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In this Economic Update report suggests that debt service is likely to exceed government’s target for the second year running.

Budget 2017: Higher financing to trump revenue gain:

Acting President, Yemi Osinbajo, signed the 2017 budget into law on the 19th of June. The budget tagged ‘Budget of Recovery and Growth’ proposed a 23% YoY expansion in aggregate expenditure to N7.44trillion split into: non-debt recurrent expenditure (N2.99trillion), capital expenditure (N2.17trillion) and debt service (N1.84trillion) with N434.41billion as allocation to Statutory Transfers and N177.46billion for Sinking Fund from maturing bonds. Given our expectation for crude production and our revised crude price forecast, we estimate FG’s share of oil revenue at N1.9trillion. The foregoing, combined with non-oil revenue estimate of N1.6trillion suggest an FGN retained revenue of N3.5trillion (31% lower than in the proposed budget). Also, the continued reliance on more expensive local borrowing suggests that debt service is likely to exceed government’s target for the second year running. Overall, we estimate a fiscal deficit of N3.9trillion (N1.6trillion higher than proposed).

Naira Renaissance, short-term outlook remains stable:

Extending the gains from the turn of the year, the naira appreciated 2.3% MoM to N366/$ at the parallel market in June. The currency appreciation continues to reflect improved liquidity at the currency market stemming from sustained FX sales by the CBN (June 2017: $1.6billion based on our estimate) and sustained influx of portfolio flows. In particular, CBN’s directive at the start of the month for Deposit Monetary Banks (DMBs) to trade FX positions among each other without seeking its prior approval as was previously required, boosted liquidity with FX turnover at the IEW surging 38% MoM to $1.8 billion in June. Overall, reflecting increased dollar sales, the once scary premium between the parallel and interbank (70% in February 2017) has contracted to a more reasonable reading of 20% at the end of H1 17.

Sustained tightening and increased borrowing guides to elevated yield:

Similar to the prior month, the naira yield curve expanded 7bps MoM to 18.28% as a surge in Treasury Bill rates (+21bps MoM to 20.47%) more than offset modest declines at the long end of the curve (-6bps MoM to 16.09). Given improved system liquidity, we believe yield expansion at the short end of the curve reflected reduction in OMO clearing rates which touched 17.9% in the period to drive a shift in sentiment towards bond instruments.  At the long end of the curve, mean marginal clearing rates declined 10bps MoM to 16.19% at the June auction. Pertinently, given FG’s posture on lowering yields at the auction even as successful diaspora issuance leaves scope for restrained domestic borrowing as the DMO cut back on its planned borrowing (-29% to N99billion).

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In this Economic Update, we discuss recent developments and our expectation for same over the near term.

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.

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In this Economic Update: April 2017, we discuss recent developments in currency and fixed income market and our expectation for same over the near term.

• Sustained dollar sales to keep naira range-bound: As part of efforts to ensure currency stability at the parallel market, the apex bank introduced a special FX window for Small and Medium Scale Enterprises (SMEs) which would allow SME applicants to access $20,000 per quarter for the payment of eligible imports. The foregoing, as well as a follow-up doubling of weekly dollar sales to BDCs to $40,000 weekly, fueled improvement in CBN’s FX supply to ~$1.9 billion, by our estimate (+58% MoM) to help keep the parallel market rate at N385/$.  Given investors’ reference to parallel market rate as the anchor for fair valuing the naira, we expect the apex bank, boosted by accretion in the reserves (+19.4% Year to date to $30.9 billion in April) to sustain its FX sales. Impact of this should leave the naira range-bound at the parallel market.

• Yields to remain elevated on liqudity strain: Over the prior month, the apex bank intensified its liquidity mop-up measures via higher OMO issuances (+16.4% MoM to N151.5 billion) as well as increased dollar sales which drove average overnight rate 32pps higher MoM to 52.50%. The effect of the foregoing also underpinned yield uptrend across bond instruments (+27bps MoM to 15.99%). At the other end though, an influx of N654 billion bond maturities tapered effect of sustained monetary tightening and drove moderation in T-bill yields (-34bps MoM to 20.4%), leaving naira yield curve 4bps lower MoM at 18.12%. Going forward, with CBN’s shift in focus to persisting MoM inflation reading effectively nullifying arguments for YoY inflation-induced tilt to monetary easing, FX market activities now assumes principal importance in determining interest rate trajectory. In the near term therefore, the introduction of a market-driven FX window for Investors and Exporters, whose rates are a shadow of the parallel FX market, should incentivize CBN into sustaining sizable FX supply and aggressive OMO issuances, with the liquidity sapping effect of the duo leaving short term interest rates elevated.

