Uptrend in core and food sub index push inflation higher - May 2014


Thursday, June 05, 2014 10:29 PM / ARM

Headline inflation continued its upward trajectory, rising to 7.9% YoY in April 2014 -10 bps higher than the March reading- whilst the MoM reading was 16bps lower at 0.62%. The volatility observed in core inflation readings since year start persisted with an April reading of 7.5% YoY, ~70bps ahead of the preceding month. The NBS attributes the rise in core inflation to higher increases in items belonging to the Housing, Water, Electricity, Gas and other Fuels component. Similarly, YoY Food inflation pushed higher by 10bps to 9.4% (MoM reading was 20bps lower at 0.8%) with the NBS ascribing the rise in food inflation to higher prices in bread, cereals, meat, dairy and fruit classes. In our view, MoM contractions in food inflation reflect above-average dry season harvests which, according to FEWS NET, began in April and spanned through May.

Over the near term, FEWSNET expects additional demand in June and July for staple cereals during the Ramadan period which suggests greater scope for an uptrend in food prices as we move into the lean season. Nonetheless, above-average dry season harvests should cap potential for greater inflationary pressures.


Figure 1: Trends in Headline, Core and Food inflation

Uptick in FX demand pressures the naira

The USDNGN reversed gains observed in the preceding month, weakening 1.2% MoM to close the month of May at N162.7/$. Recent pressures on the naira despite a further 11% MoM decline in RDAS sales in the month of May to $2.6 billion (April: -18% MoM to $2.9 billion) largely reflects the net impact of increased FX demand as foreign investors repatriated dividends amid subdued FX sales by IOCs (-25% MoM). In addition, discussions with FX traders indicate resurgence in BDC activities as the CBN, in May, just approved some banks’ cash importation requests which had been pending since January. Consequently, we believe higher BDC activity partly explains the observed compression in the spread between interbank and BDC exchange rates.


Table 1: 2014 Monthly FX Spread

Figure 2: Foreign Reserves vs. Exchange Rates

Largely reflecting softer oil exports, foreign reserves unwound recent gains to close May at $37.1 billion (-2.6% MoM). However, reserve accretion is expected to improve following the lifting of the force majeure on the Forcados terminal on the 15th of May. In the near term, we envisage some support for the naira as dollar sales by IOCs likely rebound (Bloomberg loading schedules indicate a 9% MoM rise in June exports) even as the commencement of the new automotive tariff in June is likely to keep FX demand subdued. Nonetheless, through 2014, ongoing tensions as 2015 elections draw closer could spark a reversal in portfolio flows, driving scope for further volatility in the USDNGN.


Further yield compression curbed by liquidity tightening  

Yields continued their downward trajectory despite a moderation in liquidity profiles in the month of May (-52% MoM to N357 billion) and an uptick in CBN OMO issuances (+125% MoM to N729 billion, the second highest level YTD) at the tail end of the month, possibly indicating the regulator’s discomfort with existing liquidity. However, uptick in issuance was sufficient to temper yield contraction which across the curve was much tamer than the preceding month with yields on T-bills falling an average 42bps MoM (April: 220bps) to 10.15%, 10.35% and 10.10% for the 91-day, 182-day and 364-day paper.  Also, on average, yields on FGN bonds declined ~63 bps MoM (April: 83bps) to 12.59%, 12.66% and 12.79 for the FGN 2017, 2019 and 2022.

As we had anticipated, the MPC at its most recent meeting – the last before the resumption of the new CBN governor - left monetary policy unchanged. Consequently, we view recent OMO issuances as possibly preemptive following cash importation approvals granted by the apex bank which portend higher FX demand even as imminent OMO maturities appear set to boost system liquidity. In all, liquidity profile remains robust in our view and should ultimately help underpin a slight moderation in yields over the coming month as liquidity-withdrawal impact of dividend-related FX demand and onset impact of dollar importation allocation wane. Whilst the new CBN governor at his inaugural speech hinted at gradual reduction in key interest rate, we do not see this as accelerating potential yield declines in the short term as implementation mechanism might take some time to manifest.


Softer oil exports to crimp Trade surplus

Brent crude rallied 2% MoM in May to $109, largely buoyed by the ongoing tension in Russia and Ukraine. In addition, the unrest in Libya has negatively impacted oil production with output estimated at 160,000bps vs. 1.4 million pre-uprising.[2] As with April, oil revenues are expected to decline further in May with Bloomberg loading schedules indicating a 4% MoM decline in oil exports. Consequently, the net impact of softer exports and possibly higher vehicle imports – with May being the last month before the implementation of new automotive policy in June - probably led to deterioration in trade surplus.

In light of the ongoing geopolitical tensions in Europe and Lybia, we expect oil prices to remain elevated, with the reopening of the 400kbpd Forcados pipeline in the middle of May, hinting at an uptick in oil exports--Bloomberg loading schedules point to a 9% MoM rise in June oil exports to 2.1 mbpd. On other hand, we anticipate a moderation in imports largely driven by a decline in oil and vehicle imports, respectively ~30% and 18% of total imports—on the 13% QoQ decline in PMS import allocation and implementation of the new automotive tariff in June. Overall, the expected rise in oil exports and subdued imports point to improvements in trade surplus for the month of June.


Q2 GDP growth likely to be underpinned by Non oil sector performance

Despite the potential recovery in exports as indicated by Bloomberg loading schedules for June, the persisting weakness in oil exports portend sustained weakness in oil GDP growth in Q2 14.  The inability of the current administration to decisively tackle issues pertaining to oil theft and to a lesser extent, the failure of the Ministry of Petroleum Resources to meet the March deadline set for the completion of marginal bid rounds ensured production remained weak over much of the quarter.

Nonetheless, prospects for growth remain hinged on improvements in the non-oil sector, notably agriculture and services subsector which jointly account for ~58% of total GDP.  Recent government initiatives through the Agricultural Transformation Agenda (ATA) has heightened access to inputs and credit with knock on effects resulting to an expansion in land under cultivation in the current year. In addition, power sector reforms appear to be gaining traction with power generation hitting a record high of 4,105MW in April 2014 pointing to improvements in both the manufacturing and services sectors in the coming quarters. However, a potential risk to GDP outlook remains the subsisting crisis in North-Eastern Nigeria which has disrupted agricultural and economic activities within the region and has begun pushing out with recent attacks in Kano, Abuja and Jos.

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