Tuesday, February 09, 2016 05:34 PM / ARM Research
In this month’s review of trends across the domestic macroeconomic environment over the January, we examine developments on the fiscal front, currency, FI markets and inflation and proffer outlook on same.
Shortly after resumption from the 2015 festive break, the National Assembly guided to end of February for passage of the 2016 appropriation bill (2015 bill was passed in April). However, as in prior years, we think usual bickering between the legislature and executive on suitable oil price budget benchmark could delay passage beyond this timeline.
After the 160bps uptick the prior month, the yield curve climbed a further 70bps on average to 8.54% in January. The extended uptick of the yield curve was on the back on continued CBN OMO sales during the month, as well as selloff, particularly at the long-end, that trailed the slump in oil prices.
Extending patterns since February 2015’s implementation of the order based two-way quote system, the naira remained within its narrow trading range (
N197-199/$) over the month at the interbank market. Nonetheless, following CBN’s decision to terminate sales to the BDC segment mid-month, mean BDC premium to the interbank widened 15.4pps to 48% with the naira falling to a record low of N309/$ at the parallel market.
The National Bureau of Statistics (NBS) reports that headline inflation rose for the sixth consecutive month to a 36 month high of 9.6% YoY (+30bps) in December—10bps ahead of our forecast.
The usual suspect to delay passage of 2016 bill
Shortly after resumption from the 2015 festive break, the National Assembly guided to end of February for passage of the 2016 appropriation bill (2015 bill was passed in April). However, as in prior years, we think usual bickering between the legislature and executive on suitable oil price budget benchmark could delay passage beyond this timeline. This is compounded by recent gyration in oil markets where prices plumbed to a decade low of $27.88/bbl in January, putting the average that month 17% below the $38/bbl budget benchmark. With Nigeria still reeling from decade-low GDP growth, additional delay in passage of the Keynesian-style budget implies output performance could worsen in the first quarter of 2016.
Low oil prices could stimulate a cure for Nigeria’s dutch disease
Aside the potential delay in passage, the retracement in oil prices, adds another layer of doubt to actual implementation of the budget, particularly the capex portion, which the FG hopes will revive wilting macroeconomic variables. Specifically, hinged on the recent down-leg in oil prices, we now expect 2016 fiscal deficit to range between N3.0– N3.5 trillion, vs. the N2.8 trillion communicated in our December 2015 Economic Update and N2.2 trillion implied in the 2016 budget proposal.
Though the FG admits increased pressures, the Minister of finance has reiterated the government’s commitment to fully implement the capex, arguing that 2016 budget is primarily to be funded from non-oil revenues on improved revenue collection via the TSA and on-going drive to widen the tax net. On the latter, the FG commenced enforcing payment of stamp duties on certain banking transactions.
Specifically, the CBN issued a circular that directs commercial banks to collect N50 on each deposit (teller or electronic) of N1,000 and above into current accounts. However, using CBN data, our estimate of N30 billion as the maximum accruable from this source this year seems meagre in the context of overall revenue pressures. Perhaps, the real positive from the low oil price environment, is that it forces government at all levels to innovate new ways to plug shortfalls, and in that sense is a blessing in disguise. In addition, net impact of weaker naira outlook, backward-looking trade policy and current drive at improving economic infrastructure should buoy outlook non-oil exports.
Tying diversification of fiscal revenues and export receipts, we see a silver lining in the current oil price downturn for a cure to the chronic Dutch Disease issues to have beset the Nigerian economy.
Rising OMO issuance and downdraft in oil price widen treasury yield curve
After the 160bps uptick the prior month, the yield curve climbed a further 70bps on average to 8.54% in January. The extended uptick of the yield curve was on the back on continued CBN OMO sales during the month, as well as selloff, particularly at the long-end, that trailed the slump in oil prices. Specifically, the sale of nearly N700 billion worth of OMO paper resulted in a net liquidity mop-up of N120 billion which saw the short-end of the yield curve rise 50bps on average to 3.97%, 7.47% and 8.43% for the 91 day, 182 day and 364-day papers. At the long end, yields jumped 93bps to 10.79% on average as markets priced in additional risk on further deterioration in fiscal balances.