• Base effects and naira gains to drive inflation lower: Largely reflecting high base effect from 2016, YoY headline inflation declined for the second consecutive month in March 2017 to 17.3% YoY (-53bps from prior reading) with both core and food readings moderating. On a MoM basis however, both core and food inflation printed higher in the review month. Over the near term, we expect impact of high base effect to continue to dictate core inflation and overall headline trajectory despite concerns on the food inflation front. Precisely, high base effect from the 45% hike in PMS prices in May 2016 should leave YoY core reading subdued with recent gains from Kerosene, and Diesel prices leaving sizable scope for sustained decelerations. However, we are less sanguine on the food side of things over the near term owing to recent pressures from higher transactions and transportation costs. That said, the more recent retrace in energy prices, owing to naira appreciation, suggests that pressures from the transport front would be less impacting in coming reading. Furthermore, with FEWSNET’s report already indicating favourable output from April’s dry season harvest, scope for gradual moderation in food pressures remain on the cards. Against this backdrop, we now look for headline reading of 16.7% YoY for April.

In this edition of our quarterly Nigeria strategy report, we take an in-depth look at economic indicators on the global and domestic scenes over Q1 17 as well as isolate influences of more recent developments on our outlook for the rest of Q2 17.

The ever-reverberating twist in global economy was again the toast of discuss over the past quarter, with investors ruminating over fledging recovery in advanced economies and what turned out to be a mixed growth picture for Africa. On the former, a combination of healthy jobs data and rising inflation in the US, export-led growth in Japan, as well as a shock economic expansion in the Euro zone appears to have catapulted economic growth expectations across DMs to a place of relative comfort. Elsewhere though, dour outlook for soft commodities and broadly expanding oversupply picture appear to have thrown a spanner into works across emerging and frontier economies with Sub-Sahara Africa (SSA) indisputably on the receiving end. Expectedly, the IMF swiftly revised its 2017 growth expectation lower for the region.

Against this backdrop, this report seeks to distil possible pass-through to the Nigerian market fettered by a three-quarter old economic recession for which emerging forward indicators have failed to provide tangible hopes for forbearance despite sustained gains in oil prices and a CBN-induced improvement in FX liquidity. On the issue of currency, the apex bank’s reversion from a celebrated entry into a fully float regime to a controlled float in less than 3 months is hardly news. Thus, our research focuses more on the sustainability of ongoing market interventions as well as a realistic fair value for the naira.

By way of linkage, we also investigate the implications of currency developments on overall inflation basket with keen attention paid to an over six month’s old food demand pressures from neighbouring West Africa. Perhaps adding more strength to our enquiry is the conscious effort made to situate Nigeria’s economic dilemma in the context of its volatile socio-political environment that could very easily revert to boiling point if the shenanigans embroiled in the last two gubernatorial elections and the characteristic unpredictability of the Niger Delta is anything to go by.

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In this economic update report, we discuss developments in Nigeria’s macroeconomic environment and financial market over February as well as delineate our expectations for the coming period.

CBN’s new FX policy: a change of heart?: In February 2017, the CBN announced a raft of FX policy measures which includes the commencement of dollar sales for personal and business travel allowances as well as foreign education and medical fees. In addition, the CBN announced the removal of the 60:40 FX allocation rule in favour of manufacturing companies, and reduced the tenor on its currency forwards to 60-days (vs 180-days previously) even as it signaled a desire for greater intervention to clear unfilled orders in the interbank FX market.

Going forward, we think, in view of a higher foreign reserve, the CBN is unlikely to entertain conversations around shifting the naira peg in the near term while it continues its interbank interventions in a bid to shrink parallel market premiums. Farther out, we see the upper rate limit on CBN’s intervention sales (i.e. the 20% band around the interbank peg of N305/$) as the next level for the USDNGN.

