Nigeria Economic Update – FMDQ Ignites Further FX Liquidity Flame


Wednesday, Aug 9, 2017, 5:58 PM / ARM Research

FMDQ ignites further FX liquidity flame
The naira extended gains at the parallel market to a sixth consecutive month in July (+0.3% MoM to N365/$) following sustained CBN dollar injections into various FX market strata and increase in foreign portfolio inflows—with the strength of the latter also leaving naira relatively stable at the NAFEX. 

In addition, FX turnover at the I&E window accelerated a further 5% in July to suggest that improvements on the liquidity front was sustained in the period.

In more recent development, the FMDQ selected Bloomberg as a partner saddled with the responsibility to report transactions in the I&E window electronically and enhance price discovery and transparency. Consequently, Bloomberg’s USDNGN reporting became based on the I&E window as opposed to the CBN-determined SMIS interbank rate.

In our view, the increase in FX turnover at the I&E window and an overall improvement in liquidity level guided the decision. We also think the move was effected to fast-track the synchronization of FX rates1 in Nigeria.

This, in our view, should boost investor confidence in Nigeria’s currency markets in the near term and, by extension, bolster portfolio flows into naira assets as well as leave the I&E window relatively greased with dollar supply. The recent accent in FX turnover to historical highs in early August already buttresses this expectation.  

Transport inflation to bow to lower diesel prices
In June, headline inflation moderated 15bps from prior month’s reading to 16.1% YoY following temperance in core inflation (-56bps to 12.45% YoY) which more than offset extended pressures on food inflation (+64bps to 19.91% YoY).  

Whilst core inflation maintained moderations from prior readings following reported declines in diesel prices, the pace of deceleration was relatively subdued given that base effect from 2016’s energy price surge sizably waned.  

On food inflation, though the latest MoM reading indicated sizable moderation relative to prior month’s number (June: 1.99%; May: 2.54%), it remained 64bps higher than the average of 2016. For us, food pressures reflected the impact of higher grain and livestock demand in the Ramadhan season as well as sustained challenges from structural setbacks like higher transportation cost.  

To buttress on the impact of the latter, MoM transport inflation again printed at 1.2% in June—its highest level in over 11 months—as step-wise increases in transport cost extended into the fifth month in response to the cumulative 27% jump in diesel prices between November 2016 and February 2017.  

Thus, although Nigeria witnessed the fourth consecutive contraction in diesel prices in June (-2.72% MoM to N210.42), we believe the declines were yet to sufficiently compensate for the aforementioned surge in the energy price in prior months at the time.  

This explains the further increase in transport cost in June which passed-through to monthly food readings and forced its YoY counterpart to its highest level in over 8 years.  

Going forward, we project sustained downtrend in core inflation owing to the more robust cut in diesel prices (-42% MoM) effected by the NNPC in late June. Specifically, the diesel price moderation should positively impact the Housing, Water, Electricity, Gas and Other Fuel (HWEGF) division as well as stoke moderation in transport inflation in the coming reading. 

However, pass-through to core inflation should be limited by the impacts of 50% hike in electricity price across maximum electricity users in July and planned increases in school fees at both secondary and tertiary institutions in the country. Similarly, a strong correlation between transport prices and food inflation speaks to softer food price growth farther out.  

That said, ongoing lean season across Southern and Northern Nigeria should limit market supply and cap scope for sizable moderation in the food basket. Overall, impact of our expectations for the duo should sustain the currently moderating headline trajectory in the coming months with headline inflation expected to print at 15.8% YoY in July. 

CBN goes tough on banks to extend tightening drive
The naira yield curve contracted at the fastest pace since the turn of the year in July (-13bps MoM to 18.37%), largely reflecting yield downtrend at the short end of the curve (-48bps to 19.99%).  

In our view, the decline in T-Bill yields reflected increased purchase of bills by banks following sustained issuance of stabilization securities which raised the opportunity cost of sitting on excess liquidity.

To be clear, amidst continued special forex intervention by the CBN, banks had increasingly channeled available funds towards meeting forex purchases with the consequent impact resulting in less participation at OMO auctions.  

