Thursday, April 21, 2016 2:36 AM / ARM Research
In this report, we assess events on the global stage and domestic scene over Q1 16 to establish how these stack up to our expectations as communicated in our H1 16 Nigeria Strategy Report, but more importantly, possible implications for our proposed capital market strategy.
Largely in line with our prognosis, economic recovery across developed markets remained fragile, whilst the EM growth slowdown extended over the quarter with all BRIC countries reporting markdowns in GDP growth.
Events on the domestic stage were also broadly in line with our expectation, save the surprise switch in monetary policy to a hawkish tone at the March MPC. Output plunged to 16 year lows in Q4 15 (+2.11% YoY), inflation climbed to a 44-month high in March while currency pressures persisted at the parallel market. Compounding the downbeat macroeconomic data is the delay in kick-starting planned expansionary fiscal expenditure due to the squabble between the executive and legislature over its content.
The dour macroeconomic picture, delay in fiscal stimulus and adverse sentiment triggers on the global front all combined to drag the equity market further into negative territory. In the fixed income space, the switch to hawkish tone by the monetary authorities largely underpinned the widening of the yield curve over the first quarter of 2016. In sum, with developments across the global and domestic terrain largely echoing our views, our capital market strategy is broadly unchanged, save mild tweak for the FI income leg in view of the twist in monetary thrust.
In this report, we assess events on the global stage and domestic scene over Q1 16, to establish how these stack up to our expectations as communicated in our H1 16 Nigeria Strategy Report, but more importantly, possible implications for our proposed capital market strategy. Largely in line with our prognosis, economic recovery across developed markets remained fragile, whilst the EM growth slowdown extended over the quarter with all BRIC countries, reporting markdowns in GDP growth. General concerns on a global recovery led to a less hawkish tone by the US Federal Reserve, even as similar concerns led IMF to slash 2016 global growth forecast 20 bps to 3.2% YoY.
The tale on the African continent was equally less appealing as lower commodities prices induced deterioration in external balances leading to currency weaknesses and by extension, inflationary pressures. Events on the domestic stage were also broadly in line with our expectation, save the surprise switch in monetary policy to a hawkish tone at the March MPC. Output plunged to 16 year lows in Q4 15 (+2.11% YoY), inflation climbed to a 44-month high in March while currency pressures persisted at the parallel market. Compounding the downbeat macroeconomic data is the delay in kick-starting planned expansionary fiscal expenditure due to the squabble between the executive and legislature over its content.
The dour macroeconomic picture, delay in fiscal stimulus and adverse sentiment triggers on the global front all combined to drag the equity market further into negative territory. In the fixed income space, the switch to hawkish tone by the monetary authorities largely underpinned the widening of the yields curve over the first quarter of 2016. In sum, with developments across the global and domestic terrain largely echoing our views, our H1 16 capital market strategy is broadly unchanged, save mild tweak for the FI income leg in view of the twist in monetary thrust.
Review of Global Economy & Market
Slowing growth underpins accommodative monetary policies
Amidst slowdown in economic activities in the United States (-60bps QoQ to 1.4%) and Euro Area (-10bps QoQ to 1.5%), alongside contraction in Japan (-270bps QoQ to -1.4%), global growth decelerated to an annualized rate of 1.6% QoQ in Q4 15 1(Q3 15: + 2.4% QoQ). Over 2016, global growth was projected lower by both the World Bank (-40bps to 2.9% YoY) and the IMF (-20bps to 3.2% YoY) largely on the back of weaker growth prospects from EM countries. Concerns about the tamer growth picture together with extended decline in oil prices reverberated in the equity markets which recorded their worst start in nearly fifty years (MSCI World Index: -11.6%)2 in 2016. Unsurprisingly, in response to weak global growth prospects, softening inflation expectations and financial markets’ turmoil, central banks across developed and EM markets mostly maintained low rates or expanded their monetary easing programs.
Focusing on DM, despite strengthening housing and labour market data, the US Federal Reserve left its interest rate unchanged (between 0.25% and 0.5%) even as it lowered its FOMC dot projection to 0.875% by the end of 2016 from 1.5%.
Similarly, the BoE, amidst persistently low inflation and uncertainty around the upcoming referendum on U.K. membership in the EU, left both its policy interestrates and asset purchase program unchanged at 0.5% and £375 billion, respectively. Elsewhere, the ECB lowered its deposit rate to -0.4% (-10bps), benchmark rate to 0% (-5bps) and marginal lending rate to 0.25% (-5bps). In addition, it included non-bank corporate bonds in its asset purchase program which it expanded by €20 billion to €80 billion and extended to, at least, March 2017.
