Nigerian MPC to Retain Status Quo for Later Devaluation?

Lagos, Nigeria (Capital Markets in Africa):- In light of the recent happenings in the monetary and fiscal policy space, the Monetary Policy Committee (“MPC”or “The Committee”) will be sitting on the 18^th and 19^th May, 2015 for its third meeting in the year to discuss and take critical policy decisions relating to the economy. In the plethora of issues to be considered, the recent pressure on exchange rate, declining external reserves, rising price level and slowing domestic economic growth will likely take the centre stage.

The Committee in the immediate past meetings has taken certain bold policy decisions relating to currency devaluation, Net Open Position (NOP) and the Monetary Policy Rate (MPR) in light of daunting fiscal and monetary policy challenges. The RDAS (Retail Dutch Auction System) was closed in February 2015 while all demand for FX was directed to the interbank market even as the CBN continues to intervene intermittently in the Interbank Market to moderate volatility swings.

Whilst the financial system is being observed for full digestion of these recent policy pronouncements, the sustained pressure on the Naira, widening spread between the interbank and BDC markets and low levels of external reserves will be top on the priority list of the MPC. In this light, we look through our crystal ball that the decisions of the MPC would most probably be to maintain status quo on major policy rates while postponing the possible further devaluation of the Naira to a later meeting after installation of new administration. We highlight below some of the key developments the MPC will be considering to arrive at this forecast decision.

Global Economic Conditions
Global economic recovery remains moderate and uneven; hence, monetary policy in the advanced economies remains broadly accommodative.  The Dollar continues to strengthen against major currencies gaining 3.8% Year to Date (YTD) thereby distorting financial stability and competitiveness in regions that have debts denominated in dollars. Meanwhile, US –Federal Reserve kept interest rate at low level as quarterly economic data released in April indicated a slower growth rate than predicted.

In the UK, the landslide victory by the incumbent Prime Minister (David Cameron) in the just concluded election is expected to sustain the pace of economic progress made in the first term of the returning Prime Minister.In Europe, the ECB launched an asset purchase program worth 1.1 trillion euros in March (60bn euro monthly till Sept-2016) to rekindle the faltering growth in the region amid controversy surrounding Greece debt crisis.

Growth in emerging and oil dependent economies stays stifled by lower commodity prices, regional and geo-political crisis. Consequently, major, central banks continue to alter interest rates intermittently, in a bid to boost economic activity.

However, we note that global oil prices seem to have picked in the last few weeks as the Brent Crude currently trades at US$66.7 as against US$55.1 before the last MPC meeting. On the basis of the foregoing, global recovery is expected to remain fragile in the short to medium term.

Domestic Economy, General Price Level and Polity
Much in line with our expectation, the domestic economic activity was broadly constrained by fall in global oil prices and bottlenecks in socio-political and fiscal space. This was reflected in the recently reported Gross Domestic Product (GDP) figures by the National Bureau of Statistics (NBS) which puts 2015 first quarter estimates at a growth of 3.96% Y-o-Y. NBS attributes this to activity decline of 8.2% in oil GDP and slower growth pace of 5.6% in non-oil sector.

However, we believe pressure in the fiscal and monetary policy space also accounted for the sluggish performance of the economy. Whilst this may be of concern to MPC, we note that it may likely count for less in monetary policy decisions for May given other overriding issues that should take precedence.

Also, Headline inflation rate continued northwards for the fifth consecutive month, settling at 8.7% in April 2015. This is expected, given the perceived pass-through of the recent direct and indirect devaluation of the Naira on input cost and import prices. Upward trend in price level is anticipated to systemically intensify in May 2015 due to the recent fuel scarcity and its attendant impact on general price level. Nevertheless, we think issues on rising price level are not likely to be placed on the priority list of the committee.

The domestic polity has remained stable following the peaceful conduct of the elections and the concession of defeat by most of the candidates that lost. Although the polity condition is always a factor to consider by foreign investors, there has been a significant moderation in political risk.

Fiscal policy, 2015 Budget and Oil prices
The 2015 budget was passed by both Chambers of the National Assembly amid lower oil prices, FX volatility and weaker GDP growth forecast. Hence, modest budget assumption of US$53.0bpb oil benchmark, exchange rate of N190.00/US$1.00, 2.3mbpd crude oil production, 5.5% GDP growth rate and 1.1% Deficit to GDP ratio was approved.

Fiscal stance is planned to be broadly contractionary, with 57.8% of the 2015 budget expenditure (N4.5tn) earmarked for recurrent spending (N2.6tn) relative to capital expenditure which was scaled down to N557.0bn (11.1% of the Budget). This brought planned recurrent expenditure to about five times the capital expenditure.

Amid lower global oil prices, although recovered slightly in recent weeks, the fiscal authority has already used up half of its planned borrowing for 2015 fiscal year. According to the minister of finance, this had been spent to cover overheads and salaries.

