The week that was (November 15-19)
A week loaded with a lot of macroeconomic data releases and the monthly bond sale where the DMO continued to display a strong appetite for borrowings.
Base effects continued to drive slowdowns in headline inflation: The NBS released the October CPI report which unsurprisingly showed that inflation maintained its decelerating trend as it slowed to 15.99% y/y from 16.63% y/y in September. The downtrend remains driven by base effects as the m/m reading came in at 0.98% (Previous: 1.15%) driven by developments in food CPI. Food prices across recent crops have started to pull back as harvest supplies drive a moderation, though prices remain above 2020 levels highlighting the depth of the dislocations. Elsewhere, core inflation remained muted given flat m/m trends across energy and transport prices.
Figure 1: Nigeria: Headline, Core and Food Inflation
Over the last two months of the year, harvest supplies will apply some gravitational effect on food prices and amid some large base effects, headline Inflation looks set to close 2021 at 14-14.5% levels which places 2021 average inflation at 16.9-17% (2020: 13.2%).
Q3 GDP decelerates from Q2’s strong level as base effects unwind: The NBS also put out the Q3 2021 GDP report, a week earlier than on its calendar, ostensibly to allow it serve as input for the CBN ahead of its final monetary policy retreat for 2021. Economic growth slowed to 4.03% y/y from the 5.01% y/y print in Q2 2021 as the support from base effects across Trade (+12% y/y) and Manufacturing (+4.8% y/y) unwound over the quarter. Though Services output strengthened (+7% vs 4.5% in Q2 2021), continued weakness in oil output (down 10% y/y) due to lower production (1.57mbpd vs 1.6mbpd in Q2) dampened growth. Over the first three quarters, Nigeria’s economy has expanded 3.2% y/y which is running well ahead of revised IMF/WB 2021 projections at 2.6% and 2.4% respectively. Over the last quarter, growth is likely to slow further into 3% region which would suggest that the high point of the base effects is now behind us.
Figure 2: Nigeria: Oil, Non-oil and Real GDP growth
DMO continues to hit the borrow button: At the monthly bond auction, where the DMO had NGN150billion on offer, demand remained soft with bid-cover of 1.8x well behind the 2x bid average observed in the first three quarters of 2021. Nevertheless, the DMO sold NGN225billion (+17% m/m) at a higher average stop rate (12.63% vs 12.60% in October) by lapping up more of the 2050s which was making its last hurrah as an on-the-run bond. The sale brings YTD gross bond sales to NGN2.6trillion which implies 2021 is already a record year for bond sales with one more auction to go and a planned NGN200-250billion sukuk issuance program. This is testament to the size of the projected budget deficit.
Figure 3: Primary and Secondary Market Bond Yields
Source: DMO, FMDQ
Tight system liquidity conditions drive interest rates higher along the Naira curve: Financial markets opened the weak tighter reflecting hang-over from CRR debits in the prior week. With only thin OMO bill maturities which the CBN cycled out, markets braced for debits for the bond sale which swung the system into a net-deficit position which pushed interbank rates higher with OBB/Overnight rates closing at 19-20% levels from 14-15% previously. In the bond market, the higher close on the 2050s at the auction repriced the long end (10-30yr) of the curve higher (+5bps). Activity along the front-end and belly remained flattish with no buying as in the prior week given the tight liquidity conditions. It also appears the CBN conducted another out-of-cycle CRR debit on Friday.
Figure 4: Naira Yield Curve
FX reserves moderate, Naira appreciates at the official segment: Last week, the Naira appreciated at the official window (+0.2% w/w to NGN414.4/$). Average turnover at the Investors & Exporters (IE) window stood at USD132million (vs. USD150million in the prior week) with spot transactions remaining dominant (81% of total trades) with most transactions between NGN400-446/$ while forward transactions were consummated NGN418-453/$. A note on Nigerian forward rate quotes, these are theoretical modelled prices using the interpolated risk-free rates and not actually traded prices. I’ve seen a few analysts trying to explain trends in these quotes which makes little sense as it essentially reflects changes in interest rates not in expectations around the exchange rate. Though parallel market quotes are difficult to come by these days, it would appear that the Naira softened at the segment over the last week. External reserves declined 0.2% w/w to USD41.4billion as the CBN continued to ramp-up interventions to clear back-logs in the FX market.
The week ahead (November 22-26)
The week ahead sees limited system maturities remain soft: NGN18billion (FGN bond coupons), NGN119billion in NTB maturities and NGN33billion in OMO bill maturities. The latter two imply that there would be a NTB and OMO auction on Wednesday and Thursday. The week is likely to see FAAC inflows come in at some point which should buoy system liquidity and the CBN will conduct its final two-day monetary policy retreat for 2021. On the sub-national front, Lagos state is out with NGN125billion bond which is targeting the 10-year tenor while Dangote Cement is out with a NGN50billion commercial paper issuance program.
Heterodoxy to continue at the November 2021 MPC? Looking at the personal statements of the CBN from the September 2021 MPC meeting, it appears unlikely that the CBN will deviate from its current dovish monetary policy stance. On growth, despite the strong 5% print in Q2, most members including the governor emitted concern that outlook remained fragile. As such the latest numbers are likely to be supportive of maintaining the status quo. As for inflation, the CBN is likely to interpret the seven-month deceleration as proof that its plan is working even though this largely reflects base effects, and its staff forecasts are likely to show that headline inflation will likely to remain outside its target band (6-9%) or its 12% inflation threshold. On the currency front, the improvement in external reserves and rally in oil prices will likely be positively viewed by the MPC members though they are likely to express concern about the onset of a global interest rate tightening cycle. Lastly given that the CBN appears to practice a crude form of monetary targeting, the subdued trend in M3 over September (+2.2% annualized) down from August levels (+5.8% annualized) is likely to douse any concerns on this front. That said, growth in M2 remained strong (+9.6% annualized) over September as CBN bill maturities (included in M3) tend to distort clarity over money supply trends. Furthermore, underlying patterns are likely to have picked up over November given the recent return of out-of-cycle CRR debits by the CBN in the last two weeks. Overall, across all measures the overwhelming feeling is that the CBN is likely to maintain the current course of action consistent with its ‘heterodox’ monetary policy setting. Any potential pressures from excess Naira liquidity are likely to be addressed using its administrative CRR measures.
Nevertheless, Nigeria is yet to evaluate the effectiveness of this descent into unorthodoxy or its long-term implications for financial markets and the banking sector. Furthermore, in a rising USD interest rate world likely over 2022, financially repressed interest rates will present downside risks to the exchange rate. Nigeria should seek to normalize monetary policy with a credible inflation targeting approach while interventions for underserved should be handled by capitalized development banks. The longer we continue down this approach the greater the risks for financial market stability and confidence in the financial system.