The Week that was (December 14-18, 2020)
After the confusing signals from last week, the tone from the official side of things (DMO + CBN) was that there were no plans to move interest rates higher. However, debt markets require some convincing in the face of another rise in inflation in November. The World Bank came through with a USD1.5billion loan (not the budget support) but no sweat and capital flow data over Q3 reveal the adverse impact of dovish CBN policies on badly needed portfolio flows.
Yields moderate at the PMA: In a reverse from the prior week, where thin demand at the PMA drove a surge in the 1-yr NTB, there was less room for controversy at the penultimate NTB sale for 2020 given the small size on offer (NGN7billion). As such the CBN, on behalf of the FGN, took advantage of robust demand (Bid-cover: 16.4x) to easily rollover the maturities at lower levels for 182-day (-10bps to 0.5%) and 364-day (-206bps to 1.139%) whilt the 91-day closed 4bps higher at 0.048%. The read-through from both the low rate on the CBN Special Bill sales and as we shall see for the last bond auction suggests that Nigeria’s fiscal and monetary policy managers remain aligned with regards to interest rates and that the spike observed in the prior week was a ‘false alarm.’ In the secondary market, the average NTB yield contracted by 5bps, as market participants scrambled to cover for lost bids.
DMO reluctant to move towards market neutral posture: At the last bond sale for 2020, the DMO elected to undercut the bond market bears by underselling its planned offer. At the auction, where NGN60billion was on offer (down from NGN80billion in November), and bids of 2.3x the amount showed up, the DMO elected to slash sales to NGN30billion with a marginal clearing rate of 6.97% (November: 5.39%). This in part reflects the relative comfort the DMO has with 2020 borrowings which are 100% of its planned target.
Chart 1 : Annual FGN bond sales and average borrowing rate
Over 2020, the DMO sold a record NGN1.87trillion worth of bonds (2019: 1.75trillion) to help fund the large fiscal deficit occasioned by the dual covid-19 and oil price shock to Nigeria’s fiscal account. However, dovish monetary policy supported by CBN’s move to proscribe access to its OMO auctions for non-bank investors helped ensure robust demand (with bid cover of 3.4x, a record level) and lower borrowing rates (9.05%). In 2021, the FGN proposes to borrow a record amount NGN2.2trillion from domestic debt markets and will need extremely accommodative monetary policy to help manage the cross current of likely FX pressures, a thinner liquidity profile relative to 2020 and soaring inflation. Reading from the Q4 auction sales, one gets the sense that the bond market has grown fatigued with accepting lower rates and the bears are likely going to gain the upper hand over 2021.
Inflation rises less than expected, electricity tariff measurement delayed: The National Bureau of Statistics (NBS) reported that headline inflation tracked higher in November, up 65bps to 14.89% y/y, driven by further acceleration in food inflation (+92bps to 18.3% y/y), while core inflation slowed (-9bps to 11.05% y/y). Relative to my expectations, the November print was positive as I was looking to see the effect of electricity tariff hikes (average of 65%) which went into effect in November. However, as most Nigerian households use the post-paid option which implies that electricity bills due in November are paid in December, this delayed the feedthrough to inflation to December CPI which should see inflation move to the 15.5-6% y/y range.
Looking at the sub-parts of food inflation, food price pressures stemmed from farm produce inflation, in particular pressures resurfaced in the rural CPI as monthly farm produce prices are up 2.45% (October: 1.65%), the fastest pace since May 2017 and accounts for the strength of the expansion in food inflation. The turnaround in urban farm produce with the monthly inflation print moving to 2.63% from 2.08% helped support higher food inflation. In the search for theories about underlying structural drivers of food inflation, there is no single driver in my view. Rather a perfect storm of events: subpar food production due to COVID-19 restrictions, flooding and insecurity issues in the north, the distortion brought about the border closures and currency weakness. Thankfully with the recently announced border re-openings some respite could come for food inflation but Nigeria will require one-full planting cycle to normalize prices.