Inflation – Base effects come into view: In line with the pattern in the last three months, pressures in the food basket largely accounted for the uptick in headline inflation as thinning domestic grain supply pushed Nigerian cereal prices over 132% higher YoY. On other fronts, despite broadly higher energy prices (Kerosene: +87.1% MoM, LPG: +39.4% MoM, Diesel: +22.6% MoM and PMS: +1.4% MoM), core inflation slid for the second consecutive month (-19bps MoM to 17.85%) in January.

Going forward, base effects from the 45% hike in electricity tariffs in February 2017 pose hurdles to CPI readings. Thus, while naira weakness should continue to stoke higher food prices, we see downward pressure on inflation numbers from the elision of the 2.3% MoM base effects from electricity tariff increase in February 2016. This backdrop informs our call for a 153bps MoM moderation in overall headline reading to 17.2% YoY (+/- 50bps) in February.

Fallout from FX interventions halt bullish run on the naira yield curve: The naira yield curve trended higher in February (+16bps MoM to 17.31%) as system liquidity tightened following CBN’s Secondary Market Intervention Sales (SMIS) which drove overnight money market rate to 133.3% (from 6.9% at the end of January). The SMIS helped offset impact of lower paper supply (as the CBN net issued N92 billion in OMO paper in February vs N701 billion in January 2017) which had resulted in the mounting liquidity at the short end that drove bullish sentiment in the T-bill market over the first few weeks of the month.

Ahead of the March 2017 MPC meeting, our views regarding potential declines in inflation raise scope for an end to current hawkish monetary policy stance. That said, CBN’s move to raise FX supply, which has been accompanied by increased liquidity mop-ups, could yet drive “a no change decision” at the meeting. Taking a cue from the July 2016 hike, the apex bank could leave MPR unchanged and lower the clearing rates at its OMO auctions to lower the naira yield curve. Given limited clarity on the emerging FX policy, we see strong scope for the CBN to adopt this position.

Read more on our economic update here

Insights from the Nigeria Strategy Report H1 2017:

Global economic growth decelerated for the second consecutive year in 2016 as emerging economies continued to grapple with the impact of commodity price shocks to their external accounts and growth across developed economies remained largely sub-par. Though growth picked up in the US and Japan in the second half of the year, subsisting political concerns, particularly Brexit, weighed on economic activities across Europe. In response, global central banks responded to the lacklustre growth with increased monetary stimulus which pushed yields across developed world close to record lows for a sizable part of the year.

However, the emergence of Donald Trump as the US President elect and rising voter backlash against globalization ensured FPI flows to EM fell to its lowest in eight years even as US bond yields rose. Closer to home, growth in SSA economies more than the broader EM class stagnated which resulted in IMF’s downgrade of its 2016 growth forecast for the region to a 20-year low of 1.4% YoY. Unsurprisingly, the current account pressures fed sizable exchange rate weakness and by extension rising inflation. The dour economic landscape in SSA largely mirrored activities in the continent’s biggest economy, Nigeria, where GDP contracted over the three quarters of 2016—first of its kind in 25 years—inflation printed at an eleven-year summit, unemployment surged to a record high of 13.9% in Q3 16, while negative trade balance over the last thirteen months is the longest on record.

Output weakness stemmed from both the oil and non-oil sectors with contraction in the latter reflecting cutback in government spending (states and FG), negative real wage growth of consumers, FX supply challenges and factory downtime from incessant disruptions to gas supply. With regards to oil, persisting militant attacks on oil installations ensured the country’s oil production fell to multi-decade lows of 1.5mbpd in Q3 16 which together with lower oil prices underpinned the fastest pace of oil GDP contraction in 48 years in Q3 16. Events at the oil sector were also instrumental in perpetuating the deficit in the trade balance while it’s knock-down effect on FX reserves induced further currency depreciation in H2 16, making the naira one of the worst currency performers in the world. Predictably, impact of naira depreciation reverberated to headline inflation as increased cross border exports and import substitution by domestic manufacturers weighed on domestic supply of food.

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