Thursday, April 06, 2017 2:30 PM / ARM Research
CBN sustains aggressive dollar sales
Following the raft of policy measures implemented by the apex bank in February—which shrank the parallel and interbank market spread from a high of 49% in February to 19% in March—largely reflective of over 28% NGN appreciation in the former, the CBN bolstered its campaign with further moves aimed at strengthening the convergence between both markets. First off, execution rate for dollar sales to retail users—which was earlier pegged at N375/$ (20% above interbank)—was revised downwards to N360/$ after backing out a N3 service spread for banks in March. In addition to selling to banks and BDCs at N357/$ and N360/$ respectively, the CBN also sold ~$1.2 billion in wholesale forward intervention in March. These moves were accompanied by its decision to make sales to BDCs bi-weekly as well as step up the size of the sales to $10,000 (from $5,000 previously).
To our minds, currently improving organic reserve inflows (+37% MoM to $842million as at February), reflective of the lagged impact of firmly higher oil prices and rising crude production (+7% from Q4 16 average to ~1.96mbpd in February), as well as fresh inflows from inorganic sources such as the $1billion from Eurobond issue and AFDB’s approval of $600million budget support may have provided CBN legroom to expand its dollar sales.
Given the scale of naira appreciation at the parallel market, the key question is whether the apex bank can sustain its sizable dollar sales going forward. In answering this question, we evaluate potential dollar inflow and outflow through the CBN and assess their impact on the nation’s reserves. In addition to the potential $2.2billion inflow in external borrowings (Eurobond: $1.5 billion, Diaspora: $300 million, AfDB: $400million), we forecast a $13.9 billion oil inflow over 2017 (+36% YoY) reflecting improved oil production of 2mbpd (2016 average: 1.83mbpd) and higher oil prices of $55/bbl. (2016 average: $43.87/bbl.).
In addition, assuming a $9.3billion non-oil inflow (average over the prior four years), we estimate average monthly inflow to print at $2.1 billion which is more than CBN’s $1.2 billion dollar sales in March and projected $626 million non-WDAS outflow combined. Thus, we believe the CBN should be able to sustain its intervention in the near term.
Table 1: Nigeria’s Oil inflow and Outflow ($ million)*
Eyes on inflation as NGN gains ground at parallel market…
Reflecting impact of high base effect from 2016, headline inflation moderated 92bps from prior month to 17.78% YoY in February. Finer details of the report suggest that cutback in price pressures mainly stemmed from the core inflation basket on the back of moderation in the HWEGF sub-index (-6.7pps from prior month)—wherein electricity prices are domiciled. Though we noted that base effect from 2016 and sustained deceleration in the core basket (from November 2016) would keep YoY inflation on the down-low, we were heedful of pressures from rising food prices (+71bps to 18.5% YoY) as carry-over impact from naira declines to a low of N510/$ at the parallel markets in the earlier weeks of February left price competitiveness of Nigerian farm produce intact over period.
Fastforward to March, the raft of FX policies by the apex bank from late February 2017—to reduce demand pressures at the parallel market on one hand and increase supply at the interbank on the other—which led to a staggering 22% naira appreciation at the parallel market to N390/$ in March now questions the premise for our prior food inflation expectation for the coming reading. Wafting support for this inquest is the first contraction in cereal prices in four months as at end of February (-9% MoM to N130/kg)—a month for which the full impact of CBN’s new policy was yet to take footing. Thus, with more than half of the naira appreciation at the parallel segment occurring in March (+14% MoM), we see legroom for further contraction in cereal prices with the benefit of it lasting over a more prolonged period (relative to the late drop in February) suggesting some temperance in currency-induced food demand pressures from neighboring West Africa.
To arrive at a possible scale for the implied retrace in cereal prices and, by extension, food inflation, we revisit our regression framework, whose results indicate that a N1 depreciation of the USDNGN would translate to an 11kobo rise in monthly cereal prices, with a 1% increase in the latter also resulting in 10bps and 9bps acceleration in farm produce and food inflation respectively. That said, juxtaposing the regression result alongside potential lagged impact of currency change, we now expect the N65 naira USDNGN strengthening in March to translate to a N7.15 contraction in cereal prices to N123.49 with food inflation moderating 114bps from prior month to 17.36% YoY. Thus, further aided by our unchanged expectation of base effect-induced slowdown in the core basket, we now expect inflation to moderate 120bps from previous reading to 16.6% YoY in March.
Figure 1: Movement in cereal prices and parallel market FX rate
…sparking interesting expectations in treasury market
Over March, the naira yield curve dilated a further 82bps MoM to 18.13% as a surge in T-Bill yields (+2.06pps MoM to 20.58%) trumped moderation in bond rates (-41bps MoM to 15.69%). Given improved system liquidity (+22% MoM to N229 billion on average) which stemmed from the N523 billion Paris Club debt refund to states in the period, we believe yield expansion at the short end of the curve reflected sustained sell-offs as investors gradually priced in potential impact of inflation moderation on interest rate trajectory. At the long end of the curve, marginal clearing rates declined another 37bps MoM to 16.27% at the March auction, largely reflecting cautious bidding by investors, with maximum bid rate declining 95bps MoM to 17.05%. In addition to the subdued inflationary reading, we believe increased prospect of sizable external financing by the FG underpinned the prudent bid rates at the auction.
