As Nigerian equities struggle with declining share prices, a leading investment research firm, Bismarck Rewane’s Financial Derivatives Company (FDC) Limited, has said the rising inflation could further undermine the recovery of the Nigerian equities market.
In its latest update, FDC said there was a strong probability for further increase in inflation rate in July and August, raising the stake after inflation rate increased from nine per cent in May to 9.2 per cent in June.
According to the firm, increased demand for fruits during the just-concluded Ramadan fasting period in July will lead to a seasonal rise in prices while inflation in the near term will also be affected by the new restrictions in the forex market and the effective depreciation of the Naira.
“While the stock market is historically inflation neutral, investors fear that higher inflation will virtually lead to a rise in interest rates and fall in stock prices. They will therefore begin to go short on stocks,” the report stated.
Inflation-adjusted returns on equities fell from -11 per cent in May to -17.1 per cent in June. The dollar adjusted inflation after considering the depreciation of the Naira was 35.5 per cent.
“We believe that the increasing inflationary trend is likely to extend into third quarter. Besides the fuel scarcity problem that still lingers – albeit lightly, there has been sustained attacks from Boko Haram insurgents in the Northeast, where many farm products, especially perishables, are cultivated. Lower food supplies would lead to a rise in the food sub-index of the Consumer Price Index (CPI),” the report stated.
The report noted that while the rising inflation may likely to be aberrational, the trend is becoming more consistent and is fueling the fear factor as anticipated inflation is more important than historical inflation because it influences consumer behaviour and preferences.
“Demand for goods will increase if people expect prices to rise in the near future. As demand increases, producers would be forced to increase prices up to a point that there is a struggle of bargaining power. At this level, it is the price elasticity of demand that determines if there would be a further increase in prices. Another threat to inflation is the possibility and timing of the subsidy removal, which is now becoming more inevitable,” the report highlighted what may be a double-edged sword against quoted companies which earnings, share prices and capital raising capacity would be affected simultaneously.
FDC noted that the rising inflation has also placed Nigeria’s Monetary Policy Committee (MPC), in a tight position as it now faces the typical monetary policy trilemma of increasing inflation, currency pressures and interest rate stability.
According to the analytical firm, while a decrease in interest rates is politically expedient to stimulate economic growth, it may not be the appropriate move due to currency and inflationary pressures. The increased liquidity in the system from the bailout funds is another factor that the Central Bank of Nigeria (CBN) would have to consider. The CBN will be reluctant to increase interest rates as monetary policy tightening is almost reaching its upper limit. The CBN could alternatively increase its use of administrative tools such as cash reserve ratio (CRR) and Open Market Operations (OMO).
The report pointed out that even though the CBN is committed to defending the Naira, the currency pressures facing Nigeria are becoming more intense with the spread between the interbank rate and the parallel market creating an arbitrage corridor for speculators, and is a round tripper’s paradise.
Besides, another issue of concern is the consistent decline in oil receipts as a result of falling oil prices, when the sanctions on Iran are finally removed.
FDC noted that while the appointment of new service chiefs is expected to improve the security situation in the Northeast, the aftershock of the Central Bank of Nigeria’s (CBN’s) restriction of importers’ access to foreign exchange at the interbank market would be felt in the coming months.
“We are already at the upper limit of the tightening cycle, and the more probable outcome at the MPC meeting would be for the CBN to maintain the status quo and use more administrative measures in its quest to protect the Naira in the forex markets,” FDC stated.
It however noted that many other African countries were also facing inflationary pressures. Angola’s inflation rate rose to 9.6 per cent last June from 8.86 per cent in May. Kenya also witnessed a rise in inflation from 6.87 per cent in May to 7.03 per cent in last June, just as Mozambique’s inflation rate rose from 1.29 per cent in May to 1.36 per cent in June, this year.