High Base Effect and Harvest Season Impact Should Slow YoY Inflation


Friday, July 09, 2021 / 06:05 PM / Content and Image Credit: Comercio Partners Asset Mgt

Report Summary

The Macroeconomy

  • The World Bank projects a 1.9% GDP growth for Nigeria in 2021.
  • Headline inflation moderated in May 2021.
  • The Naira weakened slightly against the U.S. Dollar on the I&E FX Window.


The Financial Markets 

  • Bears dominated proceedings in equity market.
  • Fixed income market saw renewed buy interests.
  • Inflationary concerns in the U.S. dampens NIG. Eurobond performance


Our Expectation for the Coming Quarter

  • GDP growth is expected to rebound further.
  • High base effect and harvest season impact should slow YoY inflation.
  • Equity market is expected to remain weak, but with some cherry-picking.


U.S. Labour Market Stages Robust Recovery 

Signs of improved economic recovery became evident in the U.S. after labour statistics on initial filings for unemployment insurance and on non-farm payroll printed impressively in June. The weekly jobless claims set a new pandemic-era low of 364,000 for the week ended June 26, outpacing the 390,000 Dow Jones estimate and reflecting a decline of 51,000 relative to the preceding week's numbers. Likewise, the jobs report tor June corroborated the narrative of a sustained improvement in the U.S. jobs market, as nonfarm payrolls inched up by 850,000 in June, outpacing a 706,000 Dow Jones estimate. The payroll data came in better than the upwardly revised 583,000 in May. However, unemployment rate unexpectedly inched up by 1 basis point relative to the preceding month's numbers, settling at 5.9%, and fell shy of the 5.6% estimate. Nonetheless, the jobs data airmarks a meaningful improvement in the American economy, hence, sending positive shockwaves through the financial market.


On the crude oil front, the OPEC+ policy meeting conducted on the first day of the new month birthed some uncertainties, due to the inability of the bloc to effectively conclude on a deal to taper output cuts. The policy meeting hit a snag, after the United Arab Emirates (UAE) blocked a deal agreed by top producers, Saudi Arabia and Russia, to taper output curbs by 2 million barrels per day (bpd) from August through December 2021 (400,000 bpd monthly), and then extend the remaining cuts to December 2022 as against the earlier agreed curb end of April 2022. The UAE was reportedly comfortable with the proposed increase but remained disconcerted by the extension of the timeframe for limiting supply to the end of 2022, and also unsatisfied with their baseline production, siting the massive investments put into developing their capacity as a reasonable rationale for raising their baseline from 3.168mbpd to 3.84mbpd. In the absence of an agreement, the current 5.8mbpd production cut remains in place, hence, pushing oil prices to its highest level in nearly three years, crossing the $77/bl threshold.


Monetary policy makers across major economies were faced with inflationary pressures, but the policy stance has remained accommodative. In the U.S. the Federal Reserve retained its benchmark interest rate and asset purchase program, but became hawkish in tone, signalling the possibility of hiking rates as early as 2023 and tapering the size of its asset purchase program, and also raising inflation forecast for 2021 by 100bps (2.4% to 3.4%). Likewise, the Bank of England retained its lending rates at historic lows and maintained the current size of its asset purchase program, while downplaying the risks posed by inflation.


On the home front, the Senate finally passed the long-awaited Petroleum Industry Bill, including provisions such as sharing 3% of profit made by oil firms to host communities and setting aside 30% of profits accruing from oil and gas operations by the Nigeria National Petroleum Corporation for exploration of oil in the frontier basin, amongst other provisions. Elsewhere, the National Bureau of Statistics Nigerian Domestic and Foreign Debt report for the first quarter of 2021 revealed that total states and Federal Capital Territory's debt profile fell slightly to N4.12tn as of the end of March 2021, from N4.19tn as of the end of December 2020.

