Monthly Economic News and Views

at

Lagos Business School

Executive Breakfast Meeting

February 2010

Presented by B.J. Rewane

Financial Derivatives Company Limited

Outline

• Political Update

• Policy Update

• Business Activity review

• Leading Economic Indicators

• Stock Market Analysis

• Outlook

Theme: Perils of uncertainty

haunts the Nigerian Economy

Uncertainty haunts Nigeria

• Olivier Blanchard said crises feeds uncertainty and uncertainty affects behaviour

• Frank Knight, the 20th century economist of the Chicago school said:

– “When subjective uncertainty is higher than objective uncertainty - The economic environment becomes so complex resulting in outright economic paralysis and extreme prudence”

Uncertainty haunts Nigeria

• Markets remain in the tank and investors refuse to commit themselves

• The prolonged absence of the President and the unknown status of his health is heightening speculation

• The bungling of the message and the sloppy handling of the communication is contributing to the drifting image

Risk of Polarization

• There is a risk of polarization in the policy making and political class along the centrifugal lines if the drift continues

• The fear that an involuntary transfer of political

power to the Vice President could be disorderly

in consequence is now prevalent

• The unexpected announcement by MEND, calling

of the ceasefire in the Niger Delta, reinforces the

above concern

• The scepter of a sharp drop in production to the

record lows of 2009 is now haunting the country

• This is the last thing that is needed as most

nations are struggling to recover from the global

recession in 2010

Oil production could be hit

Economic performance resilient

• The official figures released by the NBS and

reiterated by the MPC continues to show an

economy with underlying strength

• In Q4, real GDP is now estimated to have reached

a surprising high of 8.23%

• According to Governor Sanusi, the performance

was largely driven by agriculture, wholesale and

retail trade as well as oil & gas contribution

Economy remains strong

• There is a wide discrepancy between these figures and the consensus of analysts and the proxy data available

• The CBN governor is quoted as expecting double digit growth in 2010

• Based on expectations on improvement in electricity supply and an increase in oil production arising from an extended period of peace in the Niger Delta

Economy remains strong

• Both of these assumptions seem to be tenuous in light of the current political scenario

• Another phenomenon of the Nigerian economic growth story is the low correlation of growth to employment

• Thus, even before the recession this low correlation had increased the probability of a jobless recovery

Economy remains strong

• It also reinforces the view of weak sector linkages in the economy

• And underscores the fear that the proposed fiscal stimulus will have very limited impact on an increase in output employment and investment

Fitch Reaffirms Rating

• Fitch rating agency released a special report in January tagged - A Mixed Bag

• It noted that higher oil production and prices should improve the public finance of Nigeria and its external position in 2010

• It also expects the current banking reform to help restore confidence to the banking system

• However, it is concerned about the impact of the President’s prolonged absence from the country

Identifies Political Vulnerability

• It fears that there will be very little progress on reforms and infrastructure

• It believes there is a potential for rating downgrade in view of oil price and production volatility

• It retained its BB- foreign currency long term issuer default rating

• The IMF team are in Abuja and Lagos to conclude the article IV consultation with the economic management team

Nigeria Economy:

Set for recovery in 2010?

• In 2010, oil production will continue to make positive contribution to growth if current levels are sustained

• Production is now estimated to stay slightly above the 2.1mbpd

• Higher oil prices expected to average above $75pb, 50% above the $50 budget estimate

Nigeria Economy:

Set for recovery in 2010?

• Gas production will expand marginally owing to coming on stream of the GTL project in Escravos, WAGP and gas flaring reduction projects

• Public finance and fiscal deficit though set to burgeon will be moderated by strong oil & gas revenue

• Budget deficit of 4% GDP is expected - this is exceptionally high in the context of recent Nigerian economic experience

Nigeria Economy:

Set for recovery in 2010?

