Will Positive Real Yield Attract FPI?


Wednesday, August 10, 2016 1:22Pm /FSDH Research

Executive Summary

The major highlights of the Monthly Economic and Financial Market Outlook report are:

·         The International Monetary Fund asserts that the global economy faces significant risk from the United Kingdom’s decision to leave the European Union


·         The IMF expects Gross Domestic Product (GDP) to contract in Nigeria because of the lower oil receipts, lower power generation, and weak investors’ confidence


·         We expect the inflation rate to increase to 17.35% for July 2016, from 16.48% in June 2016


·         The rising inflationary pressure is largely a reflection of structural factors, including high cost of electricity, high transport cost and, high cost of inputs


·         We expect the yields on the fixed income securities to increase in the month of August 2016


·         The rising yields on fixed income securities may have a negative impact on the equity market in August 2016


·         We expect long-term investors to take strategic position in stocks with strong fundamentals.


Global Developments

The prices of government bonds depreciated in more countries in July 2016 than they appreciated. The 5.87% March 2023 Nigeria Government Bond recorded the highest month-on-month price decrease of 4.51% to 104.36. The Turkey Government Bond followed with an decrease of 2.48% to 96.50.


The 17% April 2022 Argentina Government Bond recorded the highest month-on-month price increase of 37.53% to 129.63. The Argentina Bond and Nigeria Bond closed the month at negative real yields. Other bonds we monitored closed the month at positive real yields. The Egypt Government Bond offers the most attractive real yield amongst the selected bonds in July 2016.


According to the United States (U.S.) Bureau of Economic Analysis, the United States (U.S.) economy grew by 1.2% in Q2 2016. The Q1 2016 growth was reviewed downwards to 0.8%, from 1.1%. The Q2 2016 growth was well below market expectations of 2.6%. Consumer spending was the main driver of the growth, while investment slumped and inventories fell for the first time since 2011.

The United States also left its policy rate unchanged at 0.25%-0.50% in July 2016 because of weak labour data. Meanwhile, the Chinese economy grew by 1.8% (quarter-on-quarter) in Q2 2016, from an upwardly revised 1.2% growth in Q1 2016 and beating market expectations of a growth of 1.6%. It was the strongest expansion since Q2 2015.

The Global GDP
The global economy faces significant risk from the United Kingdom’s (UK) decision to leave the European Union. The decision has created additional instability in the global economy. The International Monetary Fund (IMF) revised its global Gross Domestic Product (GDP) growth forecasts downwards by 0.1% relative to its April 2016 forecast.


The global economy is expected to grow by 3.1% and 3.4% for 2016 and 2017 respectively. The latest forecast as contained in the IMF World Economic Outlook (WEO) Update, July 2016 Edition. The IMF added that the outlook appears worse for the advanced economies, majorly due to the Brexit.


The outlook remains broadly unchanged for emerging and developing economies. The IMF added that the GDP in Nigeria is expected to contract in 2016 because of the lower oil receipts, lower power generation, and weak investors’ confidence. Growth in China and India are also expected to be lower in 2016, compared with 2015. The weak global economic growth would lead to downward pressure on the oil price.


Global Commodity Prices

The World Bank raised its 2016 forecast for crude oil prices to US$43/b from US$41/b because of supply outages and robust demand in Q2 2016. Oil prices rallied in Q2 2016 due to disruptions to supply, particularly wildfires in Canada and sabotage of oil infrastructure in Nigeria. This is contained in the World Bank’s latest Commodities Markets Outlook (CMO), July edition.


The report noted that despite the recovery of oil and many other commodity prices in Q2 2016, most commodity prices are expected to decline this year. This trend is due to persistently elevated supplies, and weak growth prospects in emerging market and developing economies for industrial commodities (energy, metals, and agricultural raw materials). However, most of the declines are projected to be lower than expected in the April 2016 outlook.


Energy prices, which include oil, natural gas and coal, are due to fall by 16.4% in 2016, a more gradual decline than the 19.3% drop anticipated in April 2016. Non-energy commodities, such as metals and minerals, agriculture, and fertilizers, are expected to drop by 3.7% in 2016, a more moderate contraction than the 5.1% contraction forecast in the previous outlook. Metals prices are projected to fall by 11% in 2017, a sharper decline than the 8.2% drop forecast in April 2016, reflecting weak demand prospects and new capacity coming on line. Agriculture prices are forecast to fall less than projected in April 2016, as a result of reduced harvests in South America and flat demand for biofuels.


The World Bank added that the movements in energy prices have been a major factor in the path of food prices. Energy constitutes more than 10% of the cost of agricultural production. Energy prices fell 45% in 2015 and are projected to drop again in 2016.


About one-third of the likely 32% drop in prices of grain commodities and soybeans from 2011 through 2016 is due to energy price declines. Lower energy prices have also eased pressures to produce biofuels as an alternative energy source. Biofuels production has been an important driver of demand growth for food commodities in the past decade. 


The Monetary Policy Rate (MPC)
The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) met on July 25-26, 2016 against the backdrop of fragile global and domestic economic and financial conditions. The MPC recognized the weak macroeconomic environment, as reflected particularly in increasing inflationary pressure and contraction in real output growth in the Nigerian economy.