Furthermore, the ECB announced plans to launch a new series of four targeted longer-term refinancing operations 3(TLTROs) with maturities of four years, starting in June. As for Japan, after nearly 5 years of 0% interest rate, the BoJ joined the ECB to introduce negative interest-rate of -0.1% to spur banks into lending. In addition, the BoJ also included exchange-traded funds and Japan real estate investment trusts in its ¥80 trillion asset buying program, the size of which it left unchanged.
A similar scenario played out across EM countries as the PBoC cut its reserve requirement ratio (RRR) by 50bps to 16.5%, to boost economic growth, while the Reserve bank of India, Bank of Russia and the Central Bank of Brazil left their policy rates unchanged on the back of rising inflationary pressures. The largely dovish monetary policies which boosted investors’ appetite for riskier assets helped global equities pare most of their earlier losses (MSCI World Index Q1 16: -0.9%). More importantly, the less hawkish stance of the US Fed which resulted in the weakening of the dollar (Q1 16: -4.1%) drove an appreciation of other global currencies.
Figure 1: Q1 16 equity and currency performance of selected countries
Going forward, the still weak outlook on global growth—which the IMF notes is increasingly at risk of derailment—suggests an extension of current accommodative monetary policies. Nonetheless, concerns about uptrend in banks’ non-performing loans, amid rising private debt and slowing economic growth, as well as fears from Britain’s June 2016 referendum on its EU membership hint at increased volatility in global financial markets.
Africa’s economy to remain dour over 2016
Africa’s equity markets tumbled in the first two weeks of trading in 2016 (S&P All Africa Index: -15.3%)4 against the backdrop of renewed global growth concerns and extended decline in oil prices. Importantly, the slump in Africa’s bourses coincided with the January 2016 downward review of SSA’ 2016 growth forecast by both the IMF (-20bps to 4% YoY) and World Bank (-30bps to 4.2% YoY) from prior forecasts.
Meanwhile, mean GDP growth for North Africa was revised 2.86pps higher at 9.31% YoY, largely on the back of economic recovery in Libya (+20.7pps to 35.7% YoY) which is expected to benefit from UN-sponsored political agreement in December 2015. Year-to-date, economic indicators released have been divergent as the pace of real GDP growth worsened over Q4 15 in Nigeria (2.11% YoY) and South Africa (+0.6%) while it improved in both Morocco (4.7% YoY) and Tunisia (+0.3% YoY). Inflation was similarly discordant as Nigeria (hike in electricity tariff), South Africa, Zambia and Morocco (higher food prices) as well as Angola (31% cut in petrol subsidies) all experienced higher inflationary pressures while inflation eased in Tunisia, Uganda, Kenya, Ghana and Egypt.
Somewhat curiously, most African currencies have been relatively stable save for the Angolan Kwanza (-21% YTD) and the Egyptian Pound (-14% YTD) which were devalued in January and March 2016 respectively. Unsurprisingly, amidst rising inflation, many central banks raised interest rates (Angola, Nigeria, Mozambique, South Africa, Swaziland and Namibia). However, unlike the other countries, the hike in interest rate (150bps to 10.75%) by the Egyptian Central Bank is primarily to stem potential inflationary pressure that could be caused by the devaluation of the Egyptian pound. Meanwhile, in Morocco where inflation is sub 1%, the Central Bank eased (-25bps to 2.25%) to boost economic growth. Overall, though Africa’s equity markets swung back into positive territory (Q1 16: S&P all Africa index: +2.1%) combined impact of extended bearish trend in commodity prices, electricity supply bottlenecks and currency depreciation6 point to a deadbeat outlook over the rest of 2016.
