| Nigeria Economy |    1870 VIEWS  |
| Nigeria Economy | |
| 1870 VIEWS | |
 |
Tuesday, August 11 2020 / 12:40
PM / by NOVA Merchant Bank / Header Image Credit: Business AM Live
Social Distancing Persists at the IEW
and BDC Segments
Following the lockdown initiated by the government in
a bid to slow the spread of COVID- 19, the apex bank implemented a similar
suspension of sales at the IEW and even to Bureau de Change operators. While
the restriction has been largely relaxed, the lockdown on FX sales at the IEW
and BDC segments still persists, even with sales across other segments at
historic lows. Reflecting the absence of dollar supply amidst present risk-off
sentiments, the BDC-Interbank premium remained above 20% at the end of July
with the parallel market exchange rate rising to N465/$.
With the absence of sales at the IEW since April, we
believe the portion of offshore holdings of maturing fixed income, estimated at
$3.65 billion, is yet to be repatriated and could be rolled over to the rest of
the year. Also, the suspension of BDC sales since April by our estimate
conserved about $4.0 billion between April and July as sales are expected to
only resume when international airports are opened.
Notwithstanding the minimal sales at other segments,
the lower inflow from oil and paucity of FPI flows continues to put pressure on
the gross external reserves. By our estimate, excluding the one-off inflow of
the foreign borrowings and other official receipts, the gross external reserves
will currently hover around $31.9 billion despite the absence of sales at the
IEW and to BDCs.
In the
month of July, CBN sales to the SMEs, Invisibles and SMIS (retail and
wholesale) segments totalled $549 million compared to $445 million in June.
Non-auction sales increased to just $215 million compared to $122 million in
June, while no sale was recorded for BDCs as the apex bank is yet to resume
sales. Notwithstanding the gradual reopening of the economy amidst moderating
fixed income yields, foreign inflows totalled $117 million compared to $98
million in June, dominated largely by foreign portfolio flows. Also, local
supplies (ex-CBN) increased to $458 million (June: $360 million), following
higher dollar sales by non-bank financial institutions. DMBs sold a total of
$394 million during the month compared to purchases from clients of $554
million. With the gradually increasing sales compared to the level of inflow,
the gross external reserves depleted by $321 million (June depletion $396
million) in the month of July to adjusted level of $35.77 billion.
OTC FX
futures market activity slowed in the month of July, with total value traded
declining to $891 million compared to $1.13 billion in April. Futures contract
worth $1.37 billion matured on July 29. Compared to the rate at initiation of
N362.5/$, the NAFEX rate on the settlement date averaged N391.1/$, indicating a
loss position of N39.1 billion compared to N53.3 billion loss on the June
settlement.
In
modelling the reserve position over the rest of the year, while we have
adjusted expected oil inflows to reflect the modestly improving oil price and
expected foreign borrowings, we expect paucity of FPI inflows over the rest of
the year. On oil inflows, on our modelled benchmark oil price of $44.96 /barrel
and average production of 1.85mbpd, we estimate oil inflows to the apex bank to
average $790 million over H2 20, compared to average in H1 20 of $1.1 billion.
Also, with the fall in fixed income yields amidst fragile external position, we
see limited inflows of hot money into the economy. As such, we estimate that
the non-oil inflows will be dominated by inflows of FCY borrowings. In all, we
believe the apex bank will run on lower flows over 2020 with average monthly
inflow of $2.7 billion over H2 20, compared to H1 20 average of $3.8 billion.
With
the likely resumption of international flights in September by our estimate,
demand for services (especially Business and Personal travel allowances), even
below Q1 levels could further trigger a depletion in the reserve. Also, we
model resumption in BDC sales over same period, with average monthly sales of
$550 million compared to average over Q1 2020 of $1.2 billion. As mentioned
above, the yet to be repatriated offshore holdings of maturing fixed income
securities estimated at $3.65 billion and other maturities prior to Covid-19
are yet to be repatriated and could be rolled over for possible exit starting
September if the CBN resume sales at the IEW.
Assuming
25% repatriation of backlog and maturing offshore holdings between September
and December, even with lower imports and services demand, the gross reserve
could close the year at $33.5 billion on our best case scenario. Our base
scenario assumes that if 50% of the backlog and maturing offshore holdings are
repatriated between August and December, the gross external reserves could end
the year at $30.5 billion. With limited inflows and reduced avenues to control
outflows, recent unification of rates (with the adjustment of the official rate
to N379/$ on August 8) will have limited impact on the reserves. We believe an
outright floating of the exchange rate with intermittent intervention to avoid
unnecessary speculative attacks will have more meaningful impact. Based on our
purchasing power parity model (PPP), the fundamental value of naira lies
between N427/$ and $430/$ (~10% overvaluation from current NAFEX rate of
N386.0/$ and ~10% undervaluation from current parallel market rate of
N472.5/$).
