Nigeria Fixed Income Weekly

Inflation hits 17-year high, Economy muddles along, CBN takes steps towards orthodoxy, DMO surrenders, Naira on the ropes

The Week that Was (August 15-26)

Nigeria’s economy expands over Q2 2022, oil now only 6% of the economy: The National Bureau of Statistics (NBS) put out economic data for the second quarter which showed that Nigeria’s economy expanded 3.54% y/y, a pick-up from the 3.11% reading in Q1. Looking through the report, the oil sector continued to shrink (down 12%, milder than the 26% in the first quarter) as oil production remained weak due to continued theft (avg daily output: 1.43mbpd vs 1.61mbpd in Q2 2021). On the other hand, activity in the non-oil sector slowed with growth of 4.8% down from over 6% posted in the first quarter. This stemmed from reflecting soft trends across Agriculture, trade, and manufacturing amid steady trends in services. The weakness across trade and manufacturing likely reflects sensitivity to a deterioration in USD supply. However, Telecoms sector growth remained robust (+7.7%). A key trend to pick up is the shrinking share of oil (6.3%) in Nigeria’s GDP which now tails manufacturing (10%) and Telecoms (15%).

Figure 1: Nigeria – Non-oil output disaggregation

Source: NBS

Inflation accelerated further in July 2022, monthly trends hint at peak: Nigeria’s Inflation continued to rise over July with the headline print at a seventeen-year high of 19.6% y/y (Prior: 18.6% y/y) with familiar drivers. Food inflation cleared 22% y/y while core inflation came in at 16.3% y/y. However, on a monthly basis, inflation slowed to 1.8% from 1.82% previously which would appear to suggest that the current spiral is nearing its peak. Looking at the underlying components, farm produce (the main element in food CPI which tracks prices of domestic crops) decelerated over the month with slowdowns in maize prices likely reflecting the early green harvests. Elsewhere the core basket continues to shift gears as the effects of higher energy costs (diesel and kerosene) feed through to transportation and Naira weakness anchors inflationary expectations. Where do we go from here? Nigeria’s main harvest period is about to get underway which suggests scope for a further slowdown in farm produce and implies that we might be nearing the peak of the current inflationary spiral. However, this is unlikely to change the y/y print which will likely cross 20% in September before peaking at 21-22% in Q4. Supply side shocks to Nigeria’s CPI basket tend to be disinflationary due to the statistical ‘base effect’ so assuming no seismic shocks in energy and the exchange rate heading into 2023, headline inflation will succumb to gravity.

Figure 2: Nigeria Inflation – Actual and Forecasts

Source: NBS,

Money supply contracts for the second consecutive month: Money supply data shows that for the second consecutive month, the CBN maintained a tight lid on liquidity across Nigeria’s financial system. The main monetary aggregates (M3 and M2) shrank 0.5% m/m to NGN48.3trillion with annualized growth running at 17.4% – down from the 26% in May. The focus of the current tightening wave is on base money (M0) and follows a withdrawal in CBN Special Intervention reserves fell over 2% m/m with annualized growth now at 9%. Aggregate CRR deposits stood at NGN10.8trillion at the end of the month. From a structural perspective, strong growth lending across the private sector (+23% to NGN39trillion) and public sector (+87% to NGN20trillion) continues to offset the effect of a contraction in net foreign assets which slipped to the lowest level in decades NGN4.9trillion. The outsized expansion in public sector lending over 2022 reflects strong deficit monetization by the CBN which I suspect is a big driver of the turbo-charging in USD demand.

CBN provides further hints about the end of its unorthodox monetary policy experiment: Over the month, the CBN took two steps which provided further hints that the apex bank is drawing a line on its three-year experiment with unconventional monetary policy. First, the CBN raised the floor for savings rate back to its pre-covid level set at 30% of the Monetary Policy Rate (MPR) which it had hitherto set at 10%. This was followed up by the dramatic reset in interest rate on intervention facilities to 9% after the 5% covid-era level was extended for another 12-months only in March 2022. The timelines for these adjustments were also interesting with the savings rate move effective in August and the intervention facilities effective in September. Viewed alongside the tightening action across money markets the CBN appears to have come around to the long-known history fact:  Wanton Naira liquidity is always and everywhere the underpin for USD demand pressures. CBN governors who ignored this theory under quixotic ‘developmental’ objectives always learned the hard way. The die now appears cast that the CBN will embark on virulent monetary policy though the exact form is unknown.

CBN surrenders to pressure from airlines, reserves on the rise: Following complaints from IATA about a mounting USD backlog in Nigeria amid threats by some international airlines (Emirates) to cancel flights from Nigeria, the CBN caved in on Friday with the announcement that it had sold USD265million to clear backlog via a special FX intervention. Though the timing appears propitious as external reserves have lately commenced an ascent towards USD39billion, the episode highlights the flaw problem with the current approach to managing Nigeria’s exchange rate wherein the CBN tries to determine allocation and pricing.

