Decline in Foreign Inflows to Persist - Comercio Partners


Friday, July 10, 2020 04:25 PM / By Comercio Partners Asset Mgt / Header Image Credit: Belt and Road News

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Report Summary


The Macroeconomy

  • A second wave may be on the horizon.
  • U.S.-Sino trade relations back in the headlines.
  • Inflation continues its relentless climb.


The Financial Markets

  • Bullish momentum sustained in the Fixed Income Market.
  • Activity in the l&E Window remained muted.
  • Anti-climactic end to an impressive quarter in the Equities Market.


Our Expectation for the Coming Months

  • Oil production expected to decline as Nigeria adheres to OPEC+ quota.
  • Decline in foreign inflows to persist.
  • Equities market to be under immense pressure.
  • No significant improvement for the PMI Index in sight.


Equities, Oil, And U.S.-China Relations Make A Comeback


The fallout of the coronavirus pandemic was felt all through the second quarter of 2020. There was hope that while the impact of the virus would be felt strongly in the second quarter, reported cases and deaths would begin to subside and the world would slowly reopen. The world did start to reopen as some cities lifted some lockdown restriction, and certain places (New Zealand in particular) declared victory over the virus. However, towards the end of the quarter, due to some social unrest and other factors, a second wave of the virus appeared to be taking hold.


In the U.S., unemployment spiked to a high of 14.7% in April before settling at 13.3% in May - payrolls are nearly 20 million below their pre-COVID-19 level. At the FOMC meeting of the Federal Reserve Bank, the Fed voted to keep benchmark short-term rates near zero. In addition, the Fed is continuing its bond buying program to the tune of $80 billion a month in Treasuries and $40 billion in Mortgage Backed Securities. Along with the rate decision, U.S. central bankers projected that the economy will shrink by 6.5% in 2020 with 2021 expected to show a gain of 54 and 3.5% in 2022. The National Bureau of Economic Research - the body responsible for officially dating economic expansions and contractions - declared that a recession started in February bringing an end to the decade-long economic expansion.


In the U.K., the Bank of England voted to pump an additional $125billion into the U.K. economy, though it will slow the pace at which it would inject the money. The BoE's move to slow down the rate of Quantitative Easing means that it will no longer be able to soak up all the additional debt created by the U.K. government. The private sector will be required to finance the fiscal deficit. The bank's Monetary Policy Committee also voted to keep interest rates at the historic low of 0.1%.


The U.S.-China trade relations came back in the headlines this quarter as the relationship appears to be souring even as the "phase 1" deal barely hangs in the balance. U.S. President Donald Trump said he opposed renegotiating the U.S.-China "Phase 1" trade deal after a Chinese state-run newspaper reported some government advisers in Beijing were urging fresh talks and possibly invalidating the agreement. Under the Phase 1 deal signed in January, Beijing pledged to buy at least $200 billion in additional U.S. goods and services over two years while Washington agreed to roll back tariffs in stages on Chinese goods.


On the home front, the virus has dealt a severe blow to the economy. The IMF recently revised downward the GDP projection for Nigeria, from negative 3.4% to negative 5.4% for 2020. However, the IMF predicted a rebound to positive territory in 2021 with the expectation that the economy will grow by 2.6%. Overall, Sub-Saharan Africa is expected to see a decrease in output by 3.2% in 2020 but see a rebound in 2021 to 3.4%. In addition to the decline in output, the IMF also indicated that fiscal responses to the pandemic by emerging market economies have resulted in a sharp increase in government debt. Consequently, Fitch ratings agency has downgraded Nigeria's Long-Term Foreign Currency Issuer Default Rating (IDR) to a "B" rating with a negative outlook from "B+".


MSCI Inc, a leading provider of research-based indices and analytics, included Nigeria in the list of Frontier Markets with accessibility issues. The "accessibility issues" in question centers around the deterioration in the Nigerian FX market.

