Impact of Inflation to Treasury Bonds value. A look at the Nigeria’s skyrocketing inflation

May 13, 2024

As first published by

The K Financial

Over the past 2 months, Nigeria's annual inflation rate has reached to an estimated 30%, marking the highest level since the early 1990s for the country and one of the highest on the continent.

This sharp increase from around 9% in 2022, and a mere 4-6% just a few years prior, underscores the rapid economic stress the West African economy is going through the increasing loss of financial asset (treasury bonds) values due to high inflation.

The USD-Naira Dilemma

The Nigerian naira has experienced a dramatic steep depreciation against the U.S. dollar and other foreign currencies, losing over 100 percent of its value—from 500 naira to the dollar a year ago to the current rate of 1300 naira. (for context, a $1,000 worth of imports needed Naira 500,000 a year ago and now the same item worth $1,000 needs Naira 1,300,000, a Naira 700,000 increase for the same item).

This depreciation has significantly contributed to imported inflation, given Nigeria's reliance on imported goods. The resulting inflation has, in turn, diminished the real value of the Naira and its financial assets like the treasury bonds, treasury bills, and other financial assets.

The USD-Naira rate over the past 3 years.

In response to the soaring inflation, Nigeria's treasury bond market has seen interest rates on 10 years to 30-year benchmark bonds climb from 13 percent a year ago to the current rate of 19 percent, with expectations of further increases.

This is driven not only by inflation but also by Nigeria's efforts to raise more funds to fund its dwindling budget deficits.

The country has been issuing longer-term treasury bonds, maturing as far out as 2050 and 2060, with interest rates hovering around 18-19 percent.

But this begs the question:

Is there value in investing in such Treasury Bonds when the interest rates they offer are lower than the prevailing inflation rate?

In essence, this means your money is losing value in real terms.

For instance, consider someone who invested in a 30-year Nigerian treasury bond in 2023, which is set to mature in 2053. At the time, it offered around 14 percent, but with current inflation rates, the value of that bond is significantly undermined as the new ones being offered are coming to the market at around 18-20%.

On the flip side, those who borrowed money when interest rates were low, such as in 2021 or 2022, and secured a fixed reducing balance rate for the next 15 years, are now in a favorable position as commercial bank rates for mortgages and other loans have soared to around 25-26 percent.

The impact of inflation is not limited to assets; it affects liabilities equally.

The Nigerian example illustrates how inflation can surpass the interest rates on treasury bonds, leading to a negative real return on investment.

For investors who have been enjoying returns of close to 14 percent annually for the past eight years, the severe currency depreciation means that when converted to U.S. dollars, their real return is virtually nil and to others a typical loss of value.

This scenario should prompt us to consider the inflation risks associated with investments in Treasury bonds or even in countries that are on verge of significant inflation outlook and possibly adopt a more risk-averse approach.

Being informed about economic trends in other countries can help us anticipate potential impacts to help us make the right decisions.

Also there is a question for experienced investors, should we keep cash on hand to invest in new bonds when inflation spikes, or buy existing bonds at a discount from other investors? These are decisions that require a deep understanding of market dynamics.

Case for Uganda

While Uganda has not yet experienced the same level of economic distress as Nigeria, it is crucial to remain vigilant.

Kenya, for example, has managed to reverse the steep depreciation of its currency, which is now appreciating. Learning from these regional experiences can provide valuable insights into managing inflation's impact on the economy and making informed investment decisions.

Happy Investing Everyone.

Alex Kakande