Nigerian MPC At a Crossroad; Between Domestic Stability and External Balance

Lagos, Nigeria, Capital Markets in Africa — The Nigerian Monetary Policy Committee (MPC) will be sitting for its 5^th session this year between 21^st and 22^nd September 2015 to review developments in the global and domestic economy, together with the financial market since its last meeting (23^rd and 24^th July 2015). It is expected that deliberation at the meeting will center on the slowing domestic growth, persistent exchange rate uncertainty, increasing risk perception in the local market in the light of the JP Morgan planned phase out of Nigeria from the EM index, financial system illiquidity and global economic fragility.

Between the last MPC meeting and now, the Bureau of Statistics (NBS) reported that Q2:2015 GDP growth slowed to 2.4% from 4.0% in Q1:2015, while inflation rate continued tiptoeing northwards Y-o-Y, berthing at 9.3% in August from 9.2% in July. Furthermore, the directive by the Presidency for the full implementation of the Treasury Single Account (TSA) by the Federal Ministries, Departments and Agencies (MDAs) to ensure transparency and improve fiscal revenue inflow has had impacts on financial system liquidity and increased volatility in the money market.

Overnight and Open Buy Back rates reached year highs of 105.3% and 100.8% respectively during the period under review and closed at 50.9% and 49.2% apiece at the close of the deadline on 15^th September, 2015. The TSA implementation in addition to the harmonized Cash Reserve Requirement (CRR) of 31.0% would weigh down the capability of banks to create risk assets and increase banking cost of funds as approximately 5.3% of majorly cheap federal government deposits have been isolated. We anticipate that DMBs would likely pass on majority of the additional-interest burden to customers, which could constrain economic capacity, although this may also increase focus on real banking – strengthening competition for retail deposits and expanding credit to the higher-margin retail sector.

Within the foreign exchange market, the naira continues to witness volatility in the parallel market. Demand management policies by the apex bank have redirected demand for the greenback to the parallel market to a great extent. The intervention rate remains N197.00/US$1.00 at the Central Bank while the interbank market rate steadied at N199.10/US$1.00; on the other hand the parallel market rate trades at a spread of more than N20.00 settling at N224.00/US$1.00. Coupled with the tight currency liquidity, the spread between the interbank market and the parallel market rates pressed foreign investors to reduce participation in the Nigerian markets in 2015. Thus, JP Morgan’s decision to gradually phase out Nigerian bond instruments from its GBI-EM index was necessitated; which has increased concerns on the absence of a fiscal economic direction and heightened expectations that ratings agencies may downgrade Nigeria’s sovereign ratings. Nevertheless, we believe the planned phase out by JP Morgan has very little impact on liquidity of Nigeria’s bond market which is majorly dominated by domestic institutional investors. In addition, the concerns that an increase in interest rate by the US Fed may spark further capital outflows from emerging and frontier markets may have eased given FOMC’s decision yesterday to keep the interest rate unchanged.

In light of the above, we expect the MPC to deliberate on alternative methods to further strengthen foreign participation in the Nigerian capital market given its current stance on FX rate. We also expect the MPC to deliberate on how to improve currency market liquidity to reduce FX rate uncertainty while assessing the current financial system liquidity in the light of 31% CRR on deposits and the TSA implementation.

Given the stance of the Apex Bank (with backing from the presidency) on not considering a devaluation, we imagine that the MPC decision would favour one of the following possible scenarios;

• Reduce CRR to 27.0% in order to repress the strains of the TSA implementation on financial system liquidity and banking cost of funds; leave MPR and official exchange rate unchanged at 13.0% and N197.00/US$1.00 respectively.
• Leave all policy rates unchanged and continue to use administrative measures to ensure financial stability within the economy.

We place a higher weighting on the first scenario with a 70.0% probability relative to the second scenario at a probability of 30.0%. This is based on the CBN’s need to keep liquidity at a level just enough to ensure a functioning and stable money market without increasing pressure on the external sector variables, amid global financial market conundrum, falling oil prices and exchange rate volatility. 

Source: Afrinvest (West Africa) Limited Research Team