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The Macro Economy


GDP Growth & Oil Production 


As at print time, OPEC has no information regarding  Nigeria's output from direct sources in the month of May (data from secondary sources showed that Nigeria's output reduced by 185,000 bpd to 1.592 mbpd). However, the coalition of OPEC members and non-OPEC members known as OPEC+ agreed to extend its 9.7 mbpd supply cuts by an additional month, bringing the total length of the cuts to 4 months. It was revealed during the meeting coalition that Saudi Arabia would no longer take on the additional 1 mbpd cut it had initially voluntarily taken on to stabilize the market and would stick to its scheduled production quota instead. It was also revealed that Nigeria and Iraq were to accelerate their production cuts to comply with the goal of taking out 9.7 mbpd from the oil market. Nigeria's scheduled production output is circa 1.4 mbpd.


Following the dramatic 56% drop in the last month of the last quarter, oil prices struggled to find its feet as OPEC tried to bring stability to the market. For most of the quarter, the price of Brent Futures failed to break above $40/barrel until the tail end of the quarter. Over the course of the reporting period, Brent Futures gained 66%.


Additionally, in a move that appears to be a bid to address the revenue situation that plagues the country as a result of the pandemic, the country has launched its first licensing round for marginal oilfields in nearly 20 years. Marginal fields are smaller oil blocks that are typically developed by indigenous companies.

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Headline inflation maintained its upward trend in May for the ninth consecutive month as food prices continued to climb. The headline number was up by 6 bps to 12.40% YoY, from 12.34% in April. The uptick was largely due to the increase in core inflation which increased by 14 bps to 10.12% (from 9.98% in April 2020), while food inflation grew by 1 bp to 15.04% in May 2020 from 15.03% in April 2020. On a month-on-month basis, the Headline index was up by 1.17%, 15 bps higher than April's rate of 1.02%.


The marginal increases in inflationary pressure was due to the double whammy of the continued border closure and the lean food season, the general increase in prices due to the depreciation of the Naira, and limited movement of goods due to the ban on interstate movements, and the increase in the prices of pharmaceutical products and other health and lifestyle products as people become more health conscious on the back of an increase in the number of COVID-19 cases and fears of a potential second wave globally.


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Capital Importation and Foreign Exchange Reserves

Total foreign capital inflow into the Nigerian economy through the I&E FX Window sustained its downward trajectory in the month of June 2020 as foreign investors remained on the sidelines due to the  covid-19 pandemic. Foreign inflows from other sources apart from Foreign Portfolio Investments (FPIs) declined by 4.6% in May from $63.3 million to $60.4 million. Similarly, FPls which is the common gauge of foreign investors' sentiment, declined by 71.1% by the end of the month to $38 million.


Despite the significant drop in foreign inflows into the country, CBN intervention as measured by the quantum of its inflows remains largely subdued for the third consecutive month. Total foreign capital inflow through the window therefore declined by 22% from $492 million to $383 million.


The 30-day moving average of Nigeria's foreign exchange reserves declined in June 2020 after a recovery in the previous month on the back of the IMF's $3.4 billion inflow coupled with the improvement in oil prices. The external reserves declined by 1.1% to $36.2 billion from $36.6 billion. 

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Purchasing Managers' Indices

The Manufacturing PMI in the month of June stood at 41.1 index points, indicating a contraction in the manufacturing sector for the second consecutive month after previously recording an expansion for 36 consecutive months. Of the 14 Surveyed subsectors, only 5 subsectors reported growth, while the remaining 9 subsectors reported declines. The composite PMI for the non-manufacturing sector stood at 35.7 points in June 2020 indicating a contraction for the third consecutive - month. Notably, a month-on-month analysis of the movement in the sub-indices indicated that non-manufacturing economic activities mildly improved in June 2020 as it improved from 25.3 index points in May 2020 to 35.7 index points in June 2020 (though it remained below 50 points, the divide between contraction and expansion). Although all the 17 subsectors surveyed recorded declines, this was amid marginal improvement in economic activities within all the 17 subsectors (save for the utilities sector) that constitute the non-manufacturing index.

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Financial Markets


Fixed Income Market

The Fixed income market sustained its bullish momentum for the third consecutive month as the relatively stable system liquidity coupled with the paucity of instruments stimulated the recovery seen in the second quarter of 2020. Monthly yields for the benchmark securities monitored declined across all maturities on a month-on-month basis, with average yields on the sovereign bonds with 3- year, 5-year, 10-year and 20-year maturities declining by 58 bps, 115 bps, 49 bps and 52 bps, respectively.


