29 June 2018 ( Lagos ) : The moderation in inflation observed so far in 2018 is impressive – annual inflation has moderated 376bps from December 2017 to May 2018 compared to 320bps between December 2016 and December 2017. This fall has been driven by abating food price pressure and continued exchange rate stability.

In addition, base effects from high H1’17 inflation has amplified the decline in 2018 inflation, but this effect is expected to wane as the year progresses. As such, the pace of inflation moderation is set to fall. Analysts note that Nigeria’s inflation has largely been cost-push in recent years and the signs are positive on this front. Nigerian National Petroleum Corporation intervention should continue to stabilize petroleum product prices ahead of the elections and exchange rate stability should persist. 

However, there is a risk of a reversal in the food price trend as effects of August 2017 Benue flooding and ongoing Herdsmen violence kick in. In addition, the demand-side now presents a greater worry. 

Delayed budget passage and pre-election spending are likely to trigger sizable fiscal injections at the tail-end of the year and create a situation where too much money is chasing too few goods. Given this expected pattern, analysts project inflation to trend downwards in the coming months before reversing trend in September 2018 as government spending weighs on prices and base effects wear off. 

Analysts note that this already manifested in May with month-on-month inflation registering at 1.1%, the highest since July 2017. Overall, 2018 average inflation is projected at 12.0% (2017: 16.6%). 

Given the outlook of a near-term reversal in inflation, analysts do not consider it a good time for the Central Bank of Nigeria to cut interest rates. Indeed, this is a view shared by many members of the Monetary Policy Committee (MPC) who have flagged the inflationary potential of government spending at year-end. As such, they predict a hold decision at all MPC meetings for the rest of 2018. 

Continued foreign exchange stability should not be underrated 

Despite still operating a multiple exchange rate system, Nigeria’s foreign exchange (FX) market has remained in a healthy position in 2018. The “Investors & Exporters” (NAFEX) window has fared particularly well, with increasing activity as the months have gone by – barring a spike in January during the mini equity market bubble, average daily FX turnover in April and May has been notably higher than previous levels, indicating resilient confidence in the window. 

In addition, the CBN has persisted with its regular currency sales across a range of retail and wholesale market segments without any deterioration in external reserves (risen from $39 billion in January to $48 billion in May). The outlook for the FX market is positive thanks to high oil prices which should lead to further reserves accretion and stable foreign currency supply. 

The outlook for capital inflows is less positive, however. U.S. Federal Reserve tightening could lead to capital reversal, and as investors focus on risk-adjusted returns, analysts are cautious that pre-election jitters may accentuate Nigeria’s risk environment and discourage some inflows. 

Nevertheless, supported by strong oil earnings, analysts expect the NAFEX rate to remain stable around NGN360/USD. Furthermore, they do not anticipate any changes to the current FX market structure; the likelihood of devaluation is faint pre-elections and market would always impose a premium in floating segments because of the market demarcation. 

All in all, the FX market status quo should persist through to 2019, barring any shocks to oil prices or volumes. 

Nigeria clinches currency swap, will ease transaction costs 

The Central Bank of Nigeria (CBN) and the People’s Bank of China (PBoC) agreed a three-year currency swap (?720 billion for 15 billion yuan) in a bid to ease trade flows. The swap is a bilateral loan agreement, which means the CBN would repay the 15 billion yuan in three years, either at a pre-arranged exchange rate or the prevailing rate at the time. 

The CBN would conduct bi-weekly yuan auctions to authorized dealers who would be able to sell to retail users. Analysts note that annual Chinese imports are c.?1.8 trillion so the swap is 40% of total annual Chinese imports whilst China has been increasing its investing in Nigerian infrastructure. 

In Analyst’s view, given the size of the swap compared to Nigeria’s annual imports from China, the primary benefits would come in terms of reducing the exchange rate carrying risk by permitting direct naira-yuan conversation, a reduction in FX transaction charges, and overall easing of transacting with Chinese firms. 

These should improve the ease of doing business and help the competitiveness of Nigerian businesses. 

Source: Analysts at Vetiva Capital Management Limited.

Reporting for EasyKobo on Friday , 29 June 2018 in Lagos, Nigeria