Recent Price Adjustment Will Have
Limited Impact on Revenue
One
month after the quoting of the official rate on the FMDQ platform at N381/$,
the CBN officially reflected an adjustment of the official exchange rate to
N379/$ from N360/$ on its website on August 7. The official rate is used for
special government transactions including importation of premium motor spirit
and other subsidized imported items. While the move suggests a gradual
unification of rates, the movement is still at a discount to the NAFEX rate.
For us, this reflects the need to generate higher oil revenue by translating at
a much higher rate following the cap placed on production by OPEC+ agreement
and the still low crude oil price. We see limited impact of the adjustment on
the FGN revenue, it however supports the deregulation of the downstream oil and
gas sector. On FGN revenue, overlaying the higher exchange rate on our modelled
FGN revenue, it translates to an increase of N108 billion and N53 billion for
net oil revenue after 13% derivation and FGN share of oil revenue,
respectively. The increase in our view is a drop in the ocean with limited
impact on our modelled fiscal deficit. However, the gains from complete removal
of PMS subsidy could unlock additional revenue of ~N250 billion for the
federation account.
On the
other hand, the increase in average oil price to $40.8/barrel in June and
$43.30/barrel in July, suggests the NNPC still subsidized PMS in June and July,
which by our estimate amounts to ~N51 billion. However, given the lower
consumption in April and May due to lockdown, we believe the level of import
could have been minimal in June and July. With oil prices currently above
$44.5/barrel, coupled with the adjustment of the official rate to N379/$, we
estimate PMS average expected market price of N165.9/litre. With ex-depot price
now fixed at N138.62/litre by the Pipelines and Products Marketing Company
(PPMC), we estimate actual pump price of PMS in August of N156/litre, which is
still below our expected market price of N165.9/litre.
Consumer Prices to Succumb to Pull and
Drag Factors
The
decline in market supplies occasioned by the restriction of movement and
disruption to farming activities resulted in a spike in prices of staple foods
and farm produce in the month of June. Food inflation expanded month-on-month
by 1.46% - the highest MoM increase in about 24 months. Largely, most of the
increase in the food index emanated from higher prices of farm produce. For
context, while the headline index expanded 5bps to 1.21% MoM in June, the
headline index excluding farm produce contracted 2bps to 0.86% MoM and when
further adjusted for energy related cost, the headline index fell 4bps in June.
Surprisingly, while imported food increased by 2bps to 1.29% MoM, processed
food prices contracted during the month. The decline in the core index by 2bps
to 0.86% MoM is however surprising given modest increases in most constituents - HWEGF (+2bps to 0.74% MoM), clothing and footwear (+3bps to 0.90% MoM) and
furnishings (+3bps to 0.84% MoM) - expanding during the month.
According to FEWSNET, livestock prices have increased
by between 20% to 30% during the lockdown relative to the pre-COVID-19 period
across most markets. Also, prices of staple foods (including maize, rice,
millet, sorghum, and yams) are above the level in 2019 and the five-year
average, as prices increased 65% to 120% between January and May. Relative to
the same period in the prior year, the food index is 162bps higher than the
June 2019 level of 13.56% YoY while the core index increased by 129bps from 8.84%
YoY in June 2019. As a result, the food index surged 13bps to 15.18% YoY,
pushing the headline index to 12.56% YoY in June, despite a flat movement in
the core index at 10.13% YoY. Relative to the same period in the prior year,
the food index is 162bps higher than the June 2019 level of 13.56% YoY while
the core index increased by 129bps from 8.84% YoY in June 2019.
We see
the trend in inflation in the month of June, mirroring similar patterns in
July. While the impact of the border closure is expected to largely fade off in
August, the combined effect of the breakup in supply chains, social distancing
measures in transportation, Naira depreciation, supply shortages and expected
volatility occasioned by the market reflective PMS price will further add to
the pressure on the core index over the rest of the year. Despite the decline
in diesel and PMS prices YoY by 0.14% and 11.3% respectively, average fare paid
by commuters for bus journey within the city and intercity increased by 25.6%
YoY and 13.5% respectively in June. With the gradual upward movement in crude
oil prices, and a translation to higher diesel and PMS prices, we see
increasing pressure on transportation prices with consequent impact on food
prices especially farm produce. Adjusting our model for the above-mentioned
pressures, we arrived at a base average inflation rate of 12.5% in 2020,
compared to average of 11.41% in 2019. For the month of July, we expect the
consumer price index to expand by 1.18% MoM, with headline YoY expanding to 12.75%
YoY.
Related News - Forex
Related News - Nigerian Economy
Signup with Facebook
Signup with Twitter
