Done and dusted...what will follow the elections?

Yesterday marked the conclusion of Nigeria’s general elections, as such, it is only fitting to examine the likely implication of its outcome, among other macro factors, for the various assets in the short term.   As we expected, the ruling People’s Democratic Party (PDP) saw its 78% and 72% majorities in the Senate and House of Representatives respectively reduced, however the party managed to maintain its grip on both legislative chambers and the Presidency in an election that has been relatively credible. Accordingly, the elections and its outcome appear to have been well received by the international community and more importantly international investors who currently constitute ~68% of equity market activity. 

Logically, a smooth transition points to the maturation of Nigeria’s democracy, stability of the operating environment and the likely continuity of policy, particularity in the areas of; fiscal consolidation, energy and power sector reforms, peace in the Niger-Delta and electoral reform, factors which improve Nigeria’s overall investment case.  As such I am are optimistic that the impact of the concluded elections on capital markets will be positive. In particular:

Equity Market – is likely to experience an improvement in activity as recent declines in equities ahead of elections – and in reaction to the MENA crisis - resulted in increasingly attractive equity valuations. Notably, from its high of 27,797 on January 25^th 2011, the NSEASI has declined ~11.2%, with YTD performance at 1.9%. Furthermore, equity risk is reduced by the clarity provided by FY’10 earnings releases by banks and non-financials. Whilst recent performance indicators for financials and non-financials leave much to be desired, especially in revenue growth, they suggest intermediate improvements to fundamentals on the back of the significant progress made in resolving banking sector asset quality issues . I recommend that declines be used as an entry points to take positions in attractively valued stocks.

Exchange rates - The CBN has successfully kept the Naira within the pre-specified band at the official market in 2011, in spite of significant demand pressure ahead of the elections. As I expected, following the elections there has been a notable decline in demand at the WDAS even as the CBN has continued to oversupply. I believe the post-election decline in demand is partly due to moderating commodity prices, reduced political spending, and balanced capital flows. As such I expect these factors to combine with significant accrual of the nation’s dollar reserves to provide support for the Naira. On the back of this, I see a reversal of much of the capital flight that may have prevailed through Q1.

Bond Market – The relatively successful conclusion of the elections clearly decreases perceived political risk, implying policy continuity and likely fiscal consolidation which should improve the attractiveness of Nigerian debt, and drive yields lower. The likelihood of further monetary tightening due to rising inflation as well as the supply overhang created by the recent listing N1.7trn of AMCON bonds could temper expectations for yield compression. This is especially so considering the fact that the government’s reform agenda (including deregulation) suggest a less benign outlook for inflation in the short to medium term. I recommend that investors position at the short end of the curve, prospecting further afield only where there is sufficient compensation for risk.

Fiscal Prudence: The FG "appears" to be spending less.

At its last meeting on Monday, April 11th 2011, the Federal Accounts Allocation Committee (FAAC) announced the disbursement of N425 billion to the three tiers of government for the month of March, a 2.7% increase from its disbursement in February. The committee further noted that due to recent maintenance work on platforms at the Qua-Iboe, Bonny and Amenam terminals, and pipeline sabotage at Brass terminal and on the Trans-Niger pipeline, total monthly revenue declined 14.8% to N615 billion in March. In spite of the production setbacks, Nigeria's Excess Crude Account (ECA) rose to US$6.9 billion on the back of higher crude prices. 

While the depletion in the ECA and higher cost of borrowing in H2’10 combined to explain the decline in government expenditure, its reluctance to increase expenditure, in the face of significant ECA accruals in Q1’11, suggests renewed fiscal prudence . My analysis reveals that on an inflation adjusted basis, the FAAC allocation for Q1’11 is 7.1% (N80.2 billion) above allocation in Q1’09 but 24.4% (N294 billion) below allocation in Q1’10. This is also in view of other apparent indications of fiscal discipline, especially with regard to a significant drop in net government borrowing and the attempt to keep the executives 2011 budget proposal (N4.1 trillion) in line with the medium term expenditure framework.

While it is premature to view the current fiscal stance as a structural shift towards longer term restraint, think it is a step in the right direction, especially in the context of broader macro trends and other policy initiatives.  Of these policy initiatives, keeping inflation under control is an obvious benefit of fiscal moderation.  Notably, at its last Monetary Policy Committee (MPC) meeting in March, the MPC cited its desire to counter expansionary fiscal spending as one of the primary reasons for its aggressive upward adjustment of the Monetary Policy Rate (MPR). I believe the improvement in fiscal discipline could combine with softening global commodity prices, currency stability and hawkish monetary policy to moderate inflation in the short term. 

Mandela Toyo

Is the recent interest rate hike an over reaction?

Last week, the Monetary Policy Committee (MPC) voted 9-3 to resumed monetary tightening citing; fiscal imbalances, rising global commodity prices and currency stability as its primary basis for the hike. Much has since been made about the hawkish outcome of the meeting and as is to be expected, capital market participants have stood on either sides of the MPC’s decision. Opponents caution that the MPC’s “excessively” hawkish policy action may stifle economic growth and upset the fragile recovery in the banking sector, while proponents note that such steps are necessary to curtail foreign reserve depletion, curb fiscal excesses and to maintain long term price stability. With the effects of MPR hike beginning to pay out across the capital markets and banking sector, I ask: Did the CBN over react?