Table 1: Interest rate movement across Africa
Commodities market: miles from rebalancing
Oil freeze talks pull oil prices from 12 year nadir
Brent crude oil prices rose 4.7% QoQ to $39.04/bbl in Q1 16, erasing the steep declines over the prior two quarters—Q4 15: -29% and Q3 15: -23%. Examining movement on a monthly basis, Brent oil prices dropped nearly 7% MoM in January on fears that additional supply out of Iran, given the (then) looming 15th January date for lifting of Iranian nuclear sanctions, could widen the surplus in the global crude oil markets. However, after touching 12 year nadir of $27.88/bbl, days after the sanctions were lifted, oil prices rebounded quite sharply for a number of reasons. Iran’s return to the oil market was less dramatic than earlier communicated, with production up only about 220kb/d over February vs. the 550kb/d ramp up within a week which the Iranian oil minister had claimed was possible. This disappointment coincided with a mid-February offer by Saudi Arabia, Venezuela, Qatar and Russia to freeze production at January output levels, even as supply outages in Iraq, Nigeria and the UAE added more bullishness. Consequently, oil prices recovered over February (+4%) and accelerated through March (+8.5%). It appears the weakness of the US dollar following the less hawkish guidance by the US Fed also contributed to the oil price rebound. Overall, Brent oil price averaged $35.4/bbl in Q1 16 largely in line with our projected range of $30 - $35/bbl for H1 16
Despite the gyrations of oil prices over Q1 16, there was little alteration in overall fundamentals of the oil market. Specifically, OPEC extended its play for market share by pumping near record levels of 32.7mbpd (+2.5% QoQ) which more than offset declines in non-OPEC production and ultimately raised overall global output to 97.8mbpd (+1% QoQ). On the other hand, underpinned by weakness in Europe, China and the US, oil demand growth remained slow, ultimately leaving global excess largely unchanged at ~2mbpd. Over the rest of H1 16, we think the near-term trajectory for oil prices will be heavily influenced by the outcome of a new round of freeze discussions scheduled for April 17, particularly as more major oil producers—including Iraq and Iran—are expected to join. However, with Iran still looking to bolster oil output to pre-sanction levels of ~4.1mbpd (vs. 3.3mbpd currently) and no firm commitment from Iraq where output climbed (8% QoQ to 4.3mbpd) even as Saudi Arabia ruled out an imminent cut, supply side dynamics are likely to remain intact in the near-term. On the other hand, amidst slowing growth across EMs, and growth concerns in DM, we expect oil demand growth to remain weak. On balance, we expect an extension of the glut over the coming months, and thus retain our $30.00-$35.00/bbl oil price band over the rest of H1 16.
Weather shocks drive recovery in soft commodities
Commodity prices remained relatively bearish in Q1 16 with the Jefferies CRB declining (-2.2% QoQ) and S&P GCSI relatively flat. Disaggregating performance on a monthly basis, continued over-supply concerns across most commodities drove an 8.1% MoM slide in January led by metals and crude oil whilst agricultural commodities posted a flat performance. In February, commodity prices rebounded 2%, buoyed by the bounce in crude oil (+8.5% MoM largely) on prospect of the oil output freeze by major producers and rebound in metal prices (5% MoM) aided by strong Chinese demand ahead of the summer construction season, even as agricultural commodities stayed flat. The flat trend for soft commodities reflect the impact of divergent drivers—weather shocks and oversupply—on prices. In particular, palm oil and rubber prices rose 17.5% and 21.4.% respectively in Q1 16 as dry weather, primarily due to El Nino event, as well as cutback in (particularly for rubber), continue to affect production in Asia (Indonesia, Malaysia and Thailand) while responding to fairly robust supplies amidst waning EM demand, prices of sugar (-2.54%), wheat (-3.28%) and cocoa (-7.8%), respectively.
Figure 3: Jefferies CRB and S&P GSCI Indices performance
Going forward, whilst global commodities markets should remain well supplied, raising scope for some down leg in prices, we think, like in Q1 15, ravaging El Nino should result in mixed outlook for commodity prices. For wheat and sugar we expect production surpluses to add to the global glut, causing further declines in prices. On the other hand, we expect the impact of El Nino and below average monsoon fall which, combined, have reduced planting and curbed output yields in India, Thailand and China, to sustain the upswing in CPO and rubber. For cocoa, we expect a rebound in prices as the global cocoa market swings into deficit over 2016—the first time in three years.
Key Developments in Domestic Economic and Policy
Governance begins with diplomacy but does charity only begin at home?
Much has been made of President Muhammadu Buhari’s trips abroad since he assumed office. In the face of severely pressured government revenues, the globetrotting appears driven by a drive to recover stolen public funds stashed in foreign banks. Whilst there’s some evidence that the president’s efforts are yielding fruit with the American, British and Swiss governments pledging to repatriate loot totaling at least $750 million (21% of FAAC allocation for January and February), severe challenges in other parts of national life (economic, insecurity) and harsh economic realities inevitably raise the question of whether the focus on corruption is undue.
For instance, despite significant gains in the fight against Boko Haram, cases of kidnapping and politically-motivated killings appear to be on the rise with Rivers State a case in point. Moreover, resumption of pipeline vandalisation and violent clashes between herdsmen and locals in several parts of the country—at least 300 persons were reportedly killed recent clashes in Benue State—have introduced a worrisome dimension to the nation’s insecurity challenges. In many ways, the various sociopolitical issues abut on each other. Whilst suggestions that the focus be on attempts to explore domestic alternatives to weak revenue are valid, time constraints to make these effective also mean that a ready pool of cash e.g. via loot recovery, is very valuable at this time. Similarly, the modest gains with insecurity might prove of little value if economic activity fails to recover even after a significant time lag. It is against this back drop that we feel the issues are not as ‘either-or’ as popularly couched. Regardless of preferred choice of focus of its individual members, we think the polity is getting collectively more anxious about a clear-cut achievement that will finally kick-start economic activity.
