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Nigeria Strategy Report H1 2018 Excerpts- Inflation has peaked, but downside risks remain

• In our H2 17 outlook, we identified the absence of currency shocks, lower energy prices and the resulting downtrend in transport inflation as central to inflation trajectory in the second half of the year. Precisely, we noted that subdued movements in MoM PMS prices and declining diesel prices will portend a reversion in transport inflation from elevated levels which will cascade to a downtrend in food and core inflation. Indeed, our view panned out with headline inflation declining by 135bps to average 15.87% YoY over H2 17. However, the scale of the impact relative to our expectations was subdued by the impact of flooding across key farming communities as well as elevated cost of transportation. Consequently, food inflation expanded 127bps over H2 17 to 19.42% YoY. Elsewhere, core inflation dipped 274 bps to average 12.18% YoY over H2 17 with education, Housing, Water, Electricity and other Gases and Fuel (HWEGF) and transport inflation as the key drivers.
• In the review period, MoM headline inflation trended lower (-70bps to 0.59% MoM) underpinned by decelerations in food (-104bps to 0.58% MoM) and core inflation (-32bps to 0.51% MoM). On the former, decelerations reflected higher food output in the harvest months which dampened the scale of inflationary pressures. Switching to the core basket, ebbing pressures captured the absence of fresh supply shocks and gains from FX liquidity pass-through. 
• In setting out our view on inflation over 2018, currency, though indirect, remains central. Going into 2018, we expect a relatively stable naira—albeit marginal decline—across all FX windows driven by higher accretion in the CBN’s FX reserves which should mitigate capital flight and demand pressures over the forecast period. Against this backdrop, we narrow the scope of potential shocks on core inflation in the forthcoming year to higher electricity tariffs, rising energy prices and elevated cost of transportation. However, against the backdrop of a tightly contested election campaign in 2019, weak consumer purchasing power as well as high unemployment rate, we hold the view that the probability of implementing higher electricity tariffs in 2018 is extremely slim. In a similar thread, we hold the view that PMS and diesel prices will be equally managed to quell political uprising and garner political popularity against the impending 2019 elections.
• Switching to food inflation, the waning impact of currency-induced jump in food prices which posed a high base over H1 17 suggests a moderation for food inflation in 2018. First off, FEWSNET reports that farmers responded favorably to the elevated domestic prices with aggregate production of major cereals^[1] (such as maize, millet, rice, and sorghum) higher than historical levels to drive moderation in prices. In a similar thread, barring the occurrence of flooding activities, we expect to witness a steeper descent in food inflation over the harvest season. On the downside, the scale of the decline in food inflation will be tapered by structural bottlenecks in transportation costs.
• Overall, our analysis suggests that while base effects fuels CPI downside, structural bottlenecks from elevated transportation costs should limit scale of moderation in inflation. Summing up developments across both core and food inflation sub-components and adjusting for their respective weightings in the CPI basket, we project mean headline inflation to hover around 12.7% YoY over 2018 (2017: 16.55%).

 

[1] According to FEWSNET, cereal production is 9% higher compared to last year, and 12% compared to the five-year average levels.