Curiously, bond sales at the primary bond auction were in stark contrast to market expectation, given fiscal pressures. The DMO offered only N80 billion at the January auction, but more importantly sold only N75 billion which, in our view, is a message to the market that the 2016 budget will not be funded at any cost.
At the external stage, Nigerian Eurobond yields reacted oil prices dipping to lowest in 12 years in January. Yields of each of the three outstanding issues climbed to record peaks, with the 7 and 10 year notes crossing the 9% mark for the first time since issuance.
Figure 1: Treasury yield curve
Given the net increase in paper supply by the monetary authorities, which is at odds with a dovish stance, FI markets appear to be facing mixed signals.
Nonetheless, given sustained downdraft in crude receipts, weak macro picture and need to accommodate fiscal spending plans, we reiterate our view that OMO sales are primarily to avert excessive liquidity in the system without which system liquidity would have exceeded N1.3 trillion levels. Over February, with N600 billion in maturities, we think the modest OMO sales will persist, though not sufficient to drive a sustained spike in yields. Although February bond auction sales are projected to be 12.5% higher MoM at N90 billion, based on our estimates, it is still 30% shy of monthly sales required per budget projections.
Putting the non-aggressive OMO sales together with the fiscal resistance to borrowing cost, we see scope for some contraction of the yield curve over February, though lack of clarity on the fiscal side leaves room for some choppiness.
Fiscal opposition continues to veto fundamental concerns about naira peg adjustment
Extending patterns since February 2015’s implementation of the order based two-way quote system, the naira remained within its narrow trading range (N197-199/$) over the month at the interbank market. Nonetheless, citing pervasive violations of anti-money laundering laws and largely illicit nature of transactions by BDC operators, CBN announced its decision to terminate sales to the BDC segment mid-month. The decision drove further widening in the mean BDC premium to the interbank widening 15.4pps to 48% with the naira falling to a record low of N309/$ at the parallel market. The subsequent lifting of restrictions of foreign deposit and transfer of same off-shore, did little to narrow the spread. External reserves, amidst sustained downtrend in oil receipts, FX reserves slid 2.9% MoM to a ten year low of $28.2 billion.
Notwithstanding the widening spread and sustained attrition to reserves, CBN remained obdurate towards naira devaluation with the apex bank, against market expectation, being largely silent on currency at the January 2015 MPC.
To our views, the resistance continues to reflect continued fiscal opposition, a point laid bare by the president during a trip to Kenya where he cited the need to shield the poor, re-echoing similar comments made during December’s media chat. Consequently, whilst we see enough in the fundamental picture to drive a 20-25% shift in the current naira peg, lack of presidential assent to CBN relaxing its grip on the peg should drive further market dislocation resulting in sustained increase in parallel market premiums.
Figure 2: USDNGN and parallel market premium
Inflation soars to three-year high on extended PMS scarcity
The National Bureau of Statistics (NBS) reports that headline inflation rose for the sixth consecutive month to a 36 month high of 9.6% YoY (+30bps) in December—10bps ahead of our forecast. Parsing through sub-components, core inflation was flat from November reading at 8.7% YoY while food inflation rose 20bps from prior reading to a 3-year high of 10.6% YoY. Adducing drivers, pressures in food stemmed largely from farm produce basket (+40bps) which offset 200bps moderation in processed food reading over the month. High food prices reflect effect of sustained fuel shortages in December which stoked additional increase in average PMS prices to N119.04/litre (+3% MoM), after the 23% jump in November. Feed-through from the fuel price pressures weighed on transport CPI, which rose at its fastest pace since November 2012.
Figure 3: Trends in Headline, Core and Food inflation
Going forward, improvement in petrol supply situation in January and marginal reduction in retail pump price (-N0.50 to N86.50/litre) removes a key pillar of December’s up-thrust in inflation. Furthermore, FEWSNET reports of increased food availability and diversity as markets remain well-supplied should combine with moderation in transport costs in tempering impact of feed-through from FX pressures in driving pull-back in CPI. Consequently, our forecast is for a 20bps contraction in headline numbers to 9.4% YoY in January.