Budget: Lost, found, padded; eventually passed but still unsigned?
One particular area that checks the boxes of being economically significant but recording slower-than-expected progress is the budget. In February, the National Assembly reported that the 2016 budget was riddled with repetitions of items and inflated provisions. Coming just a month after the entire document was said to have disappeared, the president ordered an investigation which led to the sack of the DG of the Budget Office and 26 other top civil servants. Understandably, the rigmarole on the budget has made the president cautious in signing the 2016 budget version eventually passed into law. Notwithstanding, the criticality of the budget to national economic life re-emphasizes, if at all needed, the anxiety surrounding economic prospects. For us, simply based on the budget delays and without any growth numbers being released for 2016, we have been forced to lower our GDP growth forecast by 60bps to 2.9% in tune with our assertion that our forecast was very sensitive to materialization of the fiscal stimulus embedded in the 2016 budget.
Surge in FG independent revenue ameliorates dip in FG’s FAAC allocation
Similar to the preceding quarters, Q4 15 gross federally collected revenue contracted 28% YoY to N1.6 trillion (-16% QoQ) as the plunge in both oil and non-oil proceeds continued over the period. Consequently, FY 15 gross federally collected revenue was down 31% YoY to N6.96 trillion. In Q4 15, oil receipts dipped to N830 billion (-53.3% YoY)–the lowest in 25 quarters—as lower oil prices of $44.69 on average (-42% YoY) offset the modest pickup in crude oil production (+2.7% YoY to 2.2mbpd). On the other hand, Q4 15 gross non-oil revenue reversed the negative trend witnessed in the last two quarters (+3% YoY to N770 billion) buoyed by a surge in Companies Income Tax & Other Taxes (+38% to N279 billion) which more than offsets declines in VAT (-8% YoY to N178 billion), Customs and Excise Duties’ receipts (-10% YoY to N142 billion) and Other proceeds (-11% to N172 billion). Nonetheless, reflecting lower receipts in the first 9 months of 2015, FY 15 gross non-oil revenue declined 5% YoY to N3.1 trillion.
Interestingly, despite the sharp drop in gross federally collected receipts in Q4 15, FG’s retained revenue contracted only 2.5% YoY to N818.4 billion. The modest dip was underpinned by the 80% YoY surge FG’s in independent revenue7 to N310.2 billion (QoQ: +245%) perhaps reflecting government’s success at plugging leakages following the implementation of the Treasury Single Account (TSA) late Q3 15. Nevertheless, like in prior quarters, retained revenue fell 12% short of budget estimate on low FAAC receipts. Tracking the modest slowdown in FG’s revenue, total expenditure in Q4 15 was ~5% lower YoY at N1.1 trillion leading to an 11% YoY contraction in Q4 15 fiscal deficit to N289.1billion (FY 15: N1.04 trillion). Interestingly, capital spend jumped 83.4% YoY to N352.2 billion as the FG released funds that had stalled in the build up to the 2015 general elections and subsequent change of government in May. Accordingly, Q4 15 capex ratio of 32% is the highest in more than five years. On the flip side, though recurrent expenditure was cut 27.2% YoY to N660.1 billion it came in line budget projection.
Going forward, the outlook for government revenues remains bleak due to continued pressure on key revenue streams. For oil receipts, depressed oil prices and prospect of lower oil production due to rising cases of pipeline vandalisation should keep receipts low, even as slowdown in economic activity, partly due to forex shortage and tepid outlook for corporate earnings suggests non-oil receipts will remain soft. This prognosis leaves our updated 2016 budget deficit unchanged at ~N3 trillion.
Economic Review and Outlook
Economic growth challenges show no sign of abating…
Nigerian economic growth8 slowed to a fresh trough of 2.11% in Q4 15, implying 73bps and 383bps deficits to Q3 15 and Q4 14 numbers respectively, and paring FY 15 economic growth to a 16-year low of 2.89%. Weaker growth mirrored compression in oil sector (-8.1% YoY) following 5% YoY decline in crude production to ~1.89mbl9; owing to several disruptions along the Trans Niger, Nembe Creek and Forcados pipelines over Q4 15, as well as narrowing oil prices.
