Falling Oil Prices: Analysts weigh implications of CBN’s policy measures

30 November 2014, Abuja – It gets tougher before it gets better seems to be the message sent to the financial market and the entire economy by the Central Bank of Nigeria after the historic monetary policy committee meeting last week. Festus Akanbi, who attended the briefing of the CBN Governor, Mr. Godwin Emefiele, where major policy pronouncements were made to address impact of the sliding oil prices on the economy,  presents the views of economic analysts who have been keeping close tabs on the financial system
It was 2 o’clock  on that sunny afternoon of Tuesday, November 25 and scores of local and international financial journalists had taken their seats on the 11th floor of the imposing Central Bank of Nigeria building in the Central  Business Area District of Abuja, the federal capital, venue of the post-Monetary Policy Committee press briefing.
Oil steady below $80The news hounds, whose figures were conservatively put at well over 150, were not oblivious of the tension in the international and local financial markets over the issue of the tumbling oil prices and the attendant constraints on an oil dependent nation like Nigeria.
Meanwhile, as the CBN Governor, Mr. Godwin Emefiele, who led a team comprising his deputies took his seat, the silence in the room was deafening, except for the large TV screens showing the readiness of the crew of the CNBC Africa, positioned to beam the media briefing live to the rest of the world.
By the time Emefiele began to read the decisions of the Monetary Policy Committee which had deliberated on a range of issues for two days, at exactly 2.15pm, it dawned on reporters that Nigerians were in for a great change.

The Decisions
The MPR was hiked 100 basis points from 12 percent to 13 percent.  The private sector CRR was hiked 500 bps from 15 percent to 20 percent.  The RDAS mid-rate was moved to 168 from 155, and the band around it widened to +/-5 percent.

A Word of Assurance
The Coordinating Minister for the Economy and Minister of Finance, Dr. Ngozi Okonjo-Iweala has assured Nigerians that the finance ministry and the economic management team are working on several scenarios, which include reviewing the nation’s policies on investment incentives, and waivers and exemptions to stem the tide of abuses.
Speaking at the Securities and Exchange Commission’s (SEC) 4th Annual Capital Market Committee Retreat holding in Abuja, last week, she listed other measures to include reducing oil price expectations; increasing the nation’s non-oil revenue as a percentage of gross domestic product (GDP) to $3 billion in three years; cutting certain recurrent spending such as the purchase of administrative equipment, overseas travel and training; and implementing some cuts in capital expenditure in the 2015 budget.
She stated that her first measure was to make up her mind that panic would not solve the problem, stressing that no nation manages economic crisis successfully with panic.
According to her, “Panic is not a strategy. We are managing the situation to keep the economy on a stable sustainable course and we will not listen to those who want us to throw up our hands in despair and give up.
“Our scenario-based approach to managing the impact of the oil price drop is proactive and comprehensive. Even if the price drops to 60 dollars we are ready.
“As a central part of our strategy, we have revised our oil price expectations over the short to medium-term. We have lowered our benchmark oil price assumption to $73 per barrel after some careful analysis of the possible future direction of oil prices as well as the soft floor price for shale oil, which is estimated at about $75 per barrel.
“But let me clearly state that we are not taking a point-estimate position as regards the future price of oil. We fully recognise that oil prices may fall lower or even rebound.
“What we did was to work within a range of $60 to $85 thought possible by analysts, put a package of measures around an estimate at the mid-point of that range, that is $73, and then built additional measures for scenarios at $70, $65 and $60 a barrel.
Meanwhile, the International Monetary Fund (IMF) has said the measures put in place by the Federal Government aimed at mitigating the impact of the recent significant fall in global oil prices on the economy is a move “in the right direction”.
Gene Leon, the International Monetary Fund (IMF) mission chief for Nigeria, said this in a statement made available last week.
According to Leon, “In a combination of actions, most recently the communiqué after the Central Bank of Nigeria’s Monetary Policy Committee meeting of November 24-25, the authorities have announced a set of policies aimed at mitigating the impact of the recent significant fall in global oil prices on the economy.
However, no sooner did the CBN governor ended his briefing than the story of the daring move to halt the falling value of naira, check the haemorrhage at the stock market  and arrest the depletion of the nation’s external reserves went viral in the nation’s media space.
Expectedly, the responses of economic affairs commentators on the new regime of rate tightening were spontaneous and very informing.
According to Afrininvest West Africa, a finance and investment advisory firm, the series of adjustments at the last MPC meeting is expected to have direct impacts on the capital markets and the broader macro economy.
The firm believed certain dynamic ramifications would be unveiled as the policy continues to be implemented.

