Monday, July 06, 2015 4:13 PM / ARM Research
FG’s hiatus triggers varied market reaction
The post presidential inauguration period has been relatively quiet so far, as the new government is yet to announce key officials or give an incline into policy thrust. Despite the lull, the pronouncement by the President that the treasury is virtually empty and, more importantly, subsequent assurance that the FGN will do its best to recover loot, alongside disbanding of board of NNPC, suggest the anti-corruption drive contained in the APC manifesto remains intact. Nonetheless, with no statement on the economy, the suspense generated mixed market reaction in June with the NSEASI falling 2.5%, naira appreciating 20bps while the yield curve stayed relatively flat, save for the spike two days to the end of month.
State governments set for rollercoaster ride as weak IGRs expose vulnerabilities
Meanwhile, state governments appear to be feeling the brunt of the softer oil receipts with months of unpaid salaries stretching as long as 8 months in some cases. Beyond the anguish faced by the employees of the affected states and implication for aggregate demand, the financial crunch faced by states serves as a vivid reminder of their overreliance on the central purse. Although FAAC allocation for May (distributed in June) rose 5.4% MoM to
N409 billion, it remained substantially below prior levels when oil prices were elevated. The dire fiscal state thus brings to the fore, the issue of Internally Generated Revenue (IGR) which was usually glossed over in the era of high crude oil prices.
Excluding Lagos State, IGR of each of the remaining states is less than 20% of expenditure, and with a number having relatively stable ISPO deductions due to financial obligations, the source of susceptibility becomes apparent. Notably, the states are not the only culprits in this regard as the FGN’s independent revenue, as contained in 2015 budget, is set to fund only 11% of expenditure even if met. Amidst flagging global growth, OPEC’s stance on oil supply—reaffirmed at its June 4th meeting—suggest that a sharp rebound in oil prices is unlikely in the near-term. Thus, it would appear that the only option for the different tiers government is to ramp up IGR. This reality likely informs the on-going enforcement of remittances of 25% of gross revenue by MDAs to the FGN, even as the CBN issued a reminder to the February 2015 circular which compels banks to remit such funds to the CBN timely or face sanctions. At the state level, weak structures suggests that it could take months for IGR drive to gain some traction, thus it would appear that cost cutting measures, which a number of states have already announced, are the near-term solution.
Subsidy remains the spanner in the works
Elsewhere, and in line with our expectation, the subsidy theme remains at the fore front with recurring cycles of petroleum products shortages and attendant consequences of same stimulating increased support for subsidy removal. Amidst the President’s statement on the weak financial position of the nation, the sharp reduction in budgeted subsidy expenditure for 2015 suggests that without a pronouncement on the subsidy regime, the bouts of petroleum products scarcity will linger as the NNPC is unable to adequately cover the shortfall of other importers. Importantly using PPPRA’s template, based on average subsidy per litre of
N30, we estimate PMS subsidy bill of at least N600 billion (vs. N100 billion in the budget). Incidentally, though not expressly captured in the budget, subsidy is implicit in the NNPC’s ‘crude oil for refined products’ swap and offshore processing agreements.
Naira extends monthly gain amidst deteriorating fundamentals
The USDNGN appreciated for the fourth conservative month shedding
N0.46k to N197.47/$ in June (May +0.3% MoM). On the other hand, forex reserves gave up the gains from prior month, falling at the quickest pace in three months to a near 10 year low of $29.02 billion (-0.9% MoM). The extended naira gain, in the face of the pull back in reserves, suggests increased intervention by CBN, and its determination, to stabilise the currency. Perhaps worried about waning ammunition given latent demand, the CBN at the tail end of the month, issued a new circular, updated three times, that barred 41 (initially 40) items including rice, cement and poultry, from the forex exchange market—interbank, export proceeds and BDC segments. Unsurprisingly, the interbank parallel spread widened from N18/$ to ~ N27 by the end of the period. Furthermore, concerns on stability of the naira persist as forward transactions remain elevated. Specifically, while spot forex transactions have normalised since the switch to the OB2WQ, forex derivatives transactions have remained at the stratospheric level attained since the H2 14 oil price rout.