Elsewhere, non-oil sector held steady—for the second consecutive quarter—at 3.1% YoY over Q4 15. Cascading to non-oil sub-sector performance, we note that whilst construction faced negative growth over Q4 15 (-0.35% YoY), other subsectors returned positive growths in the period. Notably, manufacturing bucked a three quarter negative trend to post positive growth (+0.6% YoY) following 2.8% YoY expansion in Textiles, Apparel and Footwear (TAF) and a softer contraction (Q4: -5.6% YoY, Q3: -8.9% YoY) in Food, beverage and Tobacco (FBT) manufacturing. On other fronts, growth in agriculture and services were constrained at 3.5% YoY and 3.3% YoY over Q4 15, relative to prior quarter growths of 3.5% and 3.8%. On services, we note that the impact of recent regulatory activism on MTN, which resulted in the disconnection of 5.1million lines and impacted subscriber growth, as well as restraint demand for luxury real estate and bulging oversupply of office space were key pressures for its telecommunication and real estate sub-components over Q4 15. Going forward, we retain bearish outlook on overall GDP on the back of extended delays in the passage of 2016 budget which was meant to signpost a kick-start of stimulatory fiscal spending that would support production in non-oil segments of the economy. Beyond this, we expect oil GDP to continue to track declines in oil prices in the coming periods. Consequently, we retain our 2016 GDP forecast of 2.9% YoY (+/-50bps).
…though significant decline in food imports trims trade deficit
Besides weakness in domestic production, Nigeria recorded external trade deficit of $973 million in Q4 15 (vs. $152 million surplus in Q4 14) as ~38% YoY dip in exports to $10.2 billion more than offset the impact of 32% contraction in imports to $11.2 billion. On a QoQ basis though, Nigeria’s deficit significantly narrowed by 49%, owing to a sharper decline in imports (-11% QoQ) relative to exports (-4% QoQ). According to data provided by the Nigerian Bureau of Statistics (NBS), import decline in the quarter primarily reflects significant contraction (-33% QoQ) in the value of food and live animals importation (largest component of total imports in prior quarter) as well as declines in importation of manufactured goods (-8% QoQ) and machinery & transport equipment (-7% QoQ). In our view, a more aggravated foreign exchange shortage over Q4 15—which sent interbank/parallel spread to a then all-time high of 32% in December 2015 and forced CBN into greater FX rationing—appears to be the latent restraint on imports in the review period. At the other end, slight contraction in QoQ export mirrored ~4% declines in crude oil export to ~1.44mbd.
Thus far in 2016, recent releases suggest gradual improvements in Nigeria’s trade balance, with February numbers (+$183 million) indicating a return to surplus for the first time in five months, owing to currency-induced import slowdown. Whilst we expect currency issues to keep importation reasonably constrained, oil exports is likely to be pegged-back by incessant downtime at strategic pipelines such as Trans Forcados (TFP), with organisations such as SEPLAT already bracing up for significant down-time over the first half of the year. This increases prospects for renewed balance of payment pressures over the rest of 2016.
Headline inflation accelerated in each of the first three months of 2016, with March reading at a near four year high of 12.8% (February: 11.4%). Besides spelling a return to double-digit inflation, current readings tilt YTD average 291bps higher YoY to 11.25%, relative to CBN’s 6 – 9% target. Headline pressure was mainly underpinned by the 364bps YoY surge in mean core inflation to 10.69%, largely due to sharp increases in average prices of its energy-related components—
Tripod of forces heralds return to double-digit inflation
Headline inflation accelerated in each of the first three months of 2016, with March reading at a near four year high of 12.8% (February: 11.4%). Besides spelling a return to double-digit inflation, current readings tilt YTD average 291bps higher YoY to 11.25%, relative to CBN’s 6 – 9% target. Headline pressure was mainly underpinned by the 364bps YoY surge in mean core inflation to 10.69%, largely due to sharp increases in average prices of its energy-related components— particularly in HWEGF. In our view, high energy inflation in the period was driven by a combination of higher retail prices of kerosene (+66% YoY to N83/litre), electricity tariff (~50% to 70% YoY jump), as well as severe PMS scarcity (+15% YoY over Q1 16). Elsewhere, renewed pressures in farm produce (+207bps YoY to 11.9%) and imported food inflation (452bps YoY to 13.2%)—owing to higher transport cost and currency pressures—underpinned 230bps YoY jump in food inflation to 11.6%. Overall, our earlier identified tripod of inflation drivers coming into 2016 (higher electricity tariff, naira volatility and PMS scarcity) dominated inflation discuss thus far in 2016. Farther out, lingering PMS scarcity bolsters our expectation for continued pressures on prices in the coming periods. Thus, further aided by gradual depletion of carry-over stock as lean season approaches, we project a 57bps rise in headline reading to 13.4% for April 2016 with our target FY 16 average now at 12.79% (+/- 0.5%).
