Culled—Proshare

10/10/2016/ARM Research

In this report, ARM discusses developments on Nigeria’s macroeconomic front in September 2016.

FG explores asset sales as panacea for revenue woes: The recommendation by the National Economic Council (NEC) that the economic management team explore the option of selling some national assets as an immediate means of bridging the fiscal revenue shortfall generated a healthy discourse over September. As rationale for the recommendation, the Minister of Budget and National Planning explained that concerns over the country’s high budgetary allocations to debt service (2016: 24% of budget) informed the recommendation to explore asset sales rather than source for more loans that would expand the size of FG’s debt service.

Parallel-interbank premium widens as CBN re-exerts influence: On the heels of a 2% MoM gain in August, the naira held steady at the interbank in September (-0.2% MoM to N315.00/$). However, at the parallel market, the naira weakened for the fourth consecutive month, sliding 19% MoM to a record low of N490/$ with premium over the interbank jumping 24pps MoM to 57%. The increased divergence emerged despite CBN’s reversal of measures which drove depreciation at the parallel market, licensing of more International Money Transfer Organizations (IMTOs), and re-entry of nine banks into the FX market in August.

Looking at trends in volatility, the naira was least volatile in September relative to other months since the switch to flexible exchange rate regime in June (see Figure 1 below) even though liquidity at the interbank did not improve with average daily turnover yet to recover to pre-floating levels.

Monetary policy tightening ‘humps’ yield curve: In line with yield uptick since end of June, the naira yield curve widened 36bps MoM to 17.4% in September. As in prior months, the short end of the naira curve, which rose 104bps MoM to 19.9%, continued to drive overall yield uptick. Nonetheless, yields on longer dated bonds shrank 32bps MoM to 14.9% resulting in a more pronounced hump in the naira yield curve.

Inflationary pressure losing steam: The National Bureau of Statistics (NBS) reported that headline inflation rose 50bps from prior month to 17.6% YoY in August–20bps lower than our forecast. The expansion in annualized reading from July is the slowest in seven months. MoM, headline CPI also expanded at the slowest pace (+1% MoM) in seven months. Overall, while the headline CPI continues to print at eleven year highs, the underlying pattern is one of deceleration. Cascading to sub-components, food inflation rose 60bps from prior reading to 16.4% YoY while core inflation increased at a tamer pace (+30bps) to 17.2% YoY.

FG explores asset sales as panacea for revenue woes
The recommendation by the National Economic Council (NEC) that the economic management team explore the option of selling some national assets as an immediate means of bridging the fiscal revenue shortfall generated a healthy discourse over September.

As rationale for the recommendation, the Minister of Budget and National Planning explained that concerns over the country’s high budgetary allocations to debt service (2016: 24% of budget) informed the recommendation to explore asset sales rather than source for more loans that would expand the size of FG’s debt service.

Granted that the current debt service trajectory is untenable, the timing for the disposal of some economically viable assets such as NLNG, which have yielded a cumulative dividend return of over $15 billion for FG over the last decade, could lead to an undervaluation of the assets in question due to the urgency of the FG. Furthermore, given Nigeria’s history of low capex implementation (average of 46% in the last three years) and lack of a clear program for utilization of proceeds from the sale, the more plausible fiscal response to increased revenues is deployment to recurrent expenditure.

In our view, rather than a focus on asset sale, the policy impetus should be for the FG to increase private participation in the economy which could help expand both the tax base and overall government revenues. This approach would target sectors where government ownership is currently unprofitable such as railways and airports with a view to allowing private management run the assets profitably.

In view of the currently dire fiscal straits, the liberalization would allow private management raise capital to invest and turnaround these companies. As with the liberalization of the telecommunications sector in 2001, the move should open up new sectors of the economy with lasting impact on economic growth.

Parallel-interbank premium widens as CBN re-exerts influence
On the heels of a 2% MoM gain in August, the naira held steady at the interbank in September (-0.2% MoM to N315.00/$). However, at the parallel market, the naira weakened for the fourth consecutive month, sliding 19% MoM to a record low of N490/$ with premium over the interbank jumping 24pps MoM to 57%. The increased divergence emerged despite CBN’s reversal of measures which drove depreciation at the parallel market, licensing of more International Money Transfer Organizations (IMTOs), and re-entry of nine banks into the FX market in August.

Looking at trends in volatility, the naira was least volatile in September relative to other months since the switch to flexible exchange rate regime in June (see Figure 1 below) even though liquidity at the interbank did not improve with average daily turnover yet to recover to pre-floating levels. In addition, the relative calm at the interbank is also out of sync with fundamentals with foreign reserves sliding 3% over the month to $24.6billion. In adducing drivers for the relative inertia of the interbank USDNGN, we note that at the start of the month, the apex bank directed that banks reserve 60% of FX sales for manufacturers – a directive which harks to the allocation theme which was pervasive under the OB2WQ and is out of sync with the tenets of a flexible regime. The CBN’s grip on the interbank gathered steam over the second half of the month with media reports1 about fresh directives on how banks handle dollar sales marking, a reversal of CBN’s liberal stance adopted upon announcement of floating in June. For us, growing CBN assertiveness reflects its unease about naira trajectory and illuminates a point we had highlighted about the apex bank’s focus on stabilizing the USDNGN as opposed to harvesting long run gains of a weaker naira on non-oil export competitiveness. Given continued FPI reticence towards naira assets and depressed crude export receipts, we see fundamental pressures remaining intact over the rest of 2016. Thus, CBN directives on dollar allocation are more likely to drive wider divergence between the parallel market and the interbank.

