Implications of rising inflation on investment & MPC decision – Dexter


Thursday, September 01, 2016 7:00am / Dexter Analytics

The consumer Price Index (CPI) Report released by the National Bureau of Statistics (NBS) for July 2016 showed that inflation creeped to 17.1% (vs 16.5% in June 2016), the highest in almost eleven (11) years according to data from the Central Bank of Nigeria (CBN). After a nine month consecutive rise, inflation is finally showing signs of slowdown as the month-on-month pace of increase slowed for the second consecutive month to 0.6% points in July (vs 0.9% in June). This was due to slower pace of increase in most divisions contributing to the headline CPI.

Energy prices continue to drive Core Index; up 16.9%
The Core sub-index which excludes items subject to temporary price volatility increased by 0.7% points to 16.9% (year-on-year) in July (vs 16.2% in June). According to the NBS, highest increases were seen in the Electricity, Liquid Fuel (kerosene), Solid Fuels, and “Fuels and Lubricants for Personal Transport Equipment” groups.

We believe recent increase in energy prices in the form of diesel and kerosene, which have both recorded an unexpected increase of 39% and 34% respectively since June (according to NBS Diesel and Kerosene Price Watch) will continue to drive increases in the index.

Food Sub-Index rises to 15.8%
The food index rose by 0.5% points to 15.8% (year-on-year) in July (vs 15.3% in June) due to stronger increase in the Bread and Cereals, and Meats and Fish groups. Nonetheless, on a month-on-month basis the pace of increase in the index remained slower for the second month running at 1.2% points (vs 1.4% in June) due to slower increase in groups such as the Milk, Cheese and Eggs; Oils and Fats; and Fruits.  Imported inflation which continued its uptrend in July due to a weakened exchange rate, picked up by 0.4% points to 20.5% (vs 20.1% in June).

As the harvest season approaches, we expect slower increases in the Food Sub Index and inflation to peak in September. We believe the foreign exchange pass through as indicated by the slump in the Naira in both the official and parallel market will continue to be a push factor.

On Investments: Our views remain unchanged from the inflation reports released previously. We believe attractive yields on fixed income securities, which currently trades above 17%, continues to be attractive and will deter investments in equities, especially by low risk investors.

Nigerian equities continues to endure a volatile run, based on a mix of worsening economic backdrop such as the unfriendly foreign exchange regime that has made the segment undesirable by foreign investors and weak earnings performance of underlying stocks. Indeed as the Q2 2016 GDP which was reported by the NBS at -2.06% confirm the economy to be in a recession, we believe sentiments continue to favour the bears.

Though we expect mild reaction in equities as the market had largely priced in a possible recession in Q2. We reiterate that only the return of foreign investors in equities, would provide a reprieve. A major concern however is that FPIs to equities continue to flow in trickles, as against the amount needed to spur a speedy recovery.

On Monetary Policy Direction:  As the Monetary Policy Committee (MPC) of the CBN sits between 19th-20th September, 2016 we believe the uptick in inflation will continue to be a cause of concern, more so the deep plunge in Q2 GDP to -2.06%. Again, the choice between tweaking interest rates to speed-up a recovery in growth or to tame inflation presents itself. We expect the CBN to maintain rates at the current level of 14% to show consistency and to reap the objectives motivating the hike at the last meeting of the MPC. The fact that currency controls and the severe shortage of foreign currency led the economy down this road is undoubted. While we note that the economic recession throws a few spanner in the works and calls for a firm monetary policy response, we believe the current stance, which gives the economy a better chance at Foreign Portfolio Investment (PFIs) inflows gives a better shot at a short term recovery.

Outlook on Inflation
Though gradual, inflation is finally slowing down. As the harvest season beckons, we are likely to see a slower pace of increase in the headline index in the coming months. We however note that energy prices and a fast depreciating exchange rate in the official and parallel market remain downsides. For a particular case in point, some prices, such as that of petrol which is partly anchored on exchange rate of N282/$ remain points of pressure. It is not unlikely for us to see an upward adjustment which would stoke increases in the energy and transportation divisions.  

Q2 Capital Importation Data in Brief
Speaking of capital inflows, the NBS estimated the total value imported into Nigeria in the second quarter at $647.1million. This represents an alarming fall of 75.73% year-on year - the largest on record, and a fall of 8.98% when compared to the first quarter of 2016. The NBS further notes that this is the lowest level of capital imported into Nigeria.

We note that FPIs, which formed about 82% of total capital imported into Nigeria a year ago, were quick to retreat in the wake of CBN’s stringent controls – posting a paltry $268.77m in Q2 2016 (88.76% decline year-on-year).

Indeed, FDIs also took a worse turn in the wake of shortage of foreign currency for companies to repatriate earnings and to import needed productive equipment and materials in the second quarter of 2016. It declined by 37% year-on-year to $245.32m in Q2 2016.

As it stands, ‘other investments’ group now holds the largest share of capital imported into Nigeria at 41.53%, dwarfing the share of FPIs and FDIs which stands at 37.91% and 20.56% respectively.

As the CBN takes measures to attract FPIs, we believe it will take time to reap the desired results. Foreign investors took a flight due to a series of unfriendly monetary policies that lasted more than a year, it is only wise that CBN shows good faith by showing consistency and implementing investor friendly policies.

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