CBN finally wields hammer on Nigeria’s low real sector lending
Broad money supply (M2) rose 24% YoY over the first two months of 2016 as the impact of increases in demand deposits, currency in circulation, and quasi money more than offset declines in net foreign assets. In addition, while net domestic credit rose 27% YoY, much of that growth was largely reflective of higher commercial bank lending to the federal government (over nine-fold higher YoY to N4.8 trillion) as credit to private sector grew only a tame 1.9% YoY. The preference for FGN securities by commercial banks is in line with our view in the H1 16 strategy report that heightened credit risk would weigh on banks’ lending appetite.
Responding to the tepid credit to private sector, as well as the need to ensure positive real returns on investments—which turned negative following the spike in inflation—the CBN switched to hawkish monetary policy stance by tightening rates and CRR as well as narrowing its asymmetric corridor. The Apex bank’s hawkish stance in the face of its often stated (and also reiterated at the March MPC) plan to stimulate output growth, signals a shift in the CBN’s strategy for stimulating economic. Importantly, the committee noted that despite the “notion of liquidity overhang in the financial system, the wider economy appears starved of the needed liquidity to spur growth and employment”. Thus, rather than rely on banks to extend credit, we think the CBN will set-up more special-intervention funds for on- lending by banks to select sectors. However, while on the surface these initiatives might appear laudable, it is tantamount to using the same approach and expecting a different outcome. The CBN has set up over N1.3 trillion special intervention funds in the last five years, yet reported credit to private sector as persisted lagged target.
Parallel market rates remain in doldrums
Over Q1 16, naira remained flat at N199.05 as CBN held on to its interbank FX market rate peg, albeit at the expense of declines in foreign reserves (-6.5% YoY to $27.9 billion). Despite the stability at the interbank, dollar supply at this window remained soft. To buttress, the apex bank cut back FX sales across sectors, including its previously identified preference list (raw material imports, petroleum products, equipment and machinery). The impact of the lower supply was more visible in the downstream sector were the CBN cut average monthly forex supply for oil imports by 43% YoY to $376 million in Q1 15, forcing the NNPC to assume near 100% responsibility for PMS importation. Expectedly, this shifted a lot of demand to the parallel market, which combined with increased speculation due to rumours of planned ban of FX sales for overseas school fees and medical bills, drove rates to stratospheric levels of N380.19 in mid-February before slightly moderating on increased autonomous dollar supply. Nevertheless, parallel/interbank FX market rate closed the quarter 60% higher than FY 15 level.
Notwithstanding the spread and sustained attrition reserves, the CBN remained adamant towards naira devaluation. In fact, at the March MPC, the apex bank also linked the rate hike to the need to keep domestic bond yields competitive to attract the much needed foreign portfolio flows to support the exchange rate. The renewed interest in FPI, which the CBN, in concert with the fiscal authorities, quite consciously abandoned to focus on domestic growth stimulant—following the expulsion of FGN bonds from the JP Morgan index—is at best a policy “somersault”. Indeed, while this new tack fits firmly with conventional monetary policy response to external balance pressure, empirical evidence show that exchange rate benefit of restrictive monetary policy side-by-side with an expansionary fiscal policy10 accrues where capital mobility is high. As this is not the case with Nigeria, a scenario complicated by current FX restrictions, we see limited legroom for possible attraction of new FPI. This, given our pessimism on the effectiveness of this move, we maintain our call for a shift in the current naira peg, though we note that lack of presidential assent makes the timing of highly dependent of fiscal side. In all, as the CBN keeps its grip of the peg, we expect further market dislocation to result in sustained increase in parallel market premiums.
Capital Market Review and Outlook
Oil price gyrations underpin NSEASI Q1 performance
Coming into the year, we had highlighted in our NSR H1 16 outlook how a sustained rout in global crude oil markets, continuing global monetary policy discordance and delayed feed-through from domestic fiscal stimulus would combine to leave markets in bear territory. In line with our call, Nigerian equities slid over Q1 16 (-11.6%), extending the bearish run since Q3 15 as the negative drivers manifested. Starting off in January, when Brent crude hit thirteen-year lows of $27/bbl, NSEASI posted its worst monthly performance since January 2009 sliding 17% MoM. Subsequent recovery in Brent over February (+4% MoM) and March (+8.5% MoM) helped the NSEASI pare back YTD declines with 3% MoM gains in the latter two months of Q1 16.