• Increased govt. spending at the State & Federal Level as election promises get fulfilled

• External position to remain in balance due to stronger than expected oil revenues

• A slow return to credit creation and expansion will keep forex demand moderate

Economic challenges in 2010

• Oil price volatility presents the main potential downside

• Limited progress on reforms and addressing the infrastructure backlog ahead of elections in April 2011

• Even at $75pb average price revenues in 2010 will still be at 25% below the 2008 levels

• The planned deregulation of fuel prices and higher government spending are likely to keep inflation at double‐digit levels

• The fiscal stimulus required to kick-start the economy is being stalled by a decision making slowdown

• The deregulation of the prices of PMS is also being stalled while refineries are not functioning

• FGN expenditure is expected to rise by 32% in 2010 producing a deficit of 4.9% of GDP

Economic challenges in 2010

Policy Update

Privatizing profits and Nationalizing losses

Bank Regulation (going back to the future)

• The CBN like many other global regulatory bodies is intensifying the regulatory regime of the banking system

• Mainly in response to the findings of the stress test and the global trend - it is rewriting some rules

• The US recently proposed to segregate the provision of retail banking and Investment banking

• Essentially restoring the Glass Steagall act and consigning the concept of universal banking to the trash can

• It also seeks to ensure that depositors funds can no longer be used for proprietary trading

• The CBN has limited the tenure of Managing Directors of banks to 2 terms of 5 years each

• Usually the prerogative of shareholders, this is an unorthodox move taken to ensure proper corporate governance

Bank Regulation (going back to the future)

• The question remains – can governance abuse and substantial malpractice still not be accomplished in 6 months

• Thus, to expect that limitation of tenure will reduce governance abuse is a misplaced assumption

• There is no substitute for a robust banking supervision process to protect depositors and shareholders

Bank Regulation (going back to the future)

Aligning of Stakeholders Interest

Stakeholders Objective

Executives Higher Salaries & bonuses

Shareholders Larger Dividends

Regulators High Capital Levels

Borrowers More Lending

Government Tax on the Biggest Banks

Source: Business Week

Policy Update

• The MPC in its first meeting of the year acknowledged improvement in the economy

• It says that real GDP growth of 8.23% was recorded in Q4 of 2009, up from 7.07% in the previous quarter

• Left the MPR unchanged at 6% but observed that mounting inflationary pressure are downside risks to macroeconomic stability

• Expressed serious concern about the contraction in monetary aggregates

Policy Update

• The annualized growth rate of private sector credit was 26.10% - below the indicative benchmark of 45%

• Says the sub optimal monetary growth indicates the need for the continuation of an accommodative monetary policy stance

• MPC extended the guarantee on all interbank transactions up till 31 December 2010

Business Activity & Market

Review

Why everyone is owing everybody and no one can pay

Business Activity Review

• There was a lull in business activities in January after a moderate boost in December

• Political uncertainty caused by the President’s absence is taking a toll on the economy

• Foreign and local Investors are delaying investment decisions amidst political impasse

• Credit freeze, fuel scarcity and banks’ massive lay-offs also had adverse effects on business activity

Business Activity Review

• Value of cheques cleared in Lagos declined to N1.03trn in January from N1.27trn in December

• This could be partly attributed to the effect of the new CBN policy limiting cheque payment to N10m

• Monthly FAAC allocation disbursed in January declined by 2.4% to N370.3bn from N379.4bn in the previous month

Business Activity Review

• Forex sold by the CBN at the WDAS auction in January surged to $1.7bn, up from $837m in December

• Baker Hughes rig count was flat at 8 in December, but onshore rig increased to 4 from 3 in November

• Calm in Niger-Delta has continued to boost on-shore rig count

Oil Rig Count

0

1

2

3

4

5

6

Dec Nov

Un

its

Off-shore Land

Source: Bakers Hughes

Business Activity Review

• NCC recently reviewed downward interconnection rates for new telecom companies

• Call termination rates for new operators is down to N8.20 from N10.12

• The policy will protect infant operators in the industry and increase their ARPU

• This will likely translate to reduced tariffs for subscribers on their networks

Business Activity Review

• The Telecoms regulatory body has set March 31, 2010 for the commencement of SIM card registration

• It plans to out-source the registration of the SIMs

• Operators have kicked against the stringent requirements for registering SIMs

– Says it will crowd-out some subscribers and reduce their ARPU

Aviation

Aviation Update

• The aviation sector continues to suffer from the squeeze of higher oil prices and a slide in spend rate by passengers

• Recessionary pressures are forcing consumers to make hard choices

• Many are sacrificing premium class seats for economy fares

Aviation Update

• B/A has offered discount fares on the business class from Lagos for the first time

• The new return fare from Lagos to European destinations is now $2958.00 or N449,616

• The Farouk Abdulmutallab saga is having little impact on the traffic between Lagos and Atlanta on Delta airlines

Aviation Update

• Load factors remain very strong for this time of year

• The Lagos – New York traffic on Arik and Abuja –New York loads on Delta are very low

• Houston and Atlanta remain the favourite destination of passengers from Nigeria into the United States