The MPC underscored the imperative of coordinated action, anchored by fiscal policy, to initiate economic recovery at the earliest time. Members of the MPC called on the Federal Government to fast-track the implementation of the 2016 budget in order to stimulate economic activity. The MPC summarized the two policy options it was confronted with as restarting growth or fighting inflation.


The Committee was of the view that the balance of risks remains tilted against price stability. It added that the CBN lacked the instruments required to directly jumpstart growth. The MPC was mindful not to calibrate its instruments in such a manner as to undermine its primary mandate and financial system stability.


In summary, the MPC voted to:

·         Increased the Monetary Policy Rate (MPR) by 200 basis points from 12% to 14%

·         Retained the Cash Reserve Requirement (CRR) at 22.50%

·         Retained the Liquidity Ratio (LR) at 30%; and

·         Retained the Asymmetric Window at +200 and -500 basis points around the MPR


The MPC intention is to attract foreign exchange inflows into the Nigerian economy to shore up the external reserves, for the defence of the value of the Naira. We do not expect a significant attraction of the intended foreign exchange inflows because of the weakness of the Nigerian economy. Particularly the current account in the balance of payment and the trade balance from foreign trade.

Purchasing Manager Index (PMI)
The Manufacturing Purchasing Manager’s Index (PMI) in Nigeria increased marginally to 44.1% in July 2016, compared with 41.9% in June 2016. This is according to the Central Bank of Nigeria (CBN). This implies a slower pace of decline during the review period. Of the 16 manufacturing sub-sectors, 13 dropped in the review month.


The appliances and components sub-sector recorded no change, while the remaining two sub-sectors recorded expansions in the following order: computer and electronic; and cement.

The composite PMI for the non-manufacturing sector recorded decline for the seventh consecutive month. The Index rose to 43.2%, indicating a slower decline compared with June 2016. Of the 18 non-manufacturing sub-sectors, 17 recorded decline in the month of July.

Inflation Rate
The reform of the foreign exchange market reflected in high exchange rate pass-through to domestic prices of imports in the Nigerian economy. The inflation rate in June 2016 shot up to an 11-year high of 16.48%, from 15.58% in May 2016. The current and short-term inflation rate outlook is higher than the CBN inflation rate target of 6%-9%.


The inflation rate in June 2016 was driven by the faster growth in all major divisions of the Headline Index. While imported foods increased at a faster pace, the Food sub index on the aggregate increased, albeit at a slower pace in June relative to May. Year-on-year (y-o-y), the Food Price Index increased to 15.30% in June 2016, from 14.9% in May 2016.


Year on year, energy prices, imported items and related products continue to be persistent drivers of the Core sub-index. The Core Index increased by 16.20% in June 2016, higher than 15.05% recorded in May 2016.


The rising inflationary pressure is largely a reflection of structural factors, including high cost of electricity, high transport cost and, high cost of inputs. The low industrial activities as well as higher prices of both domestic and imported food products are also contributing to the inflationary expectation.


We estimate that the inflation rate would be at 17.35% in July 2016 as shown on table 6 below.

Movement in the External Reserves
The pressure on the external reserves remains unabated in July 2016. It has not received the anticipated boost from the adoption of the flexible exchange rate policy in June 2016.


The external reserve is still strongly dependent on oil earnings, which has been inadequate because of the output shortfall. The 30-day moving average external reserves declined by 0.61% to US$26.20bn as at end-July 2016, from US$26.36bn at end-June 2016.


The robustness of the external reserves level is important for achieving stability in the value of the Naira. The external reserves dependence on oil income continues to have a negative impact on its function as a back-up for the value of the Naira. The current efforts of the CBN to conserve the external reserves is not yielding the desired result because of existing and current demand.


The consumption and production patterns of the Nigerain economy is import dependent, with significant negative impact on the value of the Naira in the face of foreign exchange scarcity.


Crude Oil Market and Bonny Light Price

The daily crude oil production in Nigeria increased by 6.29% to 1.52mbpd in June 2016, from 1.43mbpd in May 2016. This is based on the secondary data available from the Organization of the Petroleum Exporting Countries (OPEC) report for the month of July 2016.


The total OPEC crude oil production from secondary sources was 32.86mbpd in June 2016, an increase of 0.83% from 32.59mbpd over the previous month. The OPEC production level in June 2016 is 2.86mbpd higher than its collective production quota of 30mbd/d.


Crude oil production output increased mostly from Nigeria, Iran, Libya, Kuwait, Saudi Arabia and United Arab Emirates; while production recorded the largest drop in Venezuela, Iraq, Qatar and Gabon.


The U.S Energy Information Administration (EIA) in its mponthly report for August 2016 noted that the benchmark North Sea Brent crude oil spot prices averaged $45/b in July 2016, a US$3/b decrease from June.


This it said was the first monthly decrease since the Brent price fell to a 12-year low of US$31/b in January 2016. Brent crude oil prices are forecast to average US$42/b in 2016 and US$52/b in 2017.