Beneath the volatile patterns in crude oil prices, one thing was constant – foreign interest in Nigerian equities over the period maintained its downward trajectory as in over 2015 while domestic activity moved in tune with the oil price dance step. In January, the oil price plunge resulted in FPI remaining net short (N9.3 billion) while domestic transactions fell to a fourteen month low (-46% MoM to N40.7 billion). Despite a recovery in oil over February, foreign inflows into Nigerian equities, at N10.9 billion, slid to its lowest level since NSE began providing monthly FPI breakdowns whilst net outflows more than doubled MoM to N21 billion. Nonetheless, domestic activity rebounded (+82% MoM to N74.5 billion) pricing in oil driven recovery in macro-fundamentals (and possibly an eye on attractive dividend yields) which drove February’s gain. The positive trend extended into March as a stream of results and dividend announcements helped offset negative triggers (uncertainty over the 2016 budget passage, rising inflation, weak GDP growth numbers) leading NSEASI higher for the second consecutive month.
Disaggregating market performance on a sectoral basis, sell-offs in the banking sector (-21% QTD), reflecting investor anxiety over impact of oil price on O&G exposures accounted for 34% of NSEASI downturn over the period. In addition, our attribution analysis reveals that investors priced in impact of delayed fiscal stimulus, via legislative holdups to budget, on defensives (Food: -15%, Brewers: -18%, Personal: -25 %) and cement (-4%) in driving negative market performance over the quarter.
Fundamental factors drive retention of a bearish prognosis
Over the rest of H1 16, whilst oil prices show signs of finding a bottom, current FX market illiquidity should continue to stymie foreign interest on the domestic bourse. Thus, domestic investor considerations should play a pivotal role in charting equity market outlook in Q2 16. However, on this wise, recent twist in monetary policy and resultant rise in interest rates raises the hurdle rate of equity exposures which should drive heightened domestic investor sensitivity to fundamentals. Scanning across the various sectors, despite parliamentary approval of the 2016 budget, fresh delays on the executive front should result in lagged feed-through from proposed fiscal stimulus for materials, construction and FMCG companies. Furthermore, resurgence in energy challenges and other inflationary pressures (electricity tariffs, rising parallel FX premiums) add more pressures on already constrained consumer purchasing power which stokes prospect for revenue weakness. On the flipside, the tightening posture and recently released draft fee guide for banks should provide some respite for bank earnings, already under pressure from impact of the economic downturn on loan creation and asset quality. Elsewhere, while recent uptick in crude oil prices should be a boon to upstream O&G, production challenges and still lower average prices relative to 2015 levels point to softer earnings trajectory. For downstream O&G, delayed sector deregulation and ongoing bouts of fuel shortages retain a broadly weak outlook. On balance, we see lagged economic policy response to the tepid economic landscape as driving a bearish market outlook over Q2 16.
Monetary policy switch widens yield curve
The Naira yield curve expanded 219bps QoQ to 10.03% in Q1 16, reversing the monetary easing-induced slump over Q4 15 (-545bps QoQ). Crucially, the widening across the curve (T-bills: +315bps and Bonds: +124bps QoQ), is at variance with the call in our H1 16 strategy report for further compression over the period. Specifically, we expected that an extension of monetary easing cycle by the CBN would blunt any upward pressure on the yield curve that could be induced by higher bond sales. In line with this expectation, though Q1 15 bond sales (~N300 billion11) were 24% higher YoY, the accommodative cycle which prevailed for much of the period acted as a dampener. Indeed, nearly 80% (+168bps MoM) of the aforementioned upswing in the yield curve was in March following tightening over the month and the eventual switch in monetary thrust to a hawkish stance.
Examining yield movement on a monthly basis, like in Q4 15, monetary influence remained the key driver. Specifically, the 70bps MoM leap in the yield curve over January was underpinned by aggressive increase in OMO sales to N700 billion which resulted in first liquidity mopup (N120 billion) in 7 months and dragged system liquidity 31% lower MoM to N570 billion. The short-end of the yield curve rose 50bps on average, with additional concerns on fiscal balances, after oil slumped to 12 year low, adding more pressure to cause a more significant 93bps increase at the long end. Over February, the yield curve contracted 10bps MoM as the Apex bank cut its open market operations, with nearly N100 billion into the system. However, this dip was reversed in March underpinned by the reversal in monetary policy, with the respective hike in CRR and MPR to 225bps and 100bps.