Aviation Update

• NCAA has instructed all foreign airlines to stop selling tickets directly to the public from Feb. 1, 2010

• Tickets can only be bought from travel agents except at the airport

• Coming shortly after the kick-off of the billing and settlement plan, this guideline will boost the fortunes of the travel agents

Aviation Update

• However, it runs contrary to some clauses in the bilateral air service agreements

• Advertising revenue has dropped sharply at the MMA2

• The banks have slashed billboard and finger display ads

• This is one of the side effects of the financial & banking crisis and adjustment

Leading Economic Indicators

Oil Markets &

Production

Oil Price & Production

• Crude oil prices fell by 8% to a one-month low of $71bp

• Decline in crude can be attributed to:– tighter credit policy in China

– a stronger dollar

– concerns over a U.S. proposal to tighten bank trading rules

– expectations that U.S. refiners processed less crude

• Year to date, oil prices averaged $78.9pb

Oil Price & Production

• Oil prices have broken below the 100-day moving average of $75.25, a key indicator of market sentiment

• Prices have fallen by almost $10 a barrel over the last two weeks since hitting a 15-month peak of $83.95 on Jan. 11

• Nigeria’s crude oil output increased to 1.98mbpd in December up from 1.94mbpd in November due to peace in Niger Delta

Oil Price Trend

0

10

20

30

40

50

60

70

80

90

Jan-09Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecJan-10

$p

b

Source: Reuters/Bloomberg

• Oil price has maintained a steady upward trend

Oyo Oilfield Starts Up

• Allied energy and Eni have started production from the Oyo oil field in the Niger Delta deep offshore

• The field will initially produce 25,000bpd from two subsea wells with a water depth of 400m

• The associated gas will be re-injected into Oyo field reservoir by a third well to prevent flaring and to maximize oil recovery

Shell sells stake in 3 Nigerian

oil licenses

• Shell had agreed to sell its stake in 3 onshore oil licenses in Nigeria to a consortium consisting of two local firms and France's Maurel & Prom

• The sale is for OML - 4, 38, 41 located in the northwestern part of the Niger Delta

• It includes 30 wells with a production capacity of around 50,000bpd

Attack on Oil Infrastructure

Resumes

• Hostility in the Niger Delta is returning after 3 months of relative peace

• MEND has called off a three-month-old ceasefire

• Shell has shut down three oil flow stations in Nigeria's Niger Delta after a key crude oil pipeline was sabotaged

• MEND recently launched a fresh attack which has forced Chevron to cut its production by 20,000 b/d

Outlook

• Oil price rally to ease in the short term

– Decline in oil demand as winter abates

– Strengthening of the US dollar

• It is expected to trade between $70pb and $75pb in February

• According to Reuters poll of 29 market analysts, U.S. crude oil is expected to rise to an average of $77.50 a barrel in 2010

Outlook

• Nigeria’s crude-oil output will increase to 2mbpd

in January

• OPEC will likely increase quota of member

countries when it meets on March 17, in Vienna

Inflation

Inflation

• Inflation rate decelerated to 12% in December

from 12.4% in November

• Core inflation component declined to 9.7% from

10.7% in the previous month

• However, food inflation component rose

marginally to 13.6% from 13.5%

Inflation Trend

0

5

10

15

20

25

%

Inflation Core inflation Food inflation

Source: NBS

Outlook

• Inflation is expected to rise in near term due to:

– Deregulation of petroleum products’ prices

– Expansionary fiscal policy

– CBN accommodative monetary policy

– Possible capital inflows to recapitalize the banks

• Headline inflation is expected to rise to 12.5-13% in February

Money Market &

Interest Rates

Money Supply & Interest Rates

• Increased liquidity in the money market in January

• NIBOR rates were unchanged at 2.14% in January due to:– Cash inflows from budgetary allocations of

N370bn

– Repayment of matured treasury bills

– Banks’ freeze on credit to the real sector

• OBB closed flat at 2.25%

• Overnight and call were also unchanged at 2.50%

Money Supply & Interest Rates

• Lending rates remain high due to banks’ freeze on credit to the real sector

• Banks now focus more on debt recovery and pay little attention to lending to the real sector

