CBN in dilemma as MPC holds make or mar meeting

*Central Bank of Nigeria, CBN.

*Central Bank of Nigeria, CBN.

24 July 2016, Lagos — Fireworks on how best to engage a recovery strategy for the economy begins tomorrow at the Central Bank of Nigeria, CBN, as its Monetary Policy Committee, MPC, appeared stretched into further review of its positions in the light of new developments in the economic and monetary sphere last week. MPC is the highest monetary policy making organ of the CBN while CBN, in turn, is the economic policy adviser to the federal government. Meanwhile, all financial market segments closed at the weekend on adverse numbers, meaning the markets would be opening tomorrow on gloomy sentiments as MPC members settle down to begin deliberations.

Stock market losses heightened with All Share Index slumping 4.0% week-on-week to settle at 27,659.44 points. Market capitalisation declined to N9.5 trillion with investors losing N393.6 billion during the week, thus YTD return worsened to -3.4%. Foreign exchange market was hit with severe scarcity of foreign currencies before CBN intervened but not until the Naira had crashed to an all-time low of N330/ USD in the interbank market segment before recovering to N307 while parallel market depreciated to N380/ USD. Interest rates in the money market trended higher on all days of the week due to tighter system liquidity, thus Open Buy Back (OBB) and Overnight (O/N) rates settled at 17.0% and 19.0% respectively, pressuring lending rates higher.

Sentiments in the Bonds market came bearish as investors sold off across the board while average yields rose 30 basis points across benchmark instruments to hit 14.9% on Monday and rose further closing the week at 15.3%. In the Eurobonds market, Nigerian Eurobonds recorded increased sell-offs as yields rose across instruments while buying an interest in the South African sovereign Eurobonds persisted and are currently the best-performing instruments for the year.

According to analysts at Afrinvest West Africa, a Lagos-based research and investment firm, performance this week is expected to be driven by the outcome of the MPC meeting tomorrow and next. Sources close to the Committee hinted that members were forced back to wider consultations and drawing boards following some major adverse developments in the economy last week after they had concluded their position papers.

According to economy analysts, major developments that appear cumbersome as at weekend include the dilemma of stagflation, the foreign exchange rate crises and the inflationary pressures as well as interest rate cross-road. Stagflation is an economic anomaly where inflation is going up while the economy, measured by gross domestic product, GDP, growth rate is going down. CBN governor, Godwin Emefiele, had earlier in the past week at a closed-door meeting with Senators, indicated that the economy was in trouble stating that it was frightening that the nation was experiencing economic stagnation and inflation at the same time. He explained that ordinarily, both were not supposed to happen simultaneously.

Earlier in the week the National Bureau of Statistics, NBS, reported that inflation was at 11-year high of 16.5 percent, indicating a steady rise month-on-month since 2015. Sources close to the MPC members also indicated that the foreign exchange crises had become more complicated as at last week following the temporal withdrawal of CBN from the inter-bank market. MPC, according to banks’ foreign exchange dealers, would now be faced with the dilemma of whether to continue with CBN intervention which would require more foreign exchange resources that are no longer available or to withhold the apex bank’s intervention which would send the Naira crashing uncontrollably.

Presidency rattled by forex crises
The foreign exchange market dilemma appears more complicated due to what market watchers see as political interference. According to a source close to the MPC, CBN has been battling presidency’s discomfort with the market-driven foreign exchange regime and the situation came to a head last week when the Naira crashed to its all time low with politicians in the presidency allegedly compelling the apex bank to intervene late on Friday to bring the rates down. Two weeks ago President Mohammadu Buhari had told a group of corporate chieftains that he was not comfortable with the new foreign exchange market stating thus, “on the value of the Naira, I am still agonizing over it I need to be educated on this I am under pressure and we’ll see how we can accommodate the economists”.