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The Macro Economy


GDP Growth & Oil Production


Nigeria is in a recovery year, but the sluggishness of the pace of recovery remains burdensome. The 0.51% real GDP growth recorded in the first half of the year illustrates the tepid nature of our GDP growth, as the oil segment was dampened by the lower output levels, while the non-oil sector had to tussle with the deep structural issues blighting the economy. The World Bank's six-monthly update on development in Africa's most populous country acknowledged the ongoing recovery, but also stressed concerns that Nigeria's post-covid growth lagged that of other economies in Sub-Saharan Africa, sighting food inflation, insecurity, and stalled reforms as the impediments to growth. The Bretton Wood institution went ahead to provide forecasts for Nigeria's GDP growth, positing that real growth is expected to print at 1.9% and 2.1% in 2021 and 2022 respectively, relative to Sub-Sahara African growth estimates of 3.4% and 4.0% in the same periods.


OPEC, in its monthly oil market report noted that Nigeria's oil production dipped by 2.04% in May 2021 to 1.34mbpd from 1.37mbpd in the preceding month. This reduction reflects the presence of disruptions to local production, as well as reduced oil demand from major trading partners like India, where the Covid-19 pandemic has shuttered their economy.


In addition, OPEC retained its world oil demand forecast for 2021 at 6.0 mb/d, bringing the total oil demand to settle at 96.58mbpd. On the supply side, OPEC forecasted a supply growth of 0.8mbpd to average 63.7mbpd, up by 0.01mbpd relative to the preceding month's estimate. The upward revision in the supply estimate was buoyed by improved estimates for US liquids production.


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The year-on-year (YoY) movement for headline and food inflation moderated in the month of May 2021. The headline index grew by 17.93% YoY in May 2021, 0.19% lower than 18.12% recorded in April 2021. Likewise, food inflation inched up by 22.28% YoY in May 2021, 0.44% lower than 22.72% recorded in April 2021. However, the core segment continued its upsurge, rising to 13.15% YoY in May 2021, 0.41% higher than 12.74% recorded in April 2021. The drop in headline inflation marks the second consecutive decline, following a 19-month uptrend that lasted from September 2019 till March 2021. The food subindex continues to be the driver behind the moderation in headline inflation, while the core segment maintained its upsurge for the sixth consecutive month.


In May 2021, headline inflation rose by 1.01% MoM, representing a 0.04% increase from the rate of 0.97% that was recorded in the previous month. The yearly average rate rose to 15.50%, 0.46% greater than 15.04% recorded in the previous month. The rise in the monthly headline index rode on the back of upsurge in both the food and core subindexes, as inflationary drivers remained active. Notably, the pass- through effect of a depreciating Naira, disruptions to food supply, as well as the impact of rising energy cost, continued to buoy the uptick in the headline index.


The food subindex rose by 1.05 % MoM, reflecting a 0.06% increase from the rate of 0.99% recorded in April 2021. The yearly average rate rose to 19.18%, 0.60% greater than 18.58% recorded in April 2021. The food subindex resumed its uptrend, blame the insufficiency and disruptions to food supply.


Core inflation stood at 1.24% MoM, up 0.25% from 0.99% recorded in April 2021.

The yearly average rate also rose to 11.50% last month, 0.25% higher than 11.25% recorded in the preceding month. The highest increases were recorded in prices of pharmaceutical products, garments, shoes and other footwear, hairdressing salons and personal grooming establishments, furniture and furnishing, carpet and other floor covering, motor cars, hospital services, fuels and lubricants for personal transport equipment, cleaning, repair and hire of clothing, other services in respect of personal transport equipment, gas, household textile and nondurable household goods.

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The moderation in the headline index seen in the month of April 2021 was sustained last month, and this improvement was on the back by the decline in the year-on-year rate of increase of the food subindex. The reduction in food inflation alludes to our earlier expectation of the base-effect kicking in towards the middle of the year, but the rise in food prices remains largely untamed, evidenced by the resumed uptick in the monthly rate of increase in food inflation. However, the core subindex continues to maintain its northward trajectory, drawing support from the active inflationary drivers. The exchange rate dilemma was a predominant driver for the core segment in the review month, forcing the Apex Bank to pursue currency unification by adopting the NAFAX rate as the official rate. The borderline concern for prices of items in the food basket remains the disruptions to an already insufficient supply, as well as rising transportation cost. 