• Yields on government securities are coming off

• 91 and 182 days Treasury bill declined to 3.19% and 4.7% respectively

Money Supply & Interest Rates

• DMO sold N93.5bn ($631.6 million) worth of sovereign bonds

– N30bn of the 20-year paper

– N25bn of the 10-year instrument and

– N38.50bn of the 3-year bond

• The bonds, which were re-openings of previously issued paper, attracted marginal rates of 8.5% for the 20-year, 8.14% for the 10-year and 6.83% for the 3-year instrument

Interbank Rate Trend

0

2

4

6

8

10

12

14

16

18

7-days 30-days 60-days 90-days

%

Jan 27th Dec 27th

Source: MMAN

Inflation risks of quantitative

easing

• Money supply growth estimated at 25-30%

• M2 growth – GDP growth = Inflation gap

25% - 5% = 20% Inflation gap

• FG injected N620bn into failing banks last year

• Representing approx 6.9% of total money supply

• The impact of Q.E is expected to be felt from Q1

• The fall in headline inflation in Dec. 2009 only attests to the lag in effects of policy

• Nigeria’s high propensity to import makes her prone to imported inflation

• Q.E = ↑M2 = ↑ INFe = ↑ Price levels

• Impact of INFe on Interest Rates

RR + INFe = NR {Fisher’s interest rate equation}

Q.E = ↑M2 = ↑ INFe = ↑NR

Import dependent economy

• Impact of expected inflation on Bond Market

– Q.E = ↑M2 = ↑ INFe = ↑ Price levels = ↓Asset prices = ↑Yield

– Price of bonds are expected to dip in the coming months as risks are repriced

– Increasing sovereign debt and future/expected inflation will make bond more risky

Increase in Price Level

• Impact of INFe on Exchange Rate Market– Q.E will lead to more money supply and increase

in price level

– Hence, there is likely to be a case of more money chasing fewer goods

– And a case of more Naira chasing fewer dollars

– Leading to a possible depreciation of the Naira

– But CBN could supply more dollars to mop-up liquidity but at the cost of building the nation’s foreign reserve

Bond prices will fall

Forex Market

Exchange Rate

• Naira depreciated marginally in the official

market by 0.4% to N148.6/$ in January from

N148.1/$ in the previous month

• In the parallel market it appreciated by 0.9% to

N152.5/$ from N154/$

• Forex demand surged in January to $1.12bn

partly due to closure of WDAS market for Xmas

Exchange Rate

• The CBN met about 69% of forex demand

• The gain in parallel market has been attributed to increase in forex supply from the CBN and oil majors in January

• International oil majors sold about $600 million in their monthly forex sale, thus relieving pressure in the parallel market

• The spread between official and parallel rates narrowed to 2.6% from 3.9% in December

Forex Trend

80

100

120

140

160

180

200

Parallel(N/$) Official(N/$)

Source: CBN, FDC

Outlook

• Accumulation of external reserves will continue to boost CBN support of naira

• This will be supported by increased sale of forex by oil majors

• Naira is expected to trade between N148/$ and N151/$ in February

Stock Market Update

Stock market update

• The Nigerian stock market is looking like a bikini

– What it shows is interesting but what it hides is even more exciting

• The market opened 2010 with a bull run, and a YTD gain of 9.79%

• But is this rally sustainable?

– Prices not responding to earnings results

– Stock prices are still being manipulated

– Sources of new investments in the market is uncertain

• Current Market Cap: 5.51trn

• ASI Index: 22,865

• Average volume and value traded in Jan was 402mn and 2.3trn, respectively; average PE ratio of 13.4x

19,500.00

20,000.00

20,500.00

21,000.00

21,500.00

22,000.00

22,500.00

23,000.00

4,700.00

4,800.00

4,900.00

5,000.00

5,100.00

5,200.00

5,300.00

5,400.00

5,500.00

1/4/2010

1/5/2010

1/6/2010

1/7/2010

1/8/2010

1/9/2010

1/10/2010

1/11/2010

1/12/2010

1/13/2010

1/14/2010

1/15/2010

1/16/2010

1/17/2010

1/18/2010

1/19/2010

1/20/2010

1/21/2010

1/22/2010

1/23/2010

1/24/2010

1/25/2010

1/26/2010

1/27/2010

1/28/2010

1/29/2010

ASI-MARKET CAP CHART

Year to date

Market Capitalisation NSE All-Share Index

Source: FDC

Recent Earnings Announcements

• Shows that share prices do not reflect earnings positions

– Costain share price has appreciated since it released a loss

– Conversely, Beco which showed earnings growth of more than 60% saw share price decline afterwards

