for a stable asset class has proved a strong catalyst for the market’s expansion, investors are attracted to government bonds for some technical reasons, such as their tax exemption status.
The corporate bond market is also developing, and this may be attributable to the need for inexpensive long-term debt capital by companies coupled with investors’ apathy to equity investments, following the impact of the global economic recession on the values of stocks. Companies including Guaranty Trust Bank Plc, UACN property Development Company Plc, United Bank for Africa Plc and Flour Mills of Nigeria Plc have successfully issued bonds in the Nigeria capital market while a number of other corporate bond application are before the Nigerian SEC.
The ISA does not specifically provide for the regulation of corporate bonds, thus the broad provisions of the ISA regarding securities offering by a public company apply to corporate bonds. In addition to the general rules on security offering, the SEC Rules also stipulates certain requirements that apply specifically to corporate bonds. The SEC Rules on corporate bonds was one of the initiatives introduced to encourage the development of the Nigerian corporate bond market.
To further encourage the development of the Corporate and State Government bonds as well as bond issuance by supranational institutions such as the International Development Bank, in March 2010 the Government approved a waiver of taxes for these categories of bonds. The taxes covered by the approval are the Personal Income Tax, Value Added Tax, the companies ‘ Income Tax and the Capital Gains Tax. However, the requisite administrative and legislative process to give legal effect to these waivers are yet to be concluded. It is expected that the waivers will be in place for a period of 10 years from the date of grant by the Government. Furthermore, the Nigerian banks are now allowed to treat state government bonds as liquid assets provided such bonds meet the requirement stipulated in the CBN circular. (DMO Circular for USD500m Sovereign Bond Issuance, 2011).
In the thick cloud of financial uncertainty and apprehension, the guarantee offered by the bond market has become an attraction. At least in the bond market, investors have their capital and pre-agreed interest guaranteed against the vicissitudes of the financial market.
Bonds are an investment made (purchased) by lending money to whoever issue the bond in exchange for future income in the form of interest payments. At the end of the life of the bond, the investor gets the original investment back, plus the interest on it. The interest payments and principal (amount of your investment) are guaranteed by the company or government that issue the bonds.
State governments and even banks are now patronizing the market, competing with the federal government, which has been the dominant player in the market since its origin. Among this states are Niger, Imo and Kwara State Governments which made their successful first entry in 2009 with an offer of N6 billion, N18.5 billion and N17 billion respectively (DMO, 2009).
1.2 OBJECTIVE OF THE STUDY
This study strives to evaluate the development of the Government Bond Market in Nigeria. In order to achieve this general objective, the study however strives to achieve the following specific objectives:
- The evolution of the Government Bond Market in Nigeria
- To evaluate the key success factors that make the Nigeria Government Market successful.
1.3 SCOPE OF THE STUDY
The study analyses the performance of the Nigerian Bond Market as regards to FGN Primary Bond Issuance, FGN Secondary Market Trades, domestic debt growth trends and the transformation of the domestic debt stock by instrument.
1.4 LIMITATIONS OF THE STUDY
Access to data from secondary sources was difficult. As a result, the study to a large extent relied on statistics compiled from the Nigerian Debt Management Office, Central Bank of Nigeria Statistical Data, members of the African Stock Exchange Association (ASEA), Nigerian Stock Exchange facts books, IMF etc. As this is a working paper series, quantitative data hereby reviewed on annual basis.
1.5 SIGNIFICANCE OF THE STUDY
In most African Countries, the domestic bond market is generally under-developed in both breathe and depth compared to the banking system and the equity market. Because of the experience of the Asian crisis, many studies have made a case for developing the domestic bond market as an alternative source of debt financing in cash strapped Africa where general shortcomings are observed in terms of the variety of debt financing.
The rationale for developing a domestic bond market is that, firstly, it is an alternative source for debt financing. This decreases the over-reliance on bank lending for debt financing and minimizes exposure of the economy to the risk of a failure in the banking system. Secondary, these markets reduce financing costs through disintermediation. Thirdly, an active and efficient bond market would broaden capital markets by offering investors opportunities to invest in a wider range of assets. A forth consideration is that the exercise of a well-functioning bond market can lead to the efficient pricing of credit risk, since expectations of all bond market participants are incorporated into bond prices. Lastly, a developed bond market supports the economy in meeting its financing needs during periods of rapid economic growth (IOSCO 2002:3).
The Domestic Bond market is of benefit to the Nigeria Economy in the sense that it enthrones in more rational management of government’s fiscal and monetary operations. By funding its debt in the capital market and by issuing longer tenured securities. Government will further its economic reform program and help develop the nation capital market.
Also, the investors will benefit from the domestic bond market through following:
- The investment is “default risk-free”.
- Tax-free interest income.
- Relatively high returns.
- It can be used as a collateral security.
- It is fully transferable/marketable on the floor of the Nigerian Stock Exchange (NSE).
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