West Texas Intermediate (WTI) crude oil prices are forecast to be slightly less than Brent in 2016 and the same as Brent in 2017. The EIA added that the current values of futures and options contracts suggest high uncertainty in the price outlook.


According to the data from Thomson Reuters, the Bonny Light oil price decreased by 14.84% to US$42.12/b as at end-July 2016, from end-June 2016. The average price of Bonny Light was US$46.14/b in July 2016, an increase of 6.28% from the average price of US$49.23/b recorded in June 2016.

Foreign Exchange Rate
The demand pressure returned and firmed up in July 2016. The CBN supply of foreign exchange is still dominated by the oil price revenue from the Federal Government of Nigeria (FGN).


The low oil receipt from supply shortages continue to put a strain on the CBN ability to defend the value of the Naira. The lacklustre attraction of foreign exchange inflows from the adoption of the flexible exchange rate also puts additional pressure on the Naira.


The ability of the CBN to intervene via its Secondary Market Intervention Sales (SMIS) has become difficult because of the need to conserve the external reserves from attrition.


The value of the Naira has depreciated after the adoption of the flexible exchange rate policy of the CBN in June 2016. There has been increasing tendency towards a divergence of foreign exchange rate between the inter-bank and parallel market rates after the new foreign exchange policy of the CBN. As at end-July 2016, the value of the Naira closed at US$1/N321.16 at the inter-bank market, a depreciation of 11.89%, from US$1/N282.97 at end-June 2016.


The parallel market has moved away from its immediate appreciation of 6.29% to US$1/N328, from US$1/N350 after the adoption of the new foreign exchange policy of the CBN. The demand pressure returned to the parallel market as foreign exchange users realised the weakness of the CBN supply intervention.


Consequently, the Naira depreciated by 6.63% at the parallel market to close at US$1/N377 at end-July 2016 from US$1/N352 as at end-June 2016. The average exchange rate at the parallel market depreciated by 3.41% to stand at US$1/N364.86 in July 2016, compared with US$1/N352.43 in June 2016.


The long-term stability in the foreign exchange rate depends on the ability to grow our export base and attract both Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). The policies to drive these growths lie outside monetary policy and more towards fiscal policy.


Interest Rate and Yield Analysis 
The yields on fixed income securities increased significantly in July 2016. The increase in the yields was because of the intention of the CBN to achieve positive real yields on fixed income securities in the market.


The fixed income market analysis for July 2016 shows a net inflow of about N134bn, compared with a net inflow of about N32bn in June 2016. The major outflows in July 2016 were the Open Market Operations (OMO) and Repurchase Bills (REPO) of N397bn, Primary NTBs of about N275bn, and the bond auction of about N120bn.


Meanwhile, in June 2016, the major outflow was from the Primary NTBs of about N453bn, the OMO and REPO of N299bn, and the bond auction of about N100bn. The major inflows in July 2016 were the OMO and REPO Bills of N386bn, matured NTBs of about N275bn, and the Federation Account Allocation Committee (FAAC) injection of about N265bn.


In June 2016, the matured NTBs of about N453bn, OMO and REPO Bills of N284bn, and the Federation Account Allocation Committee (FAAC) injection of about N148bn were the major inflows.


At the NTBs auction, average yields increased significantly across the various tenors in July 2016, compared with June 2016. The average 91-day NTB yield stood at 12.45% in July, up from 8.86% in June. The average 182-day NTB yield closed at 14.91%, up from 10.80% in June.


The average 364-day NTB yield closed at 18.67%, up from 14.58% in June 2016. The average 30-day NIBOR closed at 15.10% in July 2016, up from 10.83% in June 2016. The average 90-day NIBOR increased to 16.54%, from 13.24% in the preceding month.


The yields on the FGN Bonds monitored closed higher in July 2016, compared with June 2016

Revised Outlook Going Forward
A total inflow of about N1.42trn should hit the money market from the various maturing government securities and Federation Account Allocation Committee (FAAC) in the month of August 2016.


Our expected outflows from the various sources such as government securities and statutory withdrawals are estimated at N619bn, leading to a net inflow of about N801bn.


This analysis does not include the Cash Reserve Requirement (CRR). The market is expected to be tight in the month of August 2016. The tightness will come from the OMO operations of the CBN because of the maturities to be repaid in August 2016.

We expect that the interest rate and yield will rise further in the month of August, compared with July 2016. The major drivers are:


·         The mop-up activities of the CBN through OMO because of the maturities to hit the market in August

·        The desire of the CBN to achieve positive real yield on fixed income securities

·         The intention of the CBN to attract FPI and FDI

·         Fiscal deficit financing of the FGN

·         The impact of the tight monetary policy stance of the CBN.



·         We recommend staggered investments between Treasury Bills and long dated FGN Bonds in order to minimise the impact of reinvestment risk.


The average yields on the FGN Eurobonds were lower in July 2016 than in June 2016. Consequently, the average prices of the bonds closed higher in the month of July, compared with June 2016. The attractiveness of the yields on the FGN Euro bond compared with similar risk profiled bonds led to the increase in the prices in July 2016.

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