Friday, November 28, 2014 14:54 PM / Meristem Research
Global oil prices have plunged 36.62% so far in the year, as the Brent crude price settled at USD70.40 vs. USD115.00 year high. Economies of highly oil dependent economies like Nigeria, Venezuela, and Iran have seen crashing oil prices impact negatively on government revenue, as well as fiscal and monetary buffers.
In a bid to salvage the disturbing macroeconomic indicators in Nigeria (Dwindling Reserves, FX volatility and impairing government revenue) as a consequence of the above, the FGN has proposed measures to better manage government spending, whilst the MPC on the other hand decided in its last meeting for the year; to devalue the Naira by 8.39% from NGN/USD155.5 to NGN/USD168 (with the trading band extended to +5% from +3%), hike MPR from 12% to 13%, and further sterilize bank liquidity by raising the CRR on Private sector deposits to 20% from 15% with immediate effect.
In a related development, OPEC members concluded its 166th Meeting of the Conference of the Organization of the Petroleum Exporting Countries (OPEC) yesterday. OPEC’s decided not to cut the group’s production quota, instead allowing market forces to dictate the equilibrium price.
In this report, we reassess the pass-through effect of the above policy measures on household demand, corporate performances, financial market outlook, External sector implications and the overall macro economy.
MPC devaluates the Naira by 8% ... as OPEC retains supply
In a rather shocking yet decisive move by the MPC, the apex bank announced the devaluation of the Naira against the greenback by 8%. The Committee also decided to raise MPR from 12% to 13%, whilst sterilizing more of the funds from the banking sector by increasing CRR on private sector deposit to 20% from 15% In what seemed like a foreseen decision by the MPC, OPEC members refused to cut supply at the end of their highly anticipated Meeting of the Conference of the Organization of the Petroleum Exporting Countries (OPEC) held on the 27th November, 2014. The cartel emphasized the need to allow the market restore itself to equilibrium in the face of the current supply glut, weakening demand, Russian/Ukrainian and Middle east crises, and the growing threat posed by shale oil production by the United states of America.
Whilst we welcome the decision of the MPC to devalue the Naira in the face of the dwindling reserves, we believe OPEC decision not to cut prices remains a threat to accretion to the FX reserves. Case in point of this concern was the USD667mn sold by the CBN at the last RDAS auction on Wednesday 26th November 2014, against USD200mn initially planned to defend the Naira. Events in political space and security concerns also remain a cause for concern. Although attractive asset prices and yield environment may offer some short term relief.
Corporates Performance to be pressured by Higher Cost
Naira devaluation will affect import prices with an ensuing effect on manufacturing/production costs given the level of import dependence of the Nigerian economy. Hence, we expect higher input and raw material costs, implying higher cost to sales margin for players in the consumer, industrial goods, Health care and other import dependent sectors. This is further worsened by higher finance charges for firms with exposures to foreign exchange risk most especially if not hedged appropriately. The 100bps hike in MPR to 13% further worsen this as cost of borrowing becomes higher.
With the likelihood of the above holding, we imagine hike in the prices of these commodities, with a follow-on effect on inflation.
Real Wages Wanes, Savings and Investment Sags
Whilst devaluation in itself has an inflationary tendency as noted above, higher borrowing and production costs weakens the real wage rate, and consequently the disposable income of households and individual consumers.
We expect that the compounded effect of devaluation, hike in rates, and less government spending will depress savings despite attractive interest rates, lower private sector Investment and soften effective demand in the system.
Financial Market to Gyrate and Moderate
Studies of Equities market performance and devaluation has shown that investor’s expectation of devaluing often trigger sell offs in the financial market thereby leading to cheaper asset prices. This position is buttressed by the bearish sentiment witnessed in the Nigeria Equities and Fixed Income market prior to the just concluded MPC meeting, when the Equities tumbled 18.95% in 4 weeks (between October 8th and November 7th on the back of disturbing developments in the global oil market, dwindling reserves, and huge pressure on the Naira, even as unrest in the North-eastern region and political intrigues persist.
Consequent on the above, devaluation itself is actually expected to bring about a bullish run in the market as prices are often cheaper most especially for foreign portfolio investors after the prior sell-off. Also, in the Fixed Income (FI) market, an MPR increase from 12% to 13% makes yields more attractive as average T-bills yields advanced by 0.38% in the day after the announcement.
Besides, we think the move by the apex bank to salvage the dwindling reserve and stabilize the economy no matter what it takes, send a positive signal to investors (both local and foreign) and instils a level of confidence in the commitment of the bank to stabilize the economy.
On the basis of the above, we believe the Equities and Fixed Income market may witness a bullish run in the short term since as foreign investors who may have exited the market prior to the devaluation, may be attracted by attractive prices and increased buying power for equities, as well as higher yielding FI instruments. Yet, probable headwinds in the economy going into 2015 are still a major source of concern as to the sustainability of this drive.
Overall, we believe the market will witness a level of gyration in the short term due to these developments but moderation is expected to set in in the medium to longer term.
A Monotonous Economy, Ripe Time to Diversify
As earlier said, Nigeria is a monotonous economy with Crude oil making up 94% of our exports according to OPEC. Nigeria import most of its products even those, which the country ordinarily should provide capacity to produce locally. Oil refining is a good example here, Nigeria refines significant portion of its oil abroad despite having a good number of local refineries.
Whilst devaluation is supposedly expected to favour exports and discourage importation, in our view, a country with 94% crude oil export and high import dependence may not benefit much from such a policy. Hence, we not see significant impact of the policy on exportation. More so, this further re-emphasizes the need for Nigeria to diversify its export base.