Company Date of Result

Earnings

Growth

ASI Value as

at release of

earnings

% Chg in ASI

since result

release

Price growth

Pre-results

Price growth

Post result

Price growth

YTD

7 UP 04-Jan 6.63% 20,838.90 8.43 0 4.08% 4.08%

Beco 13-Jan 69.61% 22,252.38 1.54 -4.54% -13.69% -17.79%

Fidson 14-Jan 126.66% 21,944.94 2.96 11.80% 5.03% 17.42%

Unic Insurance 18-Jan 1.94% 22,183.80 1.85 -27.27% -7.50% -32.73%

PZ Cussons 29-Jan 8.78% 22,594.90 0.00 4.00% 0.00% 4.00%

Costain 21-Jan -62.83% 22,114.93 2.17 -2.89% 32.25% 28.42%

Wema Bank 20-Jan 55.82% 22,241.18 1.59 16.13% 4.36% 21.51%

Afromedia 05-Jan -22.29% 20,956.68 7.82 0.00% -20.00% -20.00%

Aiico Insurance 25-Jan 62.92% 22,254.56 1.53 20.25% -1.05% 18.99%

Effect of Change in Bank MDs

on stock price

• Overall effect of the new appointments has been positive

8.00

9.00

10.00

11.00

12.00

13.00

14.00

15.00

16.00

17.00

18.00

31

-Dec

-09

1-J

an-1

0

2-J

an-1

0

3-J

an-1

0

4-J

an-1

0

5-J

an-1

0

6-J

an-1

0

7-J

an-1

0

8-J

an-1

0

9-J

an-1

0

10

-Jan

-10

11

-Jan

-10

12

-Jan

-10

13

-Jan

-10

14

-Jan

-10

15

-Jan

-10

16

-Jan

-10

17

-Jan

-10

18

-Jan

-10

19

-Jan

-10

20

-Jan

-10

21

-Jan

-10

22

-Jan

-10

23

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24

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25

-Jan

-10

26

-Jan

-10

27

-Jan

-10

28

-Jan

-10

29

-Jan

-10

U B A PLC ZENITH BANK PLC

Source: FDC

PFAs still sitting on the sidelines

• Total assets estimated at N1.2trn before diminution

• Portfolio is grossly underweight on equities

– Less than 3% of assets are currently invested in the stock market

Bonds and Tbills, 14.29% Equities, 2.84%

Fixed Deposits & Bankers'

Acceptances, 82.83%

Mutual Funds, 0.04%

Breakdown of PFA Assets in Dec 2009

Bonds and Tbills

Equities

Fixed Deposits & Bankers' Acceptances

Mutual Funds

Source: FDC

Awaiting the AMC – a crisis of false

expectations

• Push-back on AMC law from stockbrokers who believe it may unfairly favor the banking sector

• Regulators stress its necessity– Enhance their capacity to handle the loan assets of the

failed banks presently under liquidation

– The strong influence of the banking sector on the Nigerian stock market

• Ownership structure in dispute– CBN and Federal Ministry of Finance or

– Include regulatory agencies (SEC) and the private sector to increase credibility

Outlook

• Fundamentally, the stock market has the potential to continue the positive trend

• Resolution of key outstanding issues is pertinent

– AMC and distressed banks

– Policy stance of regulators especially the CBN

• Political risks still a deterrent for major institutional and foreign investors who may be considering re-entering the market

Outlook

• Corporate actions to drive market performance

• FCMG, Banking, Building and Construction and Breweries sectors show potential for appreciation

– Strong fundamentals will continue to drive growth in FCMG sector

– Buying opportunities in some undervalued banks e.g. Sterling Bank

Outlook for February

• Political uncertainty will continue in February

• A resolution of the political issues likely or expect some form of conflict

• Anambra state election may erupt

• Stock market volatility will continue but to the upside

• AMC bill will pass into law in March

• The impact of quantitative easing and excess liquidity on price level

– 100-150bps spike in headline inflation expected

• It is better to live rich than to die rich. -

Samuel Johnson

• He who wishes to be rich in a day will be

hanged in a year. - Leonardo-da-vinci

• Nothing is politically right which is morally

wrong. - David O. Connell

• What is moral is what you feel good after and

what is immoral is what you feel bad after. -

Ernest Hemingway

Corporate Humour

• Live and let live is not enough; live and help live is not too much. - Orion E. Madison

• Nothing in the world is more dangerous than sincere ignorance and conscientious stupidity –Martin Luther King

Corporate Humour

Thank you for listening