Impact on Lending
Afrinvest said the CBN’s decision to increase the CRR on private sector deposit by 300bps to 15.0 percent will quarantine approximately N500bn from the banking system. As such, this is expected to constrain banks’ ability to grow. In addition, the Prime Lending Rate (PLR) and Maximum Lending Rate (MLR) typically tracks the Monetary Policy Rate (MPR), therefore its anticipates a minimum 100bps increase in both the PLR and MLR.
Another financial advisory firm, Financial Derivatives Company, said in its Economic Bulletin last week that the five percent hike effectively quarantines N368bn of total private sector deposits of N7.38trn. This, according to its estimation, brings total sterilised private sector funds to N1.47trn, which is 9.72 percent of total banking deposits and 8.87 percent of money supply.
“The cocktail of decisions is expected to push up interbank rates by 100-200bps in the short term. Borrowing costs will rise and banking sector profitability is set to take a hit as net interest margins diminish further,” the report authored by the company’s chief executive, Mr. Bismarck Rewane, said.
Commenting on the impact of 1ppt MPR hike to 13 percent, a frontline financial firm, Renaissance Capital, said it expected banks to re-price naira risk assets higher on the back of the CRR and MPR increases, in an attempt to offset the revenue loss.
According to Vice President – Banking Analyst (SSA), Equity Research, Renaissance Capital Limited, Mr. Adesoji Solanke, “An MPR hike makes it an easier discussion for banks with customers on the justification for a lending rate increase.
That said, we think the impact of this lending rate increase could be somewhat diluted by two factors: 1) FX percentage of system lending has more than doubled over the past four years to 35-40 percent today on our estimates (these are Libor-priced assets), and 2) savings interest rates get adjusted upwards by 30bpts to 3.9 percent from 3.6 percent as these are pegged at 30 percent of the MPR. What would help compensate on the revenue front for the banks will be an increase in liquid asset yields, which is likely but we note that this has not necessarily played out post previous CRR hikes. On balance, while higher lending rates give some ease to the margin pressure, we think the banks move into a higher cost of risk cycle in 2015 and 2016,” he said.

Banks’ Profitability
Another question raised last week was the impacts of the new measures on banks’ profitability.
Afrinvest noted that with the plan to quarantine approximately N500billion of private sector deposits from the banking system, the opportunity cost of these funds which is the average yield in fixed income securities – 10.0 percent, will be lost. “The income lost is estimated at approximately N50.0billion over the next 12 months. Hence, we expect further selloffs in banking equities as the earnings capacity within the industry wanes,” the report said.
Renaissance Capital believed the sterilisation of additional N500billion of system deposits, at an assumed rate of 10 percent, implies a N40-N50billion knock off from system profits.  Rencap said the banks already expected this hike and have been liquidating treasury assets in anticipation, it however said it “expect system liquidity ratios (to) get squeezed further, as they were already down 6ppts to 44 percent in 9M14 from 51 percent on average in FY12 for our coverage universe.
According to Rencap report, “This is negative for growth in naira risk assets but not necessarily overall system credit growth which has remained buoyant despite the continued tightening of CRR over the past 24 months, as this growth has been funded by foreign currency liabilities which are not affected by the CRR. We expect some increase in funding costs as banks compete for deposits to fund naira risk asset creation and savings deposit rates get re-priced.”

On Naira
Managing Director, Head – Africa Macro, Standard Chartered Bank, Razia Khan, told THISDAY that henceforth, banks will find their margins squeezed a little more, and they may find that more import-reliant clients see some slowdown in activity.  “But in all, the measures give Nigeria the breathing space to adjust to lower oil prices more gradually.  We do not expect any softening in activity to be very long-lasting,” she said.
Afrinvest described the 8.4 percent devaluation of the naira from N155.00/US$1.00 to N168.00/US$1.00 at the official window as a bold move.
“In the short term, we expect the spread between the interbank rate and the official rates to widen, while in the medium term, Foreign Portfolio Investors (FPI) will be faced with dilemma of selling off positions and taking losses in anticipation of further depreciation or patiently riding the curve back up. In our view we expect the former to take precedence as the selloffs will persist in trading sessions ahead in the fixed income and equity market. Consequently, yields in the fixed income market will increase pressured by these selloffs and the additional liquidity requirement of the banks to meet up with the new CRR requirement.  In the long term, the MPC’s decision to devalue the naira by 8.4 percent (N13.0) will aid the convergence of exchange rate at all segments of the market.
Dwelling on the implications of the 8 percent devaluation of the naira, FDC in its report said “the CBN has more room to tinker with the exchange rate. The currency adjustment, according to its economic bulletin, has a direct impact on the cost of imports and may undermine the MPC’s efforts at ensuring price stability in a hugely import dependent economy.”  Recalling that the CBN Governor referred to the use of the floating rate to achieve the real equilibrium exchange rate path,
Head, Research and Intelligence, BGL Plc, Mr. Olufemi Ademola told THISDAY that imports will become more expensive.  Nigerians will cut back (in the short-term) on more discretionary import activity.
This will help provide some buffer to the trade account as export earnings weaken.
He is of the opinion that banks will find their margins squeezed a little more, and they may find that more import-reliant clients see some slowdown in activity.  But in all, the measures give Nigeria the breathing space to adjust to lower oil prices more gradually.
Ademola said, however, the fiscal financial implications of the new exchange rate level could moderate the liquidity effect of the CRR on banking system liquidity by the next FAAC allocation. This is because, the application of the new exchange rate level to government revenue proceeds implies higher naira FAAC distributable values and hence more naira inflow to the banking system. Respite for the naira exchange rate is also expected from the expected increase in bond yields as outcomes of these decisions. This is however conditioned on the sentiment on the political risks facing the economy at this time of a possible permanent lower price of oil.
But analysts from Renaissance Capital believe that devalued currency is slightly negative for asset quality and costs.
It explained that this is not a repeat of 2009. Back then, the currency devaluation was more significant (15-20 percent vs. 8 percent), sudden and other factors combined to intensify the asset quality deterioration in the banking sector beyond just the currency move. “We believe risk management structures have significantly improved across the system but current macro challenges are the greatest test that these structures will be facing since 2009.
Therefore, we think there will be some pain, largely within the trade, SME, consumer and downstream oil and gas sectors; which coupled with potentially higher lending rates, move the banks into a higher cost of risk cycle but nothing close to 2009. We think OPEX also gets pressured somewhat as suppliers’ factor in the devaluation and inflation creeps in.”