Thus, while the influence of monetary policy on yield direction remains intact, as expected, the drastic change in policy direction dictates a closer look at the motivations for that change, the likelihood of its persistence and the possible implications. Crucially, in arriving at its decision, the CBN noted that, instead of lending, banks were channelling excess liquidity created by accommodative stance into the foreign exchange market with a strong pass-through to consumer prices, which spiked to 11.4% (+180bps MoM). Given heightened credit defaults that triggered increased asset write-down in 2015, banks are likely to continue on this path, raising the odds for an extension of monetary hawkishness. However, we think economic growth concerns as GDP likely slow further in Q1 16, leaves limited headroom for further tightening. Thus our base case is for monetary policy to be stable over the rest H1 16. Importantly, our view takes cognisance of inflationary pressures, but faced with stagflation, we think growth concerns will outweigh. On the fiscal side, bearish outlook for oil prices should see extant fiscal pressures persist, leaving the FG little option than to continue to ramp up borrowing. Significantly, despite the increase in revenue collection via the Treasury Single Account (TSA), with current balance in excess of N2 trillion, we note that ~N1 trillion of this sum is already captured in the FG’s 2016 revenue projections, with the balance largely for pending commitments. Indeed, it would appear that the FG has taken cognisance of this reality with proposed bond issuance of N295 billion for Q2 16 ~50% higher YoY. In all, the new found hawkishness of the CBN, combined with prospects for elevated FGN borrowings, raises scope for some widening of the yield curve over the rest of H1 16. Nevertheless, we see limited headroom for yields as weak macro limits the aggression of monetary tightening, even as it encourages banks to ‘fly to safety’.
Capital Market Strategy
Filter search for value
Heading into 2016, our base case was for a weak macro-landscape on account of the oil price shocks to combine with current FX restrictions to temper foreign participation in Nigerian equities, leaving domestic considerations to exert greater influence on market outlook. On a sector basis, we anticipated the planned fiscal stimulus would be positive for FMCGs and cement stocks with the latter aided by modest valuation multiples. However, even more attractive valuation numbers amongst financials seemed incapable of countering the pessimism from weak asset quality and dovish monetary policy. However, the overarching tone was still to be set by oil prices whose search for a floor foreboded volatility.
Going forward, whilst oil prices have posted a quicker recovery to $40/bbl than we expected, subsisting glut and still unclear prospects for an output freeze leave room for further price volatility over Q2 16, with a near-term downside bias. Combined with current FX restrictions, we see an extension of net short FPI positions on Nigerian equities over Q2 16. On the domestic leg, the recent hawkish twist to monetary policy and persisting delays in the deployment of fiscal stimulus poses new headwinds to equity investors. The former provides scope for FI instruments to return to favour with domestic investors while the latter dampens outlook for non-financials, in particular. Whilst the switch to monetary policy tightening should be positive for banks, reduced prospects for risk asset creation, a fall-out of the weak landscape, and continuing asset quality issues should drive investor pessimism towards the sector. For non-financials, the delayed fiscal stimulus and hawkish monetary policy stance pose dual shocks to topline and earnings whilst for cement the sizable upswing in capital spending is valuation positive, though as with FMCGs delayed budget passage and lack of clarity on financing temper optimism on sector outlook.
In summary, a weak macro-economic backdrop, delay in fiscal policy execution and onset of tight monetary policy underpin a beleaguered outlook for the broader equity market leaving a stock selection focused approach in Q2 16.
Fluid policy milieu calls for dynamic portfolio management
The switch in monetary policy thrust in the final month of Q1 16, largely underpinned the deviation of yield trajectory from our expectations over the period. Nevertheless, strategy-wise we appear to have been spot-on. Specifically, though we noted that yields were likely to stay depressed on average, we saw enough vagueness on the fiscal and monetary front, given revenue pressures and inflation risks, respectively, to tweak our year-long duration building play by recommending that investors increase allocation to trading book to capture expected bumps on the yield slope. We believe timely execution of this tactic would have minimized P&L losses caused by the ‘surprise’ upswing in yields. Over Q2 16, amidst the frail macro-economic landscape and falling fiscal receipts, which casts doubt over full implementation of the 2016 budget, the recent executive/legislative squabble over contents of the budget adds another layer of uncertainty to fiscal tale.
Perhaps the difference is that whilst we expected fiscal issues to result in short-lived spikes, encouraging trading, the switch in monetary policy suggests the elevation in yields could be expected. Unfortunately the monetary side of things holds little improvement over the seemingly torpid fiscal side. Aside the surprise hike itself, the stimuli that should influence policy pose contradictory hurdles themselves, considering heightening inflationary pressures and forex shortage in the face of slowing economic output and rising unemployment. This further compounds outlook and we expect Q2 16 to be murkier with heightened interest rate volatility. Incidentally, this prognosis favours an extension of our trading-focused FI strategy, with even greater weight on monetary influence. In our view, a switch to a more permanent approach would at least require inflation to ‘settle’.
Related News from ARM’s H1 2016 Nigeria Strategy Report