Afrinvest Weekly Update | FPI to Race to a Six Year High on Pro-market Reforms
An Extraction of the Afrinvest Weekly Economic & Market Report for June 28th, 2024
This week, we spotlight the May 2024 edition of the monthly Domestic and Foreign Portfolio Investment (DFPI) report published by the Nigerian Exchange (NGX) Limited, to gauge the level of recovery in Foreign Portfolio Investment (FPI) flows to Nigeria. Our curiosity was fueled by the observation of a strong and positive correlation between FPI inflow data (reported by the NBS in USD) and foreign investor participation statistics (reported by the NGX in Naira). This trend is not surprising given that equity is one of the three investment portfolio areas into which FPIs are deployed.
Chart 1: Positive Correlation Established between FPI and Foreign Participation on the Bourse
Source: NGX, NBS, Afrinvest Research
Historically, FPI contribution to annual total capital importation usually outweighs the other two sub-components, Foreign Direct Investment (FDI) and Other Investment (OI), save for 2016 and 2023 when OI dominated. As per asset class distribution of the historical FPI inflows, money market instruments (51.0%) and equity (37.1%) are mostly preferred to bond instruments (11.9%), evidenced by their cumulative share of 88.1% of the $70.4bn FPI in the reviewed period. This preference pattern is understandable, given that ease of asset liquidation and duration play usually tops the consideration of portfolio investors (typical “hot money” strategy), especially when investing in emerging markets with a high risk of exchange rate volatility.
According to the DFPI report by the NGX, foreign investors' participation on the domestic bourse improved 7bps m/m in May to 34.97% – the highest since November 2021 at 35.45%. At the current run rate, the size of foreign participation on the bourse should reach ₦1.1tn by year-end, translating to a 267.8% y/y increase and the highest Naira value since 2018 at ₦1.2tn. Even when the number is adjusted at the current exchange rate of ₦1,510.10/$, the current run rate should deliver about $728.4m participation size on the bourse, representing a 60.9% y/y increase in USD term over the 2023 actual that was converted at an exchange rate ₦907.10/$. This marked improvement underscores the gradual return of foreign portfolio investors to Nigeria – a development we believe is largely connected to the ongoing reforms by the CBN.
Precisely, the relaxation of capital controls (which led to payment of FX backlogs worth c.$4.8bn) and financial repression tactics adopted under the last CBN regime (negative real return has narrowed to around 6.5% on a 364-days NT-Bills compared to well over 10.0% under previous CBN management) supported the improved sentiment. In addition, Naira assets are currently very attractive to FPIs given that the NGN-USD exchange rate has bottled by about 68.9% over the last 12 months. As such, we estimate that total FPIs (equities, money, and bond markets) could swell fourfold to $5.2bn in 2024 in a base case scenario.
Although FPIs are less reliable in building sustainable FX buffers (due to their characteristic nature of "flight to safety"), the recent dynamics if sustained hold positive for stabilizing the exchange rate in the short to medium term. Recall that in the 2018 and 2019 periods when FPI inflows were at highs of $11.8bn (c. ₦3.6tn) and $16.4bn (c. ₦5.0tn), the external reserves averaged $44.6bn and $49.2bn while NGN-USD rate stabilized within an average band of ₦306.11/$ and ₦307.05/$ respectively. This stabilized FX rate condition also rubbed off positively on the general price levels as inflation rate averaged 12.1% and 11.4% in these periods compared to record high of 24.5% in 2023. Overall, we posit that sustaining the improvement in FPI could help support a near term easing in price and exchange rate pressures.
Chart 2: FPI to Swell Fourfold due to Pro-Market Reforms
Source: NBS, Afrinvest Research