Nigeria – The case for further tightening

Bond yields have declined in recent sessions, with the market increasingly taking the view that further interest-rate tightening is unlikely. The appreciation of the Nigerian naira (NGN) in the interbank market, to 151 from levels of over 157 versus the US dollar (USD) has been a key influence.
(See On the Ground, 27 May 2011, ‘Nigeria – Wait and see’), in which there was caution of the likelihood of further tightening would depend very much on FX stability.)

Also, Ngozi Okonjo-Iweala, a well-regarded reformist from the World Bank, has been appointed Finance Minister with an expanded portfolio; this has raised hopes of faster fiscal consolidation in Nigeria – with pre-election government spending cited as a key factor behind earlier Monetary Policy Committee (MPC) tightening. Finally, single-digit inflation looks to be in sight. Headline CPI inflation decelerated to 10.2% in June, from 12.4% y/y in May, helped by more moderate food price inflation.

However, none of these reasons provides sufficient justification for the Monetary Policy Rate (MPR) to be kept on hold at 8% just yet. While hopes for fiscal consolidation may be running high, significant progress remains unlikely in the short term. The increase in the national minimum wage to NGN 18,000 from NGN 7,500 previously, passed before the election, will take effect in August.

Nigeria is still awash with liquidity, with a record NGN 1.317trn (USD 8.72bn) distributed at the last monthly Federal Accounts Allocation Committee (FAAC) in July. This was comprised of NGN471bn (USD 3.1bn) of statutory revenue, mainly oil earnings; NGN 52.5bn (USD 0.35bn) of VAT; and NGN 710.7bn (USD 4.7bn) of excess crude account savings, representing the arrears of budget augmentation due for January-April 2011.

Even with the best fiscal intentions, it may take several months before Nigeria sees meaningful progress in spending cuts. Any new bill would have to be passed by the National Assembly, before being signed by the president. Deliberations might be lengthy. Moreover, state governments – now forced to implement the new national minimum wage – have argued for a change in the revenue-sharing formula to allow them to do so. Fiscal pressures appear firmly embedded and difficult to rein in.

It is not clear that the FX rate remains a benign influence on inflation, despite Nigerian naira (NGN) appreciation on the CBN WDAS (the bi-weekly wholesale Dutch auction) and interbank markets. Following the official restriction on sales of WDAS funds to the Bureaux de Change (BDCs), USD-NGN rates charged by the BDCs have reportedly spiked higher to 167, reflecting tighter FX supply. But an increased spread between the official and parallel markets raises the risk of ‘round-tripping’, i.e., sourcing official funds for onward sales on the parallel market. No system is entirely leak-proof, and sustained pressure on the parallel market suggests that there is still a strong need for further tightening. Real interest rates are still negative.

A hike of at least 50bps is required, taking the MPR to 8.5%.

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