The Bond market started the month on a relatively quiet note albeit with pockets of demand seen across board. Subsequently, the unexpected reduced sale at the June bond auction of N100 billion as against the N150 billion originally offered, further strengthened the bullish run in the bond market.


The Bond auction held on 17th June, 2020 closed relatively strong with a bid to cover of 3.6x and rates declining by 120bps, 70bps and 45bps to print at 8.00%, 11.00% and 12.15% across the 3-year, 5-year and 30-year maturities respectively. As a result, yields declined sharply by an average of 156 bps to their lowest levels since 2010.

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Foreign Exchange Market

On a quarterly basis, the Naira depreciated by 3.58% at the I&E FX Window as the average exchange rate of the currency to a unit of the Dollar rose to $386.39 in June just as turnover continues to contract. Total I&E inflows for Q2 stood at $1.3 billion in contrast to $11 billion recorded in the preceding quarter. Inflows from FPls dropped by 92.9% quarter-on- quarter to $236 million in the second quarter. However, on a monthly basis, the Naira depreciated marginally by 6 bps (0.06%) in June, accompanied by a 32.7% increase in monthly turnover. The CBN maintained its quiet pose in the market by supplying only 0.1% of the total inflow in June. Other local sources contributed 74% of the funds that came in through the window. Activity at the window may continue to wane pending any major intervention from the Apex bank.

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Equities Market

The month of June marked a rather lackluster end to a very vibrant quarter. Historically, June has always been a month of negative returns before the narrative flipped in 2016 as the anticipation of positive H1 earnings typically spurred market activity. This 4-year consecutive positive print was however broken in 2020 as the month of June recorded a month-on-month decline of 3.12%. The rally seen in the market in the first two months of the quarter could largely be attributed to positive reaction towards reopening the economy and speculative trades.

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The month of June kicked off on the same theme as May and April albeit at a slower pace. Foreign investors attempted to dip their toes into the buying pool while local investors took profit, albeit slowly. OPEC + met earlier in the month, agreeing to extend production cut of 9.7 million barrels a day till July though, as originally agreed, production was set to increase in steps after June. However, market activity remained tepid as offshore sellers remained quiet and local players adopted a cautious approach, compelled by oil prices trading lower due to the resurgence of new Covid-19 cases in the U.S. The local bourse experienced more bearish sessions than those with marginal gains and all on thin volumes.


The final blow came towards the end of the month as the MSCI released its annual global market accessibility review. This report details market accessibility assessment for all countries across its Developed, Emerging, Frontier and Standalone indices. Nigeria was acknowledged for its significant deterioration of FX liquidity and the index provider stated that it would not implement any changes for Nigerian securities in its upcoming index reviews-all Nigerian stocks would maintain status quo and there would be no addition nor deletion of any security in the MSCI FM and Small cap indexes. This did not come as a surprise seeing as foreign investors have not been able to exit via the I&E FX window since April due to the CBN's weak intervention.


The second quarter performance of the NSE ASI was up 14.92% regardless of the 3.12% month-on-month decline recorded in June. The NSE ASI closed at 24,479.16 with a negative year-to-date return of 8.80%.


Our Expectations for The Coming Months

Oil production is expected to decline as the country adheres to the OPEC+ production cuts. There is also a possibility that another extension might be revisited by OPEC+, particularly as it seems a second wave of the virus appears imminent. Should there be a resurgence of the virus, we might find oil prices trending south.


Inflation in Nigeria has been above the 9% upper limit of the central bank's target band for five years and will likely continue to accelerate as border closures, initially ordered in August 2019 to curb smuggling of rice and other products, remain in place. Inflation adjusted return is currently negative on fixed income instruments as the market continues to be driven by liquidity. We expect impact on the fixed income space to be muted in the near to medium term.


Given the amount of idle pension funds sitting in bank placement (c.§1.5 trillion) and the sudden weakness in demand for equities, we expect the buying interest to persist in the near term, which should drive yields lower in the bonds market.


The mild improvement in the non-manufacturing PMI can be attributed to the partial ease in the lockdown. However, the lack of liquidity at the FX market, limited global supply chain distributions, falling demand for non-essential items, were the reasons for the continued contraction in the


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