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Tuesday, January 05, 2020 / 09:57 AM / By Coronation
Research / Header Image Credit: BBC
The Central
Bank of Nigeria (CBN) follows a managed exchange rate policy, but is it moving
towards a crawling peg? Last year saw several changes in the CBN's official
rate, and smaller (though significant) changes in Naira exchange rates quoted
by FMDQ, Nigeria's over-the-counter (OTC) exchange. Moves recorded in the last
trading sessions of 2020 brought the Importers & Exporters Window (I&E
Window) to N410.25/US$1. This goes some way to narrowing the gap - now less
than 15.0% - between the OTC currency market and the cash parallel exchange
rate, and goes some way to addressing the World Bank's criticisms of multiple
exchange rates. This suggests that there may be more step-changes in Naira/US
dollar in 2021.
FX
Last week the
exchange rate in the NAFEX rate weakened by 1.96% to N400.33/US$1 on Thursday,
31 December. In the parallel, or street market, the Naira depreciated by 1.08%
to close at N470.00/US$1. The CBN also resumed forex cash sales to Bureaux de
Change (BDC) operators to boost liquidity and ease demand pressure over the
holidays.
Bonds &
T-bills
Last week, the
secondary market yield for an FGN Naira bond with 10 years to maturity rose by
68 basis points (bps) to 7.26% and at 7 years rose by 92bps to 6.50% while at 3
years the yield declined by 6bps to 3.54%. The annualized yield on a 301-day
T-bill rose by 2bps to 0.65%, while the yield on a 299-day OMO bill remained
0.92%. We do not expect a significant change in current market sentiment over
the coming weeks.
Oil
The price of
Brent crude rose by 0.99% last week to US$51.80/bbl on Thursday 31 December.
The average price in 2020 was US$43.22 /bbl, 32.67% lower than the average of
US$64.20 /bbl in 2019. The increase is fueled by vaccine optimism, a weak US
dollar and a rebound in manufacturing activity in Asia. Members of the
Organization of the Petroleum Exporting Countries and Russia (OPEC+) were
reported to have complied with previously-scheduled cuts . The group is
scheduled to meet on today, 4 January to discuss output in February and beyond.
We expect the group to consider increasing production levels at the upcoming
meeting by 500,000 bpd.
Equities
The Nigerian Stock Exchange All-Share Index (NSE-ASI) rose by 3.79% last week with a gain of 50.03% in 2020 to close at 40,270.72, surpassing the 40,000 mark. Sustained buying enthusiasm in names like BUA Cement, MTN, and UBA can be said to have brought about the bullish close. BUA Cement (+28.92%), FCMB Group (+10.26%), and Sterling Bank (+6.25%) closed positive last week while Flour Mills of Nigeria (-6.98%), Guinness Nigeria (-2.56%) and Honeywell Flour Mills (-2.44%) closed negative. Over the weekend, an additional 4.36bn ordinary shares of AIICO Insurance plc were listed on the Nigerian Stock Exchange by way of a rights issue which was fully subscribed. For our view on the market.
Naira
Crawling Peg?
Currency
traders who were hoping for a quiet end to 2020 did not get their Christmas
wish. During 30 and 31 December the Naira/US dollar rate moved by 4.26%, to
close at N410.25/US$1 in the Importers and Exporters Window (I&E Window).
At the same time, the Naira weakened by 2.02% to close at N400.33/US$1 in the
NAFEX market. Bloomberg reported that the Central Bank of Nigeria (CBN) was
allowing the markets to do this.
Should we be
surprised, or are these moves part of a deliberate strategy? We have argued for
a long time that, over multiyear periods, the Naira/US dollar rate reflects
differences between their inflation rates. This logic can also be applied to a
single year. So, for example, given that Nigerian inflation is at 14.9% y/y
(November 2020) and US inflation is 1.2% y/y (November 2020) then the Naira
might reasonably depreciate by 13.5% over the same period. In fact, the Naira
has devalued by roughly this much over the past year, depending on which rate
you use. Taking the FMDQ OTC NAFEX rate, the Naira moved by 9.92% to
N400.33/US$1 over the past year. Taking the FMDQ OTC I&E Window rate it
moved by 12.53% to N410.25/US$1.
This calls to
mind what CBN Governor Godwin Emefiele stated in a televised address after the
Monetary Policy Council (MPC) meeting last November, when he expressed
frustration with people quoting parallel market rates. He said:
"But we are saying that, even if the currency is overvalued, shouldn't you go through a step-wise process where the shock can be less-felt, rather than those (who are supposed to know how this works) beginning to cause panic by saying that the exchange rate of Nigeria is 480?"
Here the
Governor hints at a crawling peg to make step changes in the exchange rate. A
crawling peg can be based on inflation differentials, or on other exchange rate
targets. The CBN itself made significant changes in its official rate last
year, with steps that moved the exchange rate by 24.0% (see chart).
We do not
expect see a crawling peg regime announced, but we do expect the CBN to
continue with such step-changes in Naira/US$ exchange rates during 2021. This
way the CBN would be able to gradually narrow the gap between, say, the FMDQ
OTC I&E Window at N410.25/US$1 and the cash parallel exchange rate, reported
at N470.00/US$). Doing this might go some way to addressing the World Bank's
stance that Nigeria needs to merge its currency rates. And it might improve
liquidity in the NAFEX and I&E Windows, with time.
Model Equity
Portfolio
Last week the
Model Equity Portfolio rose by 3.81% compared with a rise in the Nigerian Stock
Exchange All-Share Index (NSE-ASI) of 3.79%, therefore outperforming it by 2
basis points. Over the year 2020 it gained 57.06% against a gain of 50.03% in
the NSE-ASI, outperforming it by 703bps.
Our current
concern is that that market is getting carried away. The four largest index
weights are up substantially over the past two months: MTN Nigeria by 17.99%;
Airtel Africa by 107.65%; Dangote Cement by 53.06% (this was the subject of a
buy-back); BUA Cement by 70.00%. We doubt this rate of increase can be
sustained at the same time as market interest rates are rising.
So, and as
mentioned last week, we are beginning to trim our notional positions in these
stocks. This simply means, for the time being, raising the level of notional
cash, which has risen from 1.1% to 5.2% over the past week. But it also means
that we are putting relatively more emphasis on our notional positions in bank
stocks, which have risen by far less over the past two months.
In practical
terms we have not got much of our trimming done. There were only three trading
sessions last week and turnover in some stocks, notably Airtel Africa, was
thin. We will continue this week.
At the same
time, we remind ourselves of our maxim that we do not attempt to guess the
direction of the market. We set out to take notional positions in the stocks
that we like when their valuations are low relative to their own valuation
history; when return on equity (RoE) looks reasonable (20.5% or more in Naira);
when there are growth prospects. We will look to these metrics as we re-shape
the model portfolio.
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