Policy Pronouncements and the Recent Performance of Nigerian Equity Capital Markets

Equity Capital Markets in Nigeria have been under considerable strain in the last three (3) months with week after week of sustained price declines and losses. The All Share Index (ASI), the major stock index in Nigeria has witnessed a Year-to-date return of 13% as at Friday, 25th July. The recent deeps in the capital markets have demonstrated the potential downside in investing in equities, as many Nigerian investors have only experienced the upside potentials of the market.

The ever appreciating stock prices had pushed valuations to astronomical heights and led to a capital raising frenzy in the country and many investors and market analysts have been talking of an imminent market correction. In my view the bearish run witnessed on the Stock Exchange was not due to a market correction and return to fundamentals-based investing. I believe the market correction is yet to take place, as the bearish run was precipitated by tightening of credit brought about by policy changes.

The first policy change to hit the markets was the restriction placed on banks from extending margin facilities to Stockbroking firms and from operating margin accounts. Since a large portion of the gains in the markets over the past few months has been due to the activities of leveraged investors with easy access to credit which could be rolled over or paid off from gains from capital appreciation. Hence, a tightening of bank credit, as a matter of policy, will prevent investors from rolling over their margin facilities hence they will have to resort to selling their shares to repay the facilities. This widespread, sustained selling of equities placed an enormous downward pressure on equity prices and led to a freefall of the All Share Index.

The second major policy shift that contributed to the decline was the directive from the CBN that all Nigerian Banks harmonise their financial calendar by having a uniform financial year end pegged at 31st December. Considering the fierce competition in the Nigerian Banking sector and the urge of the various bank managers to be seen as having the largest asset base, it was clear that they will all engage in an all out battle for deposits. Nigerian banks have always engaged in the practice of obtaining huge funds from the Interbank market to beef up their balance sheets towards the end of their Financial years. The uniform year end directive from the CBN led to a near freezing of the Interbank market as banks became reluctant to lend to other banks.

The banks' reluctance to lend coupled with a clear willingness to to attract deposits to boost their balance sheets led to a spike in interest rates and a boom in Money Market activities. When rising deposit and money market rates are viewed in the light of declining stock prices it becomes clear that a good number of investors will move their funds from the stock markets into fixed deposits and money market instruments. This move into money markets resulted in more selling activity on the stock markets with attendant declines in share prices. These policy shifts coupled with already high market valuations led the All Share Index into a negative 11.7% year return.

However, the markets have rebounded in the last one week in the aftermath of the CBN's postponement of the implementation of the Uniform Year End directive to December 2008 to December 2009. This policy shift reduced the pressure on Nigerian banks to engage in aggressive deposit seeking, hence leading to lower fixed deposit and money market rates. The downward pressure on money market rates coupled with the willingness of banks to engage in Margin lending on the stock markets has made more people willing to invest once again in the stockmarket. The sharp increase in Buying activity has resulted in daily gains on the Nigerian Stock Exchange.

I think the overall lesson from this episode of "crashing" prices is the fact that the general investing public now knows that the markets can swing both ways and policymakers will become more aware of the fact that their policy pronouncements can have far reaching consequences and may have a direct, quick and measurable impact on the Financial markets as demonstrated by the CBN pronouncements and the performance of the Nigerian Stock Exchange