We opine that the effectiveness of the 2015 budget remains questionable, given that the broad objective of the budget is largely unconnected with the policy disposition of the incoming administration. Hence, we think the MPC may be more concerned about the fiscal stance of the incoming government rather than the policy thrust of the transition budget.

Financial Market Performance: Equity, Money and Bond Markets
Since the last MPC meeting that ended on 24th March, 2015, performance of the Nigerian Financial Market has been mixed with a divide between the period before and after the elections that was held on 28th March, 2015.

In the fixed income market, average bond yields rose to 15.4% before the elections. However, with the successful conduct and the attendant political risk moderation, bond yields currently trade on an average of 14.5%.

Financial system liquidity level hasbeen on an increasing trend between the last MPC meeting and now. In March, average liquidity was at N207.9bn while it declined to N233.2bn in April. Irrespective of the sustained hawkish policy stance of the CBN, liquidity level has been quite high in May with an average balance of N477.6bn. Overnight and Open Buy Back (OBB) rates continue the usual oscillatory trajectory in response to the prevailing liquidity levels.

In the equities market, the All Share Index (ASI) gained 8.3% a day following the announcement of the president elections in contrast to bearish sentiments that greeted the market prior to the elections. Benchmark equities index at 11.8% YTD loss before the elections (27/03/2015) thereafter turned positive to 3.1% (02/0/2015).

The Equities market has since been generally calm as investors took to cautious trading amidst uncertainty in monetary policy and fiscal direction of the incoming administration. We opine that the financial market performance will remain hinged on the policy direction of the next government. Hence, we do not expect the MPC to take any drastic decisions regarding the policy rate

Exchange Rate: Induced Currency Stability; How much Longer?
The FX rate at the interbank market has been trading at a tight band — between N199.00/US$1.00 and N199.75/US$1.00 – since March 2015. This is consequent on the elimination of RDAS window and the CBN’s intermittent interventions which shut out liquidity in the market even as demand remains in excess.

We believe the induced stability in the FX market may not be sustainable given the level of external reserves (US$29.7bn) and reduced prospect for accrual with low level of crude oil prices. The external reserves which has fallen 13.9% YTD can barely cover six months of import. This may even be lower when the reserves is discounted for the forward FX sales made by the CBN last year.

Meanwhile, opportunities for arbitrage continues to exist in the BDC segment with a spread of N25.5 over the CBN’s intervention rate. Although, we note that renewed confidence in the economy may favour inflow of foreign capital, the ability of the CBN to maintain the “induced stability” remains much in doubt should the apex bank maintain the current level of intervention in light of the reserves position.

Based on the forgoing, we think the CBN is faced with the options of floating the Naira, increasing the intervention price at the interbank market (tacit devaluation) or continuing with its current stance. The option of floating or devaluing may however be inexpedient in light of imminent political transition.

The Committee’s Possible Considerations

• The global economy remains resilient amidst the temporary slight recovery in oil prices, tempered rate in the US and the ECB asset purchase programme. Hence, no near term external shock is expected to affect the domestic economy.
• Domestic economic short term growth potential remains weak amidst fiscal challenges but still within the band of earlier weak projections and does not call for a major policy action.
• The general price level (April: 8.7%) has assumed a steady upward trend since the initial Nov-2014 devaluation but also does not pose a monetary policy threat yet in the light of other macroeconomic challenges.
• The induced stability of the Naira and the overwhelming pressure on the external reserves call for more attention as the weakening fiscal revenue continue to impact on reserves accretion while demand glut persistently mount dwindling effect.
• Against this backdrop, the committee will likely consider the need to either float the currency, increase the CBN’s intervention rate (tacit devaluation) or maintain the status quo.

The Committee’s Probable Decision
Against the backdrop of the above considerations, we highlight the three major possible policy options for the committee below.

1. Retain MPR at 13%, Public Sector CRR at 75%, Private Sector CRR at 20%, liquidity ratio at 30%, NOP at 0.5% and announce the floating of the currency to eliminate pressure on external reserves.
2. Retain MPR at 13%, Public Sector CRR at 75%, Private Sector CRR at 20%, liquidity ratio at 30%, NOP at 0.5% and increase the CBN’s intervention rate at the interbank market to reduce the pressure on the reserves.
3. Retain MPR at 13%, Public Sector CRR at 75%, Private Sector CRR at 20%, liquidity ratio at 30%, NOP at 0.5% and maintain status quo on exchnage rate policy to allow the incoming administration settle before grappling with any major monetary policy issue.

On a probabilistic basis, we place a 5% probability on scenario one, 45% on scenario two and 50% probability on the third scenario. Hence, we stake that the MPC is more likely to vote for the third scenario above in the overriding interest of monetary and fiscal policy stability of the economy.
Source: Afrinvest Research, Nigeria