Sunday, June 12, 2017 04.31PM / ARM Research
Nigeria’s equity market received a kiss of life following the introduction of a market-driven FX window called the “Investors and Exporters FX window”. Foreign investors once shy of naira assets returned while their domestic counterparts followed suit, with the knockdown effect driving monthly return on the Nigerian bourse to an eight year high in May. The Q1 17 GDP was released over the month and it indicated an extension of the recessionary trend to a fifth consecutive quarter. Nonetheless, the underlying picture showed signs of recovery given the rebound in non-oil GDP as well as slower contraction in oil output.
Against this backdrop as well as the still elevated inflation rate, which printed at 17.2% YoY in April, the apex bank maintained its hawkish policy in a bid to ensure stability in the currency market. Unsurprisingly, the liquidity sapping effect of sustained OMO issuances and elevated FX sales drove the naira yield curve higher. Overall, whilst CBN’s FX policies had been a strain on economic activities in the past, the recent introduction of the IEW appears to have brought the economy back on course.
Nigeria’s FX market: springing back to life?
The naira maintained its stable trend at the interbank (+0.15% MoM to N305.40/$) and parallel market (+2.1% MoM to N382/$) with premium between both contracting to 25.1% vs. 62% at the beginning of the year. The stability in the FX market largely reflects improved dollar supply stemming from the apex bank deliberate actions as well as recent influx of portfolio flows.
Focusing on the latter, following the introduction of the market driven “Investors and Exporters window” (IEW), whose closing price of N380.50 mirrored that of the parallel market, foreign investors who were once shy of naira assets returned to stoke the biggest dollar supply at the IEW, which recorded total turnover of $2.13 billion over the six weeks ended 2nd of June 2017. Added to this, the CBN, buoyed by higher FX reserves (+17.2% YTD to $30.3 billion) also maintained its elevated dollar sales ($1.7 billion in May based on our estimate) leaving the currency market with improved supply to drive stability.
Furthermore, in a bid to improve liquidity in the IEW, the CBN recently directed DMBs to trade FX positions among each other without seeking its prior approval as was previously required, though subject to a maximum spread of N1/trade which is less attractive to the N3/trade obtainable at the Invisibles window1. Irrespective, the measures implemented to enhance the IEW should be a precursor for further portfolio flows supported by the improving economic picture and high interest rate environment. Elsewhere, given prospects for higher crude oil proceeds and external borrowings, we see scope for continued dollar sales by the CBN over the rest of the year. This speaks to possibilities of adequate dollar supply at FX markets (BDCs, parallel market and Interbank Spot and Forward). Against this backdrop, as well as sustained naira appreciation at both the parallel market (+3.6% MTD to N368/$) and the IEW (+0.5% MTD to N378.67/$), we expect FX rates to converge to around the N360/$ benchmark set for the invisibles market.
Figure 1: FX turnover and CBN interbank sales
Base effect to drive steep inflation decline
The National Bureau of Statistics (NBS) reported that headline inflation flattened at 17.2% YoY in April, missing Bloomberg consensus for a 50bps decline to 16.9%YoY in the review month. Disaggregating the sub-components, food inflation surged to an eight-year peak of 19.95% YoY (87bps higher than the March reading) to offset the moderation seen in the core basket (-64bps from prior reading to an eleven-month low of 14.75%). Focusing on the former, despite the onset of the dry season harvest in April as well as sustained currency gains at the parallel market, both of which should have moderated excess demand pressures, food prices generally tracked higher with the biggest increase witnessed in Tinned Milk, Eggs, and Garri2. In our view, parallel market naira appreciation is yet to reach levels that would materially discourage rising food demand pressures from neigbouring West Africa countries.
Whilst this continues to underpin pressures on farm produce (+73bps from prior reading to an eight year high of 20.13% in April) on the one hand, producers’ sustained increases in output prices—evidenced by sustained expansions in related PMI sub-index4—provide explanation for the jump in processed food prices (+2.3pps from March reading to 10.5% YoY) recorded in the period. On the core basket, declines largely stemmed from the Housing, Water, Electricity, Gas, and Other Fuel (HWEGF)5 division which mirrored movements in MoM energy prices (Kerosene: -9.9%, PMS: -1.2%, LPG: -2.6%, Diesel: -2.3%).
We expect MoM inflation to remain elevated over the month of May (+1.6%) due to the onset of the Ramadan season, which typically bolsters demand for cereals. However, given the impact of high base effect from the May 2016 PMS surge, we project a 130bps cutback in the YoY reading to 15.9% (+/-20bps).