To answer this question, i perform a comparative analysis of the MPC’s policy action relative to other resource focused emerging and frontier economies with macroeconomic similarities to Nigeria (Table 1). Using, Pakistan, Kazakhstan, Bangladesh, South Africa and Brazil as yardsticks, I focus on viewing monetary policy  in the context of the key macroeconomic factor which drove the MPC’s last decision, including; inflation, fiscal policy (as measured my changes in budget deficit) and foreign exchange rates, in comparison to central banks in similar economic environments. 

An evaluation of these key variables points to the significant correlation between policy interest rates and inflation rate--as might be expected--with all benchmark economies maintaining policy rates in-line-with or above inflation. In this respect, Nigeria appears to be the exception, with policy rates significantly below current inflation.  The comparative analysis lends further credence to the MPC‘s hawkish stance. In fact, compared to Pakistan and Kazakhstan (both resource dependent nations with similar GDP per capita and inflationary pressures as Nigeria) the MPC’s position is relatively dovish.  Given that price stability is the primary mandate of any central bank, it would appear, on a comparative basis, that Nigerian monetary policy is largely accommodative when view in the context of 11.1% inflation. Also, with the exception of Nigeria and South Africa, other benchmarked economies have experienced significant appreciation in currency albeit due to capital importation in line with interest rate parity.

Clearly, the nuances of Nigeria economy cannot be ignored in assessing policy actions. For instance monetary policy transition mechanism remains a key concern in for Nigeria, and it might be argued that rates reviews should take its relative ineffectiveness into consideration. However, I emphasize the commonalities that underpin global inflation in the current environment, i.e. rise in commodity prices, partly driven by easing induced dollar weakness. With this in view, I highlight the fact that, from an interest rate parity perspective, economies that have moved further with policy tightening present more attractive opportunities for capital flows, which may perhaps explain the relative performance of their respective currencies.

Thus, given outcomes in the economies are further down the tightening path, I do not rule out the possibility that measures taken so far by the CBN will fall short of achieving the its key goals—reining in inflation and supporting the Naira. Thus I believe that there is scope for the CBN to continue tighten further and do not rule out the possibility of another 25-50 bps hike at its next meeting. I look to inflation figures and other monetary aggregates for March and April for a better sense of the degree to which the CBN’s previous measures have had the intended effects, for this will largely inform  the MPC’s next move.   

Table 1: Key macro economic factors across frontier and emerging economies

Inflation Change in Fiscal Policy YTD Change in FX Rate Policy Interest Rate Brazil 6.01% 2.20% -1.78% 11.75% South Africa 3.70% -6.80% 3.32% 5.50% Nigeria 11.10% -13.40% 1.58% 7.50% Pakistan 12.91% -6.30% -0.45% 14.00% Kazakhstan 8.40% -3.10% -1.23% 8.50% By Mandela Toyo

Elections, elections.....

Tomorrow’s marks the start of general elections in Nigeria; as such, it is only fitting to review the likely outcome and implication for the equity market in the short term.  As it stands, the election timetable provides for elections to begin with the National Assembly (Parliamentary) on the April 2nd 2011, followed by the Presidential on April 9th 2010, and then Governors and State Assemblies on 16th April. Though much has been made about the Presidential election, and rightly so, I am of the view that tomorrow’s Parliamentary election is equally important from a market perspective. Firstly, tomorrow’s election is likely to be a preview of the Presidential election a week later, as it will indicate voter preferences and give insight into the modalities of the election process, particularly as relates to credibility and election related civil unrest. Secondly and more importantly, Nigeria’s constitution empowers the National Assembly to pass legislation which is binding on the President and it is only organization with the authority to take precedence over the executive. The exercise of such precedence was apparent in the recent passage of the 2011 budget to the tune of N4.97 trillion (a far cry from the President’s proposal of N4.2 trillion). As such the success of tomorrow’s election is just as important as the success of Presidential election. It also marks a defining moment in the Nigeria’s history because the next National Assembly will be pivotal in consolidating recent economic gains and implementing of much needed reforms.

Currently, the ruling People’s Democratic Party (PDP) holds a 78% and 72% majority in the Senate and House of Representatives respectively and is largely expected to retain its majority in both legislative chambers after tomorrow’s election. If this scenario plays out with relatively credible and violence free polls, in the absence of significant post election litigation or violence, it is likely to be received positively by the international community and more importantly international investors who currently constitute ~68% of equity market activity. Logically, a smooth transition points to the maturation of Nigeria’s democracy, stability of the operating business environment and the likely continuity of policy particularity in the areas of; power sector reforms, peace in the Niger-Delta and electoral reform. On the contrary, a Parliamentary election marred with irregularities and significant post election violence may be viewed negatively by international investors, especially in the context of recent unrest in the MENA region and the stalemate in Côte d'Ivoire.  Furthermore, to the extent that Parliamentary election is likely to give an indication of the presidential polls, a decisive win by any political party may be a further positive signal of the eventual outcome of the presidential poll.

Though I note that a successful Parliamentary election may not necessarily shift investor perception, it is a step in the right direction and is likely to at least stem investor apathy. Indeed, I believe a successful Parliamentary poll will do much to pacify investor concerns and may result in renewed confidence, locally and internationally, in Nigerian markets. i look ahead elections and to major market indicators following the election to gain a better view on investor sentiment  in the short term even as recent declines in equities has resulted in increasingly attractive equity valuations . Nevertheless, I expect volatility to continue into the week as investors continue to search for a broad theme; I recommend that further declines be used as an entry point to take positions in attractively valued stocks.

Mandela Toyo