Capital Importation and Foreign Exchange Reserves 

For the month of June 2021, foreign capital flow into the Nigerian economy via the I&E window dropped to $967 million from $1.04 billion recorded in the previous month, representing a 7.2% decline month on month. In the month under review, FX inflows from the CBN declined by 25% to $325 million compared to $435 million recorded in the previous month. Similarly, inflows from FPIs stood at $124 million in June 2021, down 36% from $194 million recorded in May. Other local and foreign sources of FX inflow into Nigeria contributed $439 million and $79 million to total inflows for the month of June 2021, representing a 23% and 40% increase, respectively, from the preceding month.


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Total outflow through the I&E window eased to $901 million in the period under review from $1.07 billion recorded in the previous month of May. The 15% decrease in FX outflow was driven by a 55% and 95% reduction in outflows from FPIs and the CBN respectively. On the flip side, outflows from other local and foreign sources tended upwards in the period under review, increasing by 19% and 56% respectively. In actual terms, outflows from FPIs and the CBN stood at $217 million and $1.1 million, while outflows from other foreign and local sources placed at $84 million and $599.1 million, respectively.


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Consequently, I&E FX NetFlow for the month of June 2021 stood at $65.6 million, the highest recorded since August 2020 ($155.1 million). 

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Financial Markets


Fixed Income Market

The Bond market reversed its relatively bearish trend last month, as the unmet bid at the Bond auction filtered into the market. Average monthly yields for the benchmark securities rose across all maturities on a month-on-month basis, with average yields of the sovereign bonds with 3-year, 5-year, 10-year and 20-year maturities declining by 20 bps, 22 bps, 40 bps and 49 bps, respectively.


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The Bond market started the month on a relatively quiet note with minimal volumes seen across board. Nevertheless, we saw pockets of demand on the long end of the curve, particularly on the FGN 2045 and FGN 2049. Activity picked up towards the end of the month as the unmet bid at the Bond auction filtered into the market. Bulk of the demand was seen on the FGN 2035 and FGN 2050. The Bond auction held on the 23rd of June 2021 closing relatively strong as the Debt Management Office (DMO) sold 325.8 billion worth of bonds after offering 4150.00 billion at its auction, with a bid to cover ratio of 2.78x and stop rates printing as follows; 7-year, 15-year and 30-year at 12.74%, 13.50% and 13.70% respectively.


Eurobond Market

Sentiment in the Eurobond market was relatively weak in June 2021, on the back of the increasing inflationary concerns in the U.S. The market started the month on a relatively quiet note as a deal by the world's richest nations on global minimum corporate tax overshadowed bets on a full economic reopening. However, activity remained subdued in anticipation of the U.S. CPI data for the month of May. Annual inflation rate in the US accelerated to 5% in May of 2021 from 4.2% in April, and above market forecasts of 4.7%. Consequently, the Eurobond market closed the month on a relatively weak note as sentiment remains soft, given the acknowledgment of inflationary pressures by the U.S. FED. In all, yields rose by 12 bps MoM.


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Foreign Exchange Market

The average monthly value of the Naira depreciated by 80.03 at the I&E FX Window, with the average exchange rate of the currency to a unit of the Dollar climbing to 4411.30 in June 2021 from N411.27 in May 2021. Total monthly turnover traded on the I&E FX Window was up by 20.32% to $3.01 billion in June 2021 from $2.5 billion in May 2021. Despite the persistent rise in crude oil price, the Naira remained pressured downwards. This can be attributed to the existing backlog of FX demand and the low foreign exchange earnings from Nigeria's crude oil sales, which was a consequence of reduced oil demand from India, one of the major buyers of Nigerian crude, in the wake of the resurgence of the COVID-19 cases.


The average quarterly value of the Naira depreciated by 88.42 at the I&E FX Window with the average exchange rate of the currency to a unit of the Dollar climbing to 4410.98 in Q2 2021 from 8402.56 in QI] 2021. Total quarterly turnover traded on the I&E FX Window was up by 67.03% to $6.69 billion in Q2 2021 from $4.0 billion in Q1 2021. The Apex bank sold at least $25 million twice a week in June to Foreign Portfolio Investors, selling roughly $200m; a combination of spot and the 5-month forwards.