Sustained monetary tightening keeps yield curve elevated
In contrast to the prior month, the naira yield curve expanded 9bps MoM to 18.21% largely reflecting yield uptrend at the long end of the curve (+16bps MoM to 16.15%) and a modest uptick on T-Bill rates (+3bps MoM to 20.27%). The yield uptick reflected CBN’s aggressive policies which have come in form of sustained OMO issuances and FX dollar sales. For us, these efforts have left banking systems relatively illiquid with average interbank overnight rate remaining high over the month of May at 36.59%. At the long end of the curve, mean marginal clearing rate also rose for the first time in four months (+14bps MoM to 16.30%) despite FG’s cut back of planned borrowings (-21.4% to N110 billion), reflecting current liquidity mop-ups by the apex bank which pushed maximum bid rates 44bps higher MoM to 18% in May.
Figure 3: Trend in average monthly rates
Q1 17 GDP: harbinger of hope?
In line with our estimate, the National Bureau of Statistics (NBS) reported that Nigeria’s economy contracted (-0.5% YoY in Q1 17) at its slowest pace since the commencement of recession in Q1 16. The improved economic picture stemmed from both oil and non-oil GDP, with the latter recording its first growth in three quarters. Buoying the non-oil segment is the rebound in Manufacturing (+1.4% YoY) and Services (+1.0% YoY) GDP as well as resilience in Agriculture output (+3.4% YoY), which continues to benefit from favourable government policies, attractive prices, and high export demand. On manufacturing, the improved FX supply which aided the importation of critical raw materials underpinned growth in that segment, while recovery in Services, after three consecutive quarters of contraction, largely emanated from the ICT sub-sector (+2.7%).
Elsewhere, though Oil GDP remained stuck in the negative territory, Q1 17 average crude production of 1.83mbpd was higher than that of the prior three quarters. The improvement largely reflected the lifting of the force majeure on Brass terminal which had positive impact of economic activities in the Niger Delta creeks. To add, there was lower pipeline vandalism in the period as FG’s reconciliatory efforts calmed Niger-Delta militants, who are also set to receive higher amnesty payments going by the 2017 budgeted sum (over two-fold YoY to N65 billion).
Figure 4: Trend in oil, non-oil, and real GDP
Over the rest of the year, we expect the positive impact of improved FX and gas supply to sustain growth in the manufacturing sector while higher YoY mobile subscription base should maintain the positive trend in the telecommunications segment and, by extension, the Services sector. In addition, amidst continued FG’s support and favourable pricing environment, we expect farmers to remain incentivized into raising their cultivation activities, which buoys outlook for the agriculture sector. On balance, despite the impact of high interest rate environment and weak consumer income on output, our projection is for sustained growth in the non-oil segment. For oil, FG’s continued negotiations with host communities to ensure security and protection of oil and gas infrastructure, temporal nature of the closure of major pipelines (Nembe Creek Trunk Line and Qua Iboe) and reopening of the Forcados pipeline (220kbpd) should further bolster the oil outlook.
Against this backdrop, we project an average 2mbpd crude oil production over 2017, which translate to a 10.6% YoY growth from 2016 average of 1.81mbpd. In summary, given the expected rebound in Oil GDP and the prospect for continued growth in the non-oil segment, we expect the economy to rise 1.8% YoY (prior estimate: +0.3% YoY) over the year, with the first quarterly YoY growth expected in Q2 17.
Nigeria equities on a roller Coaster
The Nigerian Equities market (NSEASI) recorded its highest monthly return (+14.5%) in eight years and its third highest on record in May 2017. In our view, the improved sentiment towards the Nigerian bourse reflected influx of FPI flows on the back of accessibility to a market determined FX market, lowering the much feared currency risk implied by the interbank-parallel market FX premium.
Amidst political worries in South Africa, and expensive stock market (implied by the higher than historical P/E ratio6) in Kenya as well as limited upside in post currency floatation Egyptian bourse7, we think the new FX window in Nigeria provided a fresh platform for African-focused equity funds to invest in. Also, the upbeat economic picture, passage of the Petroleum Industrial Governance Bill (PIGB) by the senate, and review of the Pension investment guideline which among other things now permit PFAs to purchase stocks of holding companies were other positives. Against this backdrop, the average monthly traded value in the Nigeria’s stock market surged to a two year high of N4.7 billion (2017 average: N2.5 billion).
Figure 5: 2017 NSEASI performance
With South Africa now entrenched in recession, Nigeria’s tilt towards recovery and the raising of NSEASI weighting in MSCI Frontier Index (+1.4 pps to 7.9%) leaves scope for a sustenance of recent rally in the country’s stock market.
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