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Economic Update: January 2014

Category: Nigeria Economy

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Economic Update: January 2014

Thursday, February 6, 2014 5:21 PM/ ARM Research

Rising core inflation drives uptrend in inflation
Headline inflation rose to 8% YoY in December, again 10bps higher than preceding month, whilst the MoM reading was 6bps higher than November at 0.78%. Core inflation continued its uptrend for the sixth consecutive month rising 10bps from November to 7.9% YoY and bucking a 3-month flat MoM trend by climbing 20bps to 0.8%. The National Bureau of Statistics (NBS) attributes this rise to increases in ‘maintenance and repair of personal transport equipment’ possibly connected to recent hike in automotive tariffs. YoY Food inflation was flat at 9.3% from November but, MoM, registered its first uptick since August rising 10bps to 0.9% in December. This MoM rise reflects seasonal festive factors as well as the conclusion of the harvest season in December.

The headline reading completed the run of single digit inflation observed over 2013 with mean inflation 3.7pps lower YoY at 8.5%--a 6-year low. This encompasses 640bps and 210bps respective YoY declines in average core inflation and food inflation to 6.4% and 9.5% largely driven by a combination of base effects from 2012 and improved food production in H1 13. Although national food production recorded significant increases in 2013, a combination of low carryover stocks and a pick-up in export demand to neighbouring countries limited the transmission of these gains to food inflation in H2 13. Outlook for 2014 is for an extension of the benign single digit reading which is hinged on continued productivity initiatives by the agriculture ministry to sustain improvements in food production, particularly success of its planned expansion of storage capacity which should help further diminish the volatility across food prices. Key risks to this outlook include the possibility of significant currency weakness on account of quantitative easing (QE) ‘tapering’ and increased spending on account of the elections.

Tamer FPI and oil revenue support darkens naira outlook
In January, the CBN effectively reinstated parallel market demand to the interbank market by removing the $250,000 dollar cap on interbank sales to BDC which had tightened supply to the latter segment. The policy reversal coincided with heigthened naira volatility in the run-up to the US Federal Reserve FOMC meeting which drove further softness across several EM currencies in January. Promptly, interbank USDNGN weakened a further 1.4% MoM to close January at N162.49/$, having weakened 1.3% MoM in December. However, the policy appeared to have the intended effect as the parallel market exchange rate declined to N166.5/$ vs. N170/$ at the end of December 2013, improving convergence even as the official rate shed 3kobo to N155.73/$.

The higher demand was reflected in 50% MoM rise in WDAS sales to a 6-month high of $2. 9billion in January 2014 with average auction sales at a 27-month high of $373million. Consequently, amid softer foreign portfolio investment (FPI) flows, foreign reserves declined 1.1% to $43.1billion.

The policy change suggests the apex bank is yet to give up on its defence of the naira and promised ‘admin measures’ have duly arrived in the form of requirement that authorized dealers fully fund their accounts two days prior to auctions as opposed to the previous practice of funding upon bid submission. Despite these demand curtailment measures we remain bearish on the naira on account of fundamental supply side concerns on both external and domestic fronts. The US Federal Reserve shave of a further $10billion from its QE program to $65billion in January now more clearly frames market expectations for sustained cuts over 2014, as opposed to the tag of symbolism the December cut attracted from some market segments. The reduction of FPI inflows to EM ( and naira) risk assets  removes a critical support and requires greater CBN RDAS sales and/or interventions to support the naira. Set against the backdrop of greater fiscal revenue slippages which has resulted in slower foreign reserve inflows and imminent exit of the current CBN governor—whose commitment to currency stability remains flourescent in the twilight of his tenure—the expected undermining of both currency defence ability and policy will indicates greater scope for currency devaluation over 2014.

Yields rise on monetary policy tightening

Yields trended higher across the naira curve in January as domestic monetary policy tightening pressured the short end whilst knock on effects of US tapering drove bond prices lower.

Post the MPC decision to increase public sector Cash Reserve Ratio (CRR) 25pps to 75%, yields on longer term Treasury bills rose 79bps on average with 182-day and 364-day paper closing January 2014 at 12.35% and 12.25% respectively. However, the T-bill curve normalised with the 91-day paper declining 12bps to 12% aided by  negative net bill issuance of (N232million) though OMO issuance doubled over December levels.

Bond yields began trending upwards in the run-up to the  US FOMC meeting at the end of January with the news of a further $10billion cutback in the monthly asset purchases driving FPI sell-offs resulting in~55bps MoM increases  in the the FGN 2017, 2019 and 2022 to 13.68%, 13.71% and 13.8% respectively.