Importantly, recalling similar spree of circulars prior to the February closure of RDAS, we view the latest circular, particularly the subsequent spate of updates, as pointers to jitters within the CBN regarding naira stability. While the apex bank appears reluctant to embark on another round of devaluation, quivering fundamental picture suggests it might be swimming against the tide, in the near-term. Buttressing this point is the trade deficit which has persisted since Q4 14 largely due to lower exports as imports have steadied; a pattern we believe is unlikely to significantly change in the near-term. Furthermore, diminished prospects of an increase in autonomous forex inflows due to a possible hike in US interest rates and forex market illiquidity, domestically, suggests current pressures are likely to subsist. Late spike pushes yields to 3 month high
Importantly, recalling similar spree of circulars prior to the February closure of RDAS, we view the latest circular, particularly the subsequent spate of updates, as pointers to jitters within the CBN regarding naira stability. While the apex bank appears reluctant to embark on another round of devaluation, quivering fundamental picture suggests it might be swimming against the tide, in the near-term. Buttressing this point is the trade deficit which has persisted since Q4 14 largely due to lower exports as imports have steadied; a pattern we believe is unlikely to significantly change in the near-term. Furthermore, diminished prospects of an increase in autonomous forex inflows due to a possible hike in US interest rates and forex market illiquidity, domestically, suggests current pressures are likely to subsist.
Late spike pushes yields to 3 month high
Fixed income yields reversed the trend of three consecutive months of contraction, with a 100bps MoM rise, on average, in June to 14.36%. This increase however, is far from the real story as yields were flat to lower for most of the period despite aggressive monetary tightening with net OMO issuance in excess of
N200 billion helping halve system liquidity to N117 billion. Specifically, yields were 14bps lower three days to the end of the period before a 113bps spike in the last two trading days. The flat trend despite monetary tightening, suggest investors ramped up purchase of fixed income instruments in view of diminished political risk. Indeed, bid range at the June bond auction tightened to the narrowest (2.63 on average) since hike in policy rates in November 2014, even as marginal rates were the lowest in 7 months. Although political risk has eased, the spike at the end of the month suggests investors were responding to other brewing risks. Specifically, we believe the forex circular, particularly the spate of updates, stoked concerns of monetary tightening by the CBN, and combined with lack of policy direction from the government, caused investors to choose to stay in cash. Indeed, while yields were rising, call rates trended lower to close at a 6 month low of 7%.
Interestingly, the official body language appears to discount the perceived risks. The DMO released Q3 15 issuance calendar wherein proposed issuance is ~5% higher at
N210 billion and appears to deviate from desperation expected of a government facing fiscal pressures. Whilst the FGN’s external borrowing plans is set to create some comfort, we believe the haziness of the policy thrust of the new government is seeing the DMO maintain status quo on borrowings, particularly given plans to recover looted funds. In particular, the President stated that “the next three months may be hard, but billions of dollars can be recovered, and we will do our best.” For the monetary authorities, currency worries will likely underpin an extension of the current tight monetary stance. Overall, monetary tightening amidst uncertainties around economic direction is likely to drive steepening of the naira yield curve as investors continue to stay short.
Energy cost pass-through extends CPI upward path
Energy cost pass-through extends CPI upward path
The National Bureau of Statistics (NBS) reports that headline inflation rose for the sixth consecutive month to a two year high of 9% YoY (+30bps ) in May--in line with our forecast. Underpinned by the acceleration in the food and core sub-indices, MoM CPI reading rose at the quickest pace in 3 years to 1.12%. Increase in the core index was driven by higher energy prices due to scarcity of petroleum products in the period, which incidentally dovetailed in to higher food prices as transport cost surged. Amongst food items, the NBS notes Fish, Potatoes and yams as recording the highest increases in the period.
Going forward, a combination of factors points to extension of the upward trajectory. First, lower household stocks should induce a pickup in market demand this lean season, which coincides with fasting season, driving farm produce prices higher. Furthermore, with no pronouncement on the subsidy regime, we expect bouts of shortages to persist with pass-through via higher transport cost to also impact food prices. Thus, we expect a 20bps expansion in headline inflation to 9.2% (+/- 20bps) in June.
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