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Equities Market

The second quarter of the year was quite the hibernation period of the local bourse as investors retained caution towards risk assets. The first month in the quarter ended on a positive note, fuelled by the FY'2020 results season and benefit declaration. A few offshore accounts reinvested their dividend proceeds mainly for the lack of viable means to repatriate their funds. The remaining months saw the bourse return to an anchorless status quo, plagued by rising fixed income yields and FX illiquidity. Shallow trade metrics were the order of the day with a few outliers here and there.


The quiet demeanour of the market was unwavering, even Brent touching $76 during the quarter could not stimulate a holistic positive reaction across the exchange. Offshore participants who typically track oil prices were indifferent to the price gain, focusing more on repatriating their funds. The yield on the 1-year NTB retraced 4 consecutive times from the end of May into June, yet no reaction from institutional investors in the local bourse. Most local fund managers are currently enjoying high returns (over 14%) on money market instruments, and as such, not incentivized to take on risk. To provide more context, the NGSE declined further by 4% since the yield on the 1-year NTB started its decline.


Towards the end of the quarter, trading of GUARANTY shares was suspended by the exchange in anticipation of its eventual delisting and the subsequent listing of the new holding company. Shareholders in GUARANTY retained their stake in the new holding company as the scheme entailed a one-for-one conversion basis.


GT Holdco's entire issued share capital was listed at N28.55 per share. The new ticker rallied to N30 after its listing before profit-taking brought it down to N29. Regarding participation, local investors dominated market activities as foreign investors were strongly on the sell side, except when reinvesting dividends and repatriating cash. The most actively traded sector was the banking sector, as the likes of ZENITH and GTCO led activities on most trading days. The star of the exchange remains SEPLAT ENERGY. The oil and gas titan can boast of a great H1 performance, with a year-to-date return of 72% and a quarterly return of 25%. This is because of the twin impact of higher crude prices and demand from offshore fund managers. SEPLAT remains a cheaper means of repatriating cash compared to AIRTELAFRI. In a bid to clear the FX backlog, the CBN has maintained its weekly sales of $50 million in a combination of spots and forwards.


The sectoral indices performance for the quarter were as follows: the Oil & Gas sector recorded a quarterly gain of 17.76%, retaining the position of the top gainer. The Consumer goods sectors gained 10.67% while the Industrial, Banking and Insurance sectors shed 0.11%, 0.87% and 2.58% quarter-on-quarter, respectively. The benchmark ASI in the month of June closed at 37,907.28 points, recording a quarter-on quarter loss of 2.91% and a month-on-month loss of 1.38% compared to May. Year-to-date return came down further at negative 5.87%.


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Our Expectations For The Coming Quarter

The outlook for growth remains weak, but a meaningful upswing is expected in the second quarter of the year, due to the impact of a low base effect, and a recovery in the oil sector following a 4-quarter long contraction. The passage of the Petroleum Industry Bill is a welcome development, but the impact on growth would only become more apparent after its swift implementation. Also, there is the possibility of an increase in Nigeria's production quota by OPEC should the group finally reach some policy agreement.


The base effect is expected to remain supportive of both headline and food inflation in the coming months; hence, entrenching a sustained downtrend. While the depreciating Naira and the passthrough effect of rising production input costs (electricity and PMS) is expected to push the core segment inflation rate upwards, the food subindex should have the impact of the harvest season cushion the consequential pressure from such inflationary drivers.


On the policy front, the sustained moderation in year-on-year inflation is enough incentive for the monetary authorities to commit to a dovish stance, keeping economic growth as the policy priority in the interim.


We expect the Bond market to sustain its bullish momentum next month, on the back of the anticipated Bond maturity inflow.


We expect sentiment in the Eurobond market to remain soft, as the renewed covid concerns coupled with inflationary pressures continue to dampen activity in the market.


The naira is expected to remain pressured in the near term, as the size of the CBN's intervention facilities remains paltry to stabilize the market. However, the approval of the N2.3 trillion ($6.1 billion) external borrowing plan by the Senate is a welcome development, as this should help clear the backlogs and ease some of the pressure on the naira.


The outlook for the equities market in the near term remains bearish. However, we still expect to see some activities in the Banking and Oil & Gas sectors. The influx of half-year results will provide some traction during the next quarter particularly for dividend-paying tickers. We anticipate that retail local investors will continue to be the major players as local fund managers play it sate with money market instruments of pockets of demand followed by profit taking.

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