Although higher systemic liquidity since the AMCON payback with ~N1trn liqudiity balance daily, is set to be drastically reduced by the debits for the 25pps CRR hike, we expect a slightly weaker impact on yields relative to 38pps hike in July 2013. Farther out, although the CBN has guided to further tightening over the rest of 2014, the governor also acknowledged monetary policy limitations. Thus, while continued tinkering with the CRR is likely, much of the policy effect would appear to have been frontloaded as banks’ liquidity build-up limits the shock. It is a similar story with the scale-down of the US Fed LSAP through 2014 with the reversal of FPI flows unlikely to await conclusion of tapering. Overall, whilst developments on these fronts could yet stoke yields, improving liquidity from maturing paper, still-strong domestic institutional demand, especially PFAs, amid an environment of tamer issuances remain significant pointers to tempered yields. Already our expectations about lower securities issuance appears to be playing out as the DMO issued N90billion worth of bonds in January--23% lower MoM and 18% lower YoY. However, the price-setting role we highlighted for FPIs as well as sporadic domestic tightening suggest sufficient effect to induce significant yield volatility, going forward. Nonetheless, amid lower issuance the net effect is to likely encourage significant trading by banks and PFAs, marking a gradual shift in bond-pricing considerations to domestic factors over the course of the year.

Oil production and price pressures continue to crimp trade surplus
Brent Crude prices declined 3.7% MoM in January 2014 to $106.7/b on improving supply outlook as Iran signed an interim agreement that could pave way for sanctions relief. Additionally, Libya resumed production at the Sharara oil field which tripled its production to 650kbpd from December. These supply increases reflect one angle of the potential factors we expect to weigh on oil prices in 2014. Continued improvements in US production also drove a 1.1% MoM contraction in WTI to $97.49/b resulting in 26% MoM fall in the Brent-WTI premium to $8.91/b.

The price softness amidst slower oil exports--Bloomberg loading schedules indicate a 2% MoM decline in oil exports to 1.85mbpd—suggest overall exports are likely to have slowed during the month given the relative size of oil exports (~90% of total exports). Additionally, non-oil imports are likely to have declined after the CBN served notice to importers of its intention to implement the new fiscal measures on automobile and tyre imports. This is likely to limit the damage to trade surplus from declining oil exports.

Going forward, although loading schedules indicate a pick-up in exports over February (1.89mbpd) and March (1.99mbpd) this is still lower than the Q1 2013 average and retains scope for further softness in the current account. Oil prices are unlikely to provide any support as further improvements in US crude transportation and the continued prospect of Iranian oil exports will possibly keep prices on a downtrend though consensus oil price forecasts remain above $100/b2.


Sustained agriculture recovery bolsters Q4 13 real GDP growth
Preliminary GDP estimates provided by the NBS indicates that Q4 13 GDP grew at 7.67% YoY – its fastest pace in eight quarters-- bringing mean 2013 GDP growth to 6.8% - 20bps higher than in 2012. Non-oil GDP remained the key driver of growth recording its fastest growth since 2011 rising 8.73% possibly driven by continued recovery in agriculture.  Although, oil GDP growth data was lacking, average crude loading schedules in Q4 were 7% lower YoY at 1.9mbpd, suggesting an extension of the contractionary trend in sector GDP. Thus, the rebound in overall 2013 GDP owes much to the improvements in agriculture as other growth drivers such as Telecommunications and trade showed signs of decleration.

We expect agriculture GDP to continue to be the main driver of non-oil GDP pending potential shifts at the release of the rebased GDP series. These expectations are premised on continued progress on initiatives by the agricultural ministry to increase access to inputs, expand grain storage, dry season farming among others to sustain the momentum in agriculture GDP. Furthermore, we expect the effect of increased investments by leading domestic and foreign FMCG firms in several backward integration plans that cover sugar, rice, and cassava to increasingly reflect in sector GDP over the coming quarters.

Supporting optimism, we expect the looming 2015 elections and associated increased political spending to result in some pick-up in trading activity. Additionally, improvement in security conditions appear relative to the pre-state of emergency period, should boost trade GDP as distribution constraints for the rebounding agricultural sector eases.

The absence of an indiscernible policy response to illegal bunkering as the 2015 election approaches suggests no end in sight to the disruptions to production that have plagued oil GDP in recent years. Furthermore, the inability of the Ministry of Petroleum Resources to hold a licensing bid round to expand reserves and production amidst the idling of the PIB in parliament continues to constrict future sector growth. This informs our expectations of an extension of the contractionary trend in oil GDP over 2014.

Based on the current series, our forecast band for 2014 GDP growth expands 50bps to 7.0-7.5% on the back of sustained improvements in non-oil GDP via agriculture and trade.

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