However, faced with subsequent increase in market liquidity, the apex bank responded to banks’ behavior with a total forced debit of N471 billion via stabilization securities in June—with 61% of the issuance occurring on the 29th of June and at below market rate of 16%.  

Thus, we believe that banks opted for higher yielding treasuries (Average T-bill yield for July: 19.49%) out of fear of further forced debits in July. At the long end of the curve, mean marginal clearing rate rose in July (+5bps to 16.25% on average), reflecting lower subscription (bid-ask ratio contracted 25% MoM to 1.56x) and higher government borrowings (+7% MoM to N106 billion). 

Going forward, we expect elevated inflation readings and CBN’s quest for currency stability to sustain the current hawkish monetary policy orientation with knock-on effect keeping rates at currently elevated heights.   

Nigerian equities: bullish steroids remain potent
Nigerian equities market extended its bullish run over July (+8% MoM), driven by gains in Banking (+10% MoM), Cement (+9% MoM), and Food (+11% MoM) sectors. Broadly, equity market rally continues to reflect ongoing liquidity renaissance at the currency markets that have trailed CBN’s introduction of the I&E window as well as recovery in crude oil price and production which provided further indication of a potential exit out of recession.  

Thus, the relative improvement in liquidity levels also bolstered expectations for ubiquitous earnings rebound from the troughs of 2016 to provide further incentives to investors.  

To buttress on the impact of the prior driver, we note that net foreign portfolio flows into the nation’s equity bourse touched its highest level in the two months succeeding the introduction of the I&E window with the May reading remarkably surpassing September 2014’s high at N51.1 billion.  

Whilst data on FPI for July is unavailable as at now, evidence from continued improvements in average FX turnover at the NAFEX (+5% MoM to $379 million in July), wherein the CBN accounts for only 10% of activities, suggest continued foreign presence in Nigeria’s capital market. Interestingly, the raft of positives appears to have rubbed off on domestic investors, whose total transactions have consistently risen since April. 

Without doubt, the consequent feed-through of improved liquidity on currency-elastic sectors was also telling over July with companies in consumer goods sector notably benefiting from improved FX availability and/or cheaper dollars.  

Elsewhere in the banking sector, which has experienced the strongest rally YTD (+70.28%), cheaper valuations were attractions to investors. Beyond the aforementioned influences, price-led earnings rebound was also central to the rally in some equity names with Dangote Sugar, Lafarge, and DANGCEM cases in point. 

Overall, despite the recent bull run (+41% YTD), Nigerian equity market remains cheaper on relative valuation basis, with the bourses P/E currently at 11.5x (vs. 15.2x for JSE).  

In addition, with the outlook on FX market liquidity recently lifted by ongoing collaboration with Bloomberg to go electronic on most of the trading at the I&E window alongside sustained recovery on the fundamental front (Reserve: +0.4% MTD to $31 billion), we see scope for sizable foreign and local demand for Nigerian equities in the coming months.  

July PMI: Tentative signs of an economic recovery
Purchasing Managers Index (PMI) sustained its expansionary trend in July, with manufacturing and non-manufacturing readings printing at 54.1 and 54.4 points respectively. According to breakdowns, the expansion in PMI was buoyed by pick-up in activities across major sub-indices – production level, new orders, supply delivery time, employment level and raw material inventory.  

To our minds, the increase in new orders, raw materials inventory and production level reflected pass-through from improved dollar liquidity in the polity. Elsewhere, non-manufacturing PMI, which expanded for the third consecutive month in July, was supported by increased business activities in 16 of its 18 sub-sectors with ICT and Transport sectors experiencing the fastest expansion. 

Although the PMI is not always a seamless guide, sustained improvements in its reading provide some support to expectations of imminent economic recovery. Given the optimistic outlook for business at the start of the H2 17, which was largely hinged on improved dollar liquidity and higher prices, we see scope for further improvements in manufacturing and services GDP growths in Q3 17.  

Juxtaposing the mentioned with expectations of higher oil production and sustained CBN support to the agricultural sector, we now forecast GDP growth of 0.4% YoY in the third quarter of 2017.  

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