Going forward, given significantly high level of bond maturities expected in April (N474 billion), which is more than 3.6x planned government borrowing in the month, we see legroom for yield downtrend owing to potential increase in liquidity profile. This is without factoring in other maturities in forms of LCRM: N113billion and Lagos: N57billion. Beyond the liquidity implications for yield, our long-held view regarding expected declines in inflation raises scope for monetary policy easing farther out. This view is made less disputable by our projected FX-induced retrace in food price pressures. To be clear, we are now pricing in more aggressive step-down in inflation in the coming readings that could ultimately question the very basis of CBN’s tightening. In the near term though, in view of its ongoing efforts aimed at currency stability, the apex bank could prefer a tilt towards gradual step down in marginal clearing rates at coming OMO auctions.
Figure 2: Expected maturities over 2017
FG dolls out plan for revival of ailing economy
At the start of March, the Budget and Planning Ministry released Nigeria’s long awaited economic plan tagged the ‘Economic Recovery and Growth Plan’ (ERGP) which has three cardinal objectives: restore growth, improve Nigeria’s economic competitiveness, and increase social inclusion. In terms of focus areas, the plan sets six key execution areas: stabilizing the macroeconomic environment, achieving agriculture and food security, ensuring energy sufficiency (power and petroleum products), improving transportation infrastructure, and driving industrialization focusing on Small and Medium Scale Enterprises. Ultimately, the goal was to realize economic growth of 7% YoY by 2020 (2017: 2.2% YoY).
To reach this target, the plan seeks to encourage monetary policy decisions that would stimulate growth while keeping tab on inflation with fiscal policy aimed at stimulation—especially in the near term. Specifically, FG is looking to dedicate 30% of coming federal budgets to CAPEX aided by plans to widen non-oil and oil revenue base. For the latter, the plan assumes conservative oil price trajectory with a $52/bbl. target oil price for 2020 and oil production at 2.5mbpd (2017: 2.2mbpd). In terms of specific initiatives, the plan envisages increased engagement with the Niger Delta, increased pipeline security and environment clean-up efforts.
Given recent FGN charm offensive with several trips by FG to the region, increased budget for amnesty and start of clean-up efforts in Rivers state, it would appear the FGN is already in sync with this objective. That said, while this initiative has seen oil production gradually crawl to ~2mbpd thus far, we are less sanguine about expectations on the non-oil front given a still depressed consumer discretionary income and the traditional slow pace of plan implementation in Nigeria.
Contracting PMI and ERGP expectations: which way Nigeria?
Going by a recent release from the CBN, Nigeria may be hitting the deck for the third successive month of 2017 with March PMI reading suggesting another contraction in economic activities with thirteen of the sixteen surveyed sub-sectors in the manufacturing segment indicating lower level of business activities (These sectors comprised primary metal; transportation equipment; plastics & rubber products; electrical equipment; paper products; printing & related support activities; petroleum & coal products; non-metallic mineral products; furniture & related products; cement; fabricated metal products; computer & electronic products; and chemical & pharmaceutical products).
Away from manufacturing, non-manufacturing activities extended its contractionary trend to the fifteenth consecutive month with the survey suggesting that weaknesses across Construction, Real estate, and Wholesale & Retail led the declines. Whilst most of the subsectors remained in negative territories—consequent upon narrowing new orders, employment level, and raw materials inventory, Agriculture (~26% of Nigeria’s GDP) provided flicker of hope with sizable expansion in the review month (+63.2). Elsewhere, rising prices and depressed consumer discretionary income appear to have put paid on producers’ ability to pass-on cost with input price PMI edging output price PMI for the umpteenth month. Consequently, coming on the heels of rebound in crude production to ~2mbpd and the heralded introduction of the ERGP, the survey results over the past three months’ present genuine concerns. This view is principally bolstered by the strong correlation between past PMI readings and manufacturing and non-manufacturing sectors GDP performances. Importantly, we think the policy initiatives, which led to improvements in FX availability, trickled in later than was necessary to support economic activities in Q1 16.
Overall, given seasonality patterns of quarterly GDP growth in the last three years which suggest that Q1 numbers have printed at an average discount of 13% relative to Q4 numbers, we see legroom for another contraction in GDP in Q1 17 despite gains on the oil front and what now appears like an ambitious ERGP expectation for 2017 (i.e. GDP of over 2.2%) that is premised on crude production of 2.2mbpd and strong non-oil sector growth. To be clear, our base case scenario of a 13% discount would imply a 0.5% YoY contraction in real GDP over Q1 17.
Figure 3: Scenario outcomes for Q1 17 GDP growth