With demand for the greenback in the parallel market set to rise, the major question that comes to mind is whether higher demand at this segment of the FX market will further widen the official/parallel market gap, especially if the official FX rate is assumed constant. Available data from CBN’s website puts average monthly autonomous dollar at c.$4.0bn. Hence we think while there could be some volatility in the interim, impact will likely be short-lived.Clearly, autonomous dollar supply has always been available but the major bottle neck prior to now appears to be more around pricing in our view, with most holders preferring to sell at the parallel market rate, while seekers understandably favor the official window. With marketers now forced to look at the parallel market, we believe potential supply at that market is robust enough to take-in increased demand, at current price.

Policy move to further stoke inflationary flames… to what extent?

Ordinarily, It would be expected that higher PMS cost will lead to a rise in transportation costs, with attendant impact on Inflation. This plausible scenario is without a doubt daunting, given that inflation already hit a 46-month high of 12.8% in the month of March. That said, we note that key drivers of sharp jump in inflationary reading over the past two months already factors-in a large chunk of the impact of recent hike in electricity tariff (effected in February) as well as transportation costs as average PMS price across the country over the period rose to N136.0/litre which is only 6.6% below the higher end of the new PPPRA retail price band.  This suggests headline inflation will need a much stronger push from where it is currently, to sustain current pace of m/m increase.  To add, we take further evidence from a similar occurrence in 2012 where a partial removal of fuel subsidies only had a transient impact on inflation, after the initial shock. Thus, we only expect to see a moderate uptick in inflation from current levels on a m/m basis, and maintain our 2016 average forecast at around 12.5%.

MPC: All pointing toward further policy tightening, likely to be accompanied by some move on the FX front

Since the monetary policy tightening move by the Apex bank at the end of its March policy meeting, the economy appears to have thrown up new challenges. Asides from obvious strain on the FX reserves, expectations of higher inflation from a combination of persistent FX shortage and higher transportation from lingering fuel scarcity, has further pressure real return of naira assets, which was a one of the major reasons behind the aforementioned hawkish move.

On the FX side, recent comment by the VP on the need for “substantial review”  of current FX policy which may feature possible devaluation” appears to hint at a shift in the body language of the Buhari-led administration. Also, we believe the rate of depletion of the FX reserve will be of concern for the MPC. This, coupled with the need to attract foreign capital and higher near term inflation expectation from this freer pricing of PMS creates a case for more policy tightening, likely to be accompanied by some further clarity around FX policy.

Impact on naira assets:For equities, select downstream oil and gas players likely to benefit

We believe this move is the beginning of a more competitive terrain for the downstream petroleum sector, and will tilt advantage more towards industry players with scale, robust distribution network and access to capital as well as FX at a competitive price, in our view. In this regard, we favor players with foreign parentage and affiliations, specifically Mobil and Total. The entrance of Dangote refinery in 2017 will also create an interesting dynamic, and will likely further accelerate the pace downward adjustment of pump prices as supply increases.

FI market: Yields likely to continue recent ascent in the near term

For the FI market, higher inflation expectations and the possibility for further policy tightening should push yields further higher in the near term, although should events around the FX policies play out like we anticipate, re-entrance of the foreign money managers will likely see a higher demand for sovereign notes which will ultimately moderate yields

Conclusion:  Not a complete deregulation, but a good step with promise

While recent move definitely creates a more liberalized market, it is clear that the market is not yet fully deregulated given that the new retail pump price per litre is still capped at N135-N145. That said, we do see a path of wisdom, as current price cap should help prevent the possibility of price connivance by industry players in the interim. We believe the market will be fully deregulated once overall supply increases and the domestic refineries commence consistent production at optimal levels. While we look on with interest, one has to say that despite current uncertainties on the fiscal side, this move has in it a lot of promise.