Under a monopoly type market setting, the optimal decision for a proper functioning market is for the monopolist is to pick either of price determination or quantity allocation but not both. Only in extreme scenarios when a monopoly has the legal and financial ability to determine both are any deviations from this rule feasible and even then, sustainability is doubtful.  Since 2015, the present CBN (being the dominant player) has consistently sought to fix both pricing (what level the Naira trades relative to the USD) and allocation (who gets USD) despite serious constraints on its external reserves positions due to oil price shocks. Having elected to fix both price and USD access, neglected sectors are faced with either fulfilling their desires at weaker exchange rates via parallel market or waiting for the inevitable devaluation for unfulfilled orders. Rather than wait for this undesirable outcome, the airlines complaints essentially amount to ‘classic hostage taking’ as a withdrawal of services would hurt middle to upper class Nigerians who will put pressure on the authorities to act. As some analysts have noted, the present FX management policy reflects the Grand ‘Faustian bargain’ that Nigeria’s middle and upper class elites have engineered via which the CBN prioritizes their consumption of imported services (like flights via international airlines despite the presence of local carriers) but forces a ‘buy-Naija’ mantra for the lower class when they try to import goods like rice. As you can never fully iterate for all scenarios under the current FX regime, access to USD is a function of successful ‘hostage-taking’ campaigns to rise up CBN’s priority ranking scale.

It would be interesting to find out what exchange rate the special interventions occurred and, in a bid, to limit similar moves, my suspicion is that the CBN will now be hard-pressed to step-on the pedal with regards to Naira devaluation and I now see the currency clearing a runway towards NGN500/$. In terms of where things stand today, within the CBN stage managed IE window reported by FMDQ, the Naira continues to hold steady at NGN430/$ although the apex bank sold dollars between NGN450-465/$ via special intervention windows for retail end-users. If you really wanted dollars, the street rate reported in the media has commenced another slow-walk towards NGN700/$.

DMO wilts under market pressure, rates head higher: At the monthly bond auction in mid-August, tight liquidity conditions continued drive weak demand and price sensitive bids which forced the DMO’s hand. In terms of outcome the clearing rates were bang in line with my expectations with the 3-year bond clearing 12.5%, the 10-year at 13.5% while the 20-year printed at 14%. For the second month running, demand was weak with bid-cover at 1.1x, below the 2.8x norm in H1 2022 and the DMO only sold NGN200billion down from the NGN300billion average monthly sales in H1 2022. Across board, the DMO had to pay above the weighted average bid yield to fill its borrowing coffers. Secondary market trading remains bearish as yields continued to inch up with bonds now hovering between a tighter range of 13-14% up from wider 10-13% levels in the first half of the year. T-bill yields are in the process of inverting with the 3M-6M tenors now above the 1-yr yield reflecting tight banking system conditions. Short term interest rates are now hovering between 14-16%.

Figure 3: Naira Yield Curve

Source: Bloomberg

Nigeria Eurobond yields compressed over the week (down 20-30bps on average), despite a hawkish backdrop with bellicose rhetoric by US Federal Reserve Chairman at Jackson Hole. Yields remain below the June peak.

Figure 4: Nigeria Eurobond Yield Curve

Source: DMO

The Week Ahead (August 29-September 2)

The pivot back to monetary orthodoxy: After three years of dabbling with heterodox monetary policy as the CBN liked to tag its foray into the world of unconventional monetary policy, the apex bank appears to be calling it quits.

‘What experience and history teach us is that people and governments have never learned anything from history or acted on principles deduced from it’ – Friedrich Hegel, Lectures on the Philosophy of History (1832).

In 2009, in a bid to contain the fall-out from the global financial crises, the CBN embarked on a cycle of monetary easing all through to 2011 from whence it embarked on an aggressive tightening cycle which pushed yields to 15-16% by 2012. The circumstances appear familiar: The Arab spring had triggered a run-up in oil prices all through 2011 just as the Russia-Ukraine conflict has spurred another surge in oil prices in 2022. Then as with now, an outsized subsidy bill had limited pass-through from the high oil price to external reserves. Then as in now, the CBN had seen a surge in dollar demand fueled by strong credit growth under another growth pivot. That cycle only ended after the CBN embarked on crude liquidity tightening measures using CRR debits and high rates forced the FGN to embark on some fiscal retrenchment via a partial removal of fuel subsidies.

On the back of record deficit monetization and a surge in loan growth on the back of easy monetary policies, the CBN will need to adopt a similar posture to global central banks in rolling the tide on excess Naira liquidity. To be credible this will likely see short term rates move towards 18-20% as well as fiscal consolidation in some shape. In terms of rate outlook, my sense is if short term rates continue to move higher, bond prices still look expensive at current levels.    

Figure 5: Real and Nominal NGN Yields

Source: Bloomberg

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2 comments

  1. Gbolahan Taiwo · · Reply

    Thanks Wale for this insights always.

    How do you track the CRR deposits? Is it just the bank reserves?

    1. Correct. I use bank reserves

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