Figure 1: Interbank/parallel market premium

Monetary policy tightening ‘humps’ yield curve
In line with yield uptick since end of June, the naira yield curve widened 36bps MoM to 17.4% in September. As in prior months, the short end of the naira curve, which rose 104bps MoM to 19.9%, continued to drive overall yield uptick. Nonetheless, yields on longer dated bonds shrank 32bps MoM to 14.9% resulting in a more pronounced hump in the naira yield curve.

At the short end of the curve, the yield uptick emanated despite net OMO and NTB repayments of N229 billion and N76 billion respectively2. Thus, we believe market participants responded to the elevated marginal clearing rates at the OMO auction (+100bpsbps MoM to 18.5%). The apex bank also maintained its tight policy stance by leaving the MPR at historic peak of 14% at the September MPC, ignoring concerns over the onset of an economic recession. At the long end of the curve, marginal clearing rates at the monthly bond auction rose 13bps MoM to 15.43%. Thus, the decline in yields is indicative of strong buying pressure with yields at one-point sliding to a more than two-month low of 14.5% during the month.

Going forward, developments on fiscal borrowing plans, with proposed Eurobond issue in November and recent AFDB announcement of $1billion budget support, point to lower FGN paper supply in Q4 16. On the Eurobond, Ghana’s recent oversubscribed issue, which provides evidence of strong appetite for African paper, could encourage the FGN to raise more than the planned $1billion on offer. Given the scale of naira depreciation since the end of June and import for dollar loans, we believe the progress on the external leg reduces the need for sizable local deficit financing. On this wise, scanning through the FGN bond and NTB calendars for Q4 16, which both show decline in planned paper issuance, the outlook speaks to lessening fiscal grip on the local debt market. Indeed, after voting for a rate hike in July 2016, the fiscal side is now singing dovish tunes on interest rates. The foregoing shifts focus to the CBN and its policy agenda, where the deceleration in MoM inflation and the bank’s own admission of a benign outlook for CPI numbers hint at less hawkish stance going forward. Whilst developments on the currency front could stoke retention of a tight stance, the confluence of waning macro milieu, moderating inflation and growing pressures from the fiscal side suggest that the current yield elevation could be approaching an end. We therefore expect increases in yield curve to gradually lose steam in the coming months.

Inflationary pressure losing steam
The National Bureau of Statistics (NBS) reported that headline inflation rose 50bps from prior month to 17.6% YoY in August–20bps lower than our forecast. The expansion in annualized reading from July is the slowest in seven months. MoM, headline CPI also expanded at the slowest pace (+1% MoM) in seven months. Overall, while the headline CPI continues to print at eleven year highs, the underlying pattern is one of deceleration. Cascading to sub-components, food inflation rose 60bps from prior reading to 16.4% YoY while core inflation increased at a tamer pace (+30bps) to 17.2% YoY.

In line with trends over the last six months, pressures in the core basket continued to emanate from the Housing, Water, Electricity, Gas and other Fuel (HWEGF) basket and reflect the higher YoY energy prices: PMS (+40.9% YoY to N147.30/litre), Kerosene (+40.3% YoY to N298.20/litre) and Diesel (+29.7% YoY to N196.53/litre). However, on a MoM basis, prices of PMS and Diesel contracted 0.3% and 4.9% MoM respectively—which, for PMS, has been the norm since the introduction of flexible pricing in May 2016. This moderation in energy pricing largely explains MoM moderation in HWEGF basket with latest reading of 1.04% being the lowest since January.

Elsewhere, food inflation remained rife in August with MoM reading printing at 1.2% for the second consecutive month, mirroring an expansion of similar magnitude in farm produce sub-basket. Akin to prior months, pressures from farm produce reflect increasing demand from neighbouring West African countries who continue to take advantage of cheaper Nigerian farm output following naira depreciation, and increased domestic import substitution. Largely reflecting the dual pressures on demand for farm produce, domestic cereal prices rose 23% MoM in August.

Going forward, FEWSNET notes that despite initial fears about flooding along the Niger-Benue trough, flooding incidents have been localized and in line with trends in prior years. Thus, with the main harvest underway, the agency now expects above average output in most areas. Thus, in view of continued moderation in core inflation and upbeat harvest outlook, we revise our headline inflation forecast for September to 18% YoY (vs. 18.4% YoY previously) with mean 2016 forecast now at 15.6% YoY (previous: 15.8% YoY; 2015: 9% YoY).