Nigeria: CBN Maintain or Tighten Policy?

We expect policy to be held steady later today as the 100bp tightening in the MPR to 13% late-November 2014 is still yet to transmit its full effect throughout the economy. It is also unlikely for a tightening of policy prior to the election. However, there are various ways that the MPC could respond to current pressures, for example:

• Tightening monetary policy further by around 100bp.
• Raising Cash Reserve Ratio on Private Sector deposits above current 25%.
• Other indirect measures such as increase number of OMOs.
• Introduction of strict capital controls is also possible.

However, the 14 February election suggests another devaluation and/or monetary tightening before the election is unlikely. Devaluation in the post-election period is more likely given FX reserve drawdowns – assuming oil prices remain low and/or fall further. FX reserves have fallen around US$10bn to US$34bn compared to one year ago. There are large, unrecorded outflows taking place ahead of the election, which makes Balance of Payments analysis difficult. If oil prices remain low, risk of another devaluation rise, of around 8-10% shortly after elections currently appears likely. This will lead to an interbank exchange rate of around 204 to USD1 (the RDAS rate is currently set at +/-5% USD1:NGN168)

Fiscal balance will weaken due to fall in oil revenues. The fiscal deficit is likely to widen to around 2% of GDP in 2015 compared to an earlier government forecast of 0.8%. However, a reduction in fuel subsidies and a cutback in capital expenditure are two likely positive changes that will prevent the deficit from widening further. Increased issuance of domestic debt will be needed to plug the fiscal gap, but debt remains comfortable at around 10% of GDP, which is much lower than Greece, Italy, France, Spain, Portugal, and Ireland. Oil prices need to rise to around USD75/b before immediate currency pressures are reduced.

How much longer can CBN maintain managed float exchange rate regime is unclear and largely depends on the direction of oil prices. Not much longer unless restrictive controls are imposed, which in the longer term will damage economic growth. However, FDI into oil and energy sectors will help but not enough. Furthermore, portfolio flows are likely to remain weak given recent equity market sell off and falling bond prices, reflected in JP Morgan’s EMBI placing Nigeria on negative watch.

There is an increasing anomaly of low / comfortable inflation at 8% but a tightening monetary policy environment. Likewise, devaluation will raise the cost of imported goods, leading to accelerating inflation, as Nigeria is an import dependent economy, which heightens the pressures caused by naira weakening, and the reliance on hydrocarbons as the main source of export revenues. Inflation expectations are adjusting upwards and macroeconomic stability is being tested.

The central bank is unlikely to raise the policy interest rate later today, but pressures are rising according to the Ecobank release note . These range from risks to GDP growth as a result of the negative terms of trade shock from lower oil prices. Growth will slow to around 5%. And the current account moving into a deficit of around 2% of GDP for the first time this year in many years. There is scope for a further devaluation of the NGN post-election if FX reserve drawdowns continue apace. Monetary policy looks set to be held unchanged later today, but this could be an interim measure – MPR could be raised 100bp post-election in an effort to support the NGN. Savings from fuel subsidy payments and funds in the Excess Crude Account will be used to help offset oil revenue weakness. However, cutting expenditure will be necessary to prevent the fiscal deficit widening, which in turn will result in a major reduction in productivity-enhancing capital spending.