Chart II : Trend in food, farm produce and imported food inflation.
The uptick in food over the month was underpinned by farm produce inflation where pressures resurfaced in the rural Nigeria as monthly farm produce prices are up 2.45% (October: 1.65%), the fastest pace since May 2017 and accounts for the strength of the expansion in food inflation. In the search for theories about drivers of food inflation, there is no single driver in my view. Rather a perfect storm of events: subpar food production due to COVID-19 restrictions, flooding and insecurity issues in the north, the distortion brought about the border closures and currency weakness. Thankfully with the recently announced border re-openings some respite could come for food inflation.
Bond market bears continue to chip away: Despite the dovish signals by the DMO at the NTB and FGN bond auctions, the bond secondary market remained bearish with average yields up by around 65bps w/w driven by sell-offs along the mid and long end of the curve: FGN 2026s (+119bps), FGN 2034s (+180bps) and FGN 2037s (+186bps) instruments. Though money markets remained awash with liquidity, the Naira yield curve has steepened reflecting increased profit-taking and market expectations about higher rates over the medium term.
Chart III: Naira Yield Curve
Source: FMDQ, NBS
World Bank delivers near term boost to FX reserves: As I noted last week, the World Bank announced the approval of a USD1.5billion loan facility to Nigeria per the state loan request (but was silent on the USD1.5billion budget support request). Over the near term, the announcement and likely disbursal over Q1 2021 is favourable to FX reserves which declined 0.29% w/w to USD34.8billion last week. In the FX market, the naira remained flat at the official (NGN379/$) and the I&E window (NGN394.00), while it weakened by 0.4% w/w to NGN477.00/$ in the parallel market (YTD: -24.1%). After initial appreciation in the IE window in response to the USD cash remittance circular, concerns over supply have re-emerged as more fintech IMTOs shut down their remittance services as their cost model is now more expensive than before. By mandating the option of USD receipts, the CBN effectively switched the game back to traditional IMTOs as most remittance recipients do not have a dorm account, implying the cash USD will be the default mode. This will require some arrangement to bring in cash which will require costs that the fintech remittances are unlikely to bear and which are part and parcel of the traditional IMTO model. Naturally, this should raise transfer costs but my suspicion is the traditional IMTOs are likely to respond with lower fees to solidify the advantage handed down by the CBN.
Capital flows data decline on subdued portfolio flows: NBS data on capital flows showed a 13% q/q rise in total inflows to USD1.5billion at the end of September 2020, though down 74% relative to 2019 levels. For the first three quarters of 2020, cumulative flows are down 57% y/y to USD8.6billion driven by steep declines in portfolio flows (-65% y/y to USD5.1billion) largely on account of CBN’s dovish monetary policy twist and concerns over NGN outlook. Other capital flows also dropped 46% y/y to USD2.7billion while FDI flows are up 15% y/y to USD778million. In terms of how things shape up for the currency, the emergence of a current account deficit over the last nine quarters means Nigeria relies extensively on capital flows and borrowings to plug the inherent USD shortfall and stabilize the exchange rate. Per the chart below, the cap between these two has widened over the last two quarters which has underpinned the Naira weakness across the FX market. To improve FPI inflows, Nigeria will need to normalize interest rates at some points as in the prior 2017-18 episode or tolerate further Naira devaluation.
Chart IV: Trend in food, farm produce and imported food inflation
Source: CBN, NBS
Week ahead (December 21-24, 2020)
In the week ahead, not much is happening as focus shifts to the holidays. In terms of maturities, there are no NTB inflows but there are OMO maturities (NGN251billion). Trading activity across domestic debt markets should be muted as most people wind down for the holidays. Market likely to be more bearish as investors try to close out their trading books for the year but promissory note maturities (NGN195billion) over the rest of the year should help cap the scale of any selloffs. 2020 was an eventful year for Nigerian debt markets as dovish CBN action unleashed a strong bull market. Merry Christmas to you and yours 🙂