Price Stability
On price stability, analysts from Afrinvest said, given the import dependent nature of the Nigerian economy and the approximate 15.0 percent contribution of imported goods to the Headline Inflation Index, there may be a mild increase in the November 2014 inflation rate.
Inflationary pressures are not apparent but the committee noted that the underlying pressures remain potent. In reiterating its commitment to the monetary policy framework of explicit inflation targeting, the committee is now emphasising a dual anchor of the MPR and exchange rate. In addition, it is using administrative tools and at the same time allowing for flexibility in the exchange rate. The research firm said the increase in the exchange rate midpoint and the widening of the corridor provides more headroom for investors hedging against the dollar. This will allow the currency move towards its real equilibrium rate path.
Khan said the move down in the oil price globally may be overdone.  “We see demand conditions as relatively stable – and some room for retracement in prices next year.  Even so, it is good for Nigeria to budget conservatively. So assuming a lower oil price is never a bad thing, and Nigeria does need to wean itself off its oil dependence. The latest FX moves will help, and may even boost export performance.”
However, the BGL official believe the increase rate will lead to increased naira revenue to the country. He believed this will depend on the actual oil price compared to the budget benchmark. “In a situation where oil trade close to the budgeted price, government revenue would increase from exchange rate conversion,” he said, adding however that should oil price decline considerably lower than budget, the increase in revenue would not cover the gap. However, generally speaking, the action on foreign exchange will bridge the gap in the budget deficit.

Stock Market
Financial Derivatives is of the opinion that the latest steps taken by the CBN would translate into slowdown in haemorrhage of the stock market as Foreign Portfolio Investors (FPIs) are expected to return to the market.
The firm believes that the MPR increase will result in a re-pricing of fixed income securities which might deter investors from equities. This is due to the higher yield on fixed income instruments.
Ademola however said the decisions of the MPC portend downward pressure on equities and fixed income assets immediately as banks mobilise funds to comply with the CRR decision since the decision takes immediate effect. “Without prejudice to the expectation that most FPIs have left the market prior to this pronouncements, the reprising of risks by most institutional investors in the equities space could push the market lower,” Ademola said.
He explained further that high yields and interest rates implications of the decision portend reduction in valuation of many equities assets. “However, since the market is expected to correct in the near term, discerning investors would take the opportunities of the bargain prices to re-enter the market and benefit from potentially significant returns.”

Foreign Reserves
Analysts believe the 8 percent devaluation of naira will naturally check the pressure on naira and save the monetary authorities the stress of having to defend naira with foreign reserves. It is also believed that the attendant increase in cost of imported items will quench appetite for imported goods and reduce desperation for the dollars.
Another issue that raised its head is that of the controversial fuel subsidy. Speakers like Managing Director, Financial Derivatives Company, Bismarck Rewane, said the current realities have shown that fuel subsidy cannot work again.

Defending the New Policy
Emefiele said it had become imperative to take the right policy actions to forestall a situation where “the market would force the bank to take more drastic actions in the future with far less foreign exchange reserves.
“Also, given the level of excess liquidity in the banking system, it becomes imperative for the bank to address the sources of the foreign exchange demand pressure”.
According to him, a more flexible naira in the face of non-existent fiscal buffers had become the “most viable policy option at a time of heightened demand pressure for foreign exchange and falling oil prices”.
He noted that the scenario in the global crude oil slump had become complicated, as there appeared to be no end in sight to the downward movement in prices.
He said: “The current situation demands that the bank confronts the issue of declining external reserves head on in order to strengthen the value of the domestic currency.
“Consequently, stabilising prices and maintaining exchange rate stability and charting a sustainable path for medium to long-term growth are the immediate top priorities.
“The committee remains committed to these in order to sustain the credibility of our policies and anchor the expectations of our core stakeholders.”
Emefiele added that CBN would likely sustain its monetary tightening stance in 2015, stressing that the falling price of oil could be worsened should Iran get a deal to open up supply into the global oil market.
The governor, who read the committee’s communiqué, also expressed reservations over the $73 oil price benchmark for 2015.

– This Day

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