Expected pressure points trip off to drive inflation upthrust


Monday, August 10, 2015 11:34 PM / ARM Research


This Monday, and as a continuation of the serialisation of ARM’s core strategy document – The Nigeria Strategy Report, we assess the drivers of headline inflation in the first half of the year with a view to providing insights on likely price trajectory over the rest of the year.

Inflation accelerates to twenty-eight month high…   

Headline inflation accelerated in the first six months of 2015, averaging 8.7% (vs. 7.9% in corresponding period of 2014).  Headline pressures were largely driven by increases in mean core inflation which quickened 30bps from H1 14 to 7.6% YoY in H1 15 (+120bps over H2 14 mean). In turn, core inflation itself was driven by increases in the prices of most divisions of the sub index with pressures on ‘housing water, electricity, gas and other fuels’ recurring over 2015. In contrast, mean food inflation in H1 15 rose only 9bps from H1 14to 9.53% YoY, same as H2 14 mean. FEWSNET attributes the subdued growth in food prices in the first four months of 2015 to the moderating impact of carryover stock from previous periods’ harvest as well as constrained institutional and private demand that kept farm produce prices largely restrained. In particular, in most millet and white maize producing areas, prices of the staple cereals declined significantly between February and March. Perhaps another telling influence on the early restraint of farm produce prices was the 10.3% slash in PMS price to N87/litre in January 2015 which eased cost of food transportation around the country.  


Figure 1: Trends in YoY CPI readings


Food pressures to ramp up on higher farm and processed food numbers

However, whilst farm produce prices came in slightly tapered in the first third of the year, with a 30bps MoM contraction to 9.74% YoY in February 2015 being the highlight, CPI data for May and June appear to corroborate our surmise of gradual pick up in farm produce pressures in the agricultural lean season (May-Aug). As the decline in household and market stocks stoked demand pressures, farm produce recorded 13bps and 24bps increases from previous months’ readings to 9.9% and 10.2% YoY in May and June respectively. Importantly, increased military operations by coalition forces and guerilla attacks by insurgents which intensified in the three months leading to May 2015 saw access to food decline in the North East, while also leading to a 250,000 MoM increase in the number of displaced Nigerians to 1.65 million. On the supply side, poor dry season harvest, higher transportation cost on the back of trade route disruptions as well as fuel scarcity, and fear of insurgent attacks restricted distribution of food and exacerbated price pressures in the northern region. Within a context of rundown of carryover food stock from 2014 and poor 2015 offseason harvest, it is unsurprising that prices of staple cereals have also begun to trend upwards in the south.

Figure 2: Average cumulative lean season inflation (MoM readings)



Incidentally, as is the case with food inflation, a chunk of the pressures that manifested on core inflation also arose from processed foods (though the impact on food was blunted by tame farm produce). Perhaps more pertinently, the surges in processed food really started to manifest in March 2015, mainly as pass-through from currency devaluation.

Figure 3: Growth attribution analysis for components of core inflation



Thereafter, YoY processed food surged 97bps and 210bps MoM to 6.3% and 8.4% in April and May 2015, accounting for 8bps and 17.4bps of the 11bps and 30bps rises in YoY food prices respectively. Importantly, whilst the latest readings appear to retain knock-on effects from naira weakness, we note that rising production costs on the heels of reported drops in power generation as well as added pressures from fuel scarcity that stoked sharp price hikes in informal markets may have also contributed significant pressures in April and May. This is particularly evidenced by the 50bps jumps in both ’transportation’ and ‘housing, water, electricity, gas and other fuel’ components of core inflation in May. Going forward, continued erratic supply of PMS across major cities in June and July as well as CBN’s recent ban on sale of FX for the importation ~41 items at the interbank should see pressures on processed food sustained in the near term. To the latter point, latest survey by News Agency of Nigeria (NAN) already reveals ~35% surge in the prices of frozen chickens and turkeys following the implementation of CBN’s directive.  Added to this, we expect resurging farm produce to amplify the impact of processed food pressures on overall food numbers in the coming months. In particular, and as noted previously, lower household stock should induce a pickup in market demand this lean season, driving farm produce higher.

Table 1: Growth attribution analysis for components of food inflation



Re-assessing the double-digit headline proposition

Inspired by the consistency of the outcomes of naira devaluations in 2008 and 2011 with results of past empirical studies, we had earlier hinted at a return to double digit (mean) headline reading for 2015. This was principally on the back of ~8% currency devaluation in November 2014. However, contrary to expectation and despite further devaluation in February 2015, naira depreciation has had relatively tamer impact on headline than was initially envisaged – largely due to significant reduction in PMS prices in January and the moderation in growth of farm produce prices already explained. To re-emphasize, despite a further 17% devaluation in February 2015, headline inflation rose only 110bps from November 2014 to 9% YoY in May 2015 (vs. our 10.5% forecast).

Figure 4: Headline Comparative (Actual, previous, and current)



To put things in perspective, in stark contrast to the 643bps and 11bps YoY jumps in mean headline reading in the five months after 28% and 3.3% naira devaluations in November 2008 and November 2011 respectively, November 2014 and February 2015 devaluations (8% and 17% respectively) only led to 46bps rise in headline reading as at April 2015. Importantly, we believe that output from main season harvest which led to high household and institutional stock of food in the first four months of 2015, significantly moderated pass-through effect from currency pressures. The improved sufficiency was also aided by drop in post harvest losses due to better food storage facilities in the current period, relative to 2008 and 2011.


Figure 5: Comparative impacts of naira devaluations on headline inflation


Nonetheless, there are other inflationary pressures. The fuel crisis, for one, influenced the 50bps jumps in both transportation and housing, water, electricity, gas and other fuel in May to 8.3% and 7.3% relative to their previous months’ reading. The fuel price increases which extended into June would have been expected to elicit some parallels with the case in January 2012. At that time, a 50% jump in PMS prices to N97/litre dovetailed to a cumulative 250bps increase in headline over the ensuing 6 months period. However, though petrol prices across the country have already jumped 29% from year start to N112/litre in June, according to NBS data, with fears of further fuel scarcity still looming and adding to the clamour for subsidy removal, which could come with another bout of near term price increases, we still do not expect as strong an impact as in 2012. In many respects, this reflects the differing ‘context’ of the inflationary environment: indeed it seems the impact of the 2013 structural break in inflation readings which we pinpointed is even stronger than we allowed credit for. The same drivers which drove that view: strong improvements in the food output context, enhancement of the agricultural value chain especially storage and backward integration remain key elements of the headline inflation’s apparent unlimited ability of absorbing the key inflationary shocks, first devaluation and then price increases. This long-lasting improvement in the major component of the basket, food, appears central to explain why the same shocks are having less of an influence than in prior periods. Hence, even as we continue to expect some form of subsidy removal, despite FGN not appearing to be in a rush for same, and still anticipating that such removal will deliver fuel price increases (potentially reaching N137/litre) and Core inflation pressures, we are significantly more sanguine on inflation outlook for 2015. Overall, aided by the influence of the main harvest, we forecast mean inflation of 9.4% +/- 50 bps for 2015 which is still much higher than the 8.1% average in 2014 but represents a significant cutback from our 11% forecast coming into 2015. 


Figure 6: Average PMS prices in Naira (N/litre)


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