Earlier last month Buhari was quoted as saying that the economists around him always speak above his head on all these economic challenges. With this presidency disposition when the Naira exchange rate crashed to N281/ USD, the source wondered how the apex bank would carry through a full-floating exchange system which he believe should be CBN’s best position. The third dilemma, according to MPC sources, would be how to tame the inflationary pressures by playing on interest rate mechanisms. The Committee would be faced with the devil’s alternative where the apex bank would either be forced to trade off the inflation concern in other to stimulate economic growth or damn the concerns for growth in other to ensure price stability. Either way, according to economists, an adverse consequence awaits the economy, a situation which may have perplexed Emefiele in his statement at the Senate last week. However, the apex bank may decide to play safe by leaving the rate untouched, and leave with whatever outcome.

Short-Medium term Outlook by experts
Already many institutional economists have painted a gloomy picture of the economy outlook contrary to the position of the Finance Minister, Mrs Kemi Adeosun, that the economy will rebound by the end of this quarter, September 2016. While addressing the Senate last week she had stated, “I think if we are in recession what I will like to say is we are going to come out of it and it will be a very short one”. She added, “this is because the policies that we have would ensure that we don’t go below where we need to go and I think with what we are doing we would begin to turn the corner, I believe, by third quarter”.

Most economy analysts have painted a different picture of both short and even medium term difficulties contradicting Adeosun’s position. They include the International Monetary Fund, IMF, the CBN, NBS and some notable Nigerian experts. According to IMF in its recent world economic outlook released last week, Nigeria’s economy, rather than reverse the decline, would contract by a whopping 1.8 percent by the end of this year. The IMF projection is down from the 2.3 percent growth it foresaw in its April forecast. It now forecasts 1.1 percent growth for 2017, down from 3.5 percent in its April forecast. The new forecast indicates worsening economic condition not only throughout 2016 but also in 2017.

The IMF forecast tallied with earlier projections made by NBS, Nigeria’s highest authority in economic research, which foresees economic rebound in 2018. Moreover, just last week also, Emefiele had told the same Senate closed door meeting which Adeosun addressed, that the current situation may force Federal Government into owing workers’ salary by October this year.

A leading private sector financial and economic research firm, Financial Derivatives Company, FDC, run by Nigeria’s renowned economist Bismarck Rewane, told the Lagos Business School audience that economic recovery is likely to be flat in the third quarter. He explained that the absorptive capacity to digest the annual expenditure in the next five months remains in question even with the spending figures released by Adeosun last week. He said Nigeria rig count is set to decrease as government relents on cash call agreements, a similar position taken last week by Senate President, Bukola Saraki.

Adding to the woes of the oil sector that funds the economy, Rewane noted that insurgency in the Niger Delta region would remain negative for prospective investment in oil & gas, a situation which has now been compounded by conflicting signals from the presidency on negotiations with the militants to end the degradation of government’s revenue capacity.

Related to this is the poor electricity for economic activities and Rewane says “power generation is set to plunge further as pipeline vandalism is still a threat to generation and distribution capacity. We expect output to decline further in third quarter exacerbated by vandalism and illiquidity in the sector. The impact of renewed investments to reflect in the fourth quarter or early 2017” He also said that retail industry is expected to contract further as consumers react to the imminent recession, while inflation will take its toll on imported shelve products as the exchange rate pass through on prices reduce demand. In his perspectives on retail industry outlook, he opined that customers will patronise neighbourhood shops more than malls as the informal market already accounts for 90% of the entire retail market. He added that staff retrenchment will increase in an effort to maintain profitability and ensure business continuity, thus compounding the unemployment and underemployment crises which NBS had highlighted in its recent job report. He also stated that banking sector non-performing loans, NPLs, will increase and impairments will eat into profitability which will lead to more layoffs in the banking sector.

Institutional analysis
Several financial institutions and investment houses have given us their perspective on the economy in the days ahead while zeroing in on tomorrow’s MPC party which they see as a make or mar for the economy.

FSDH Merchant Bank
After analytical review of where the financial markets are currently and what led to the larger economic crises, economists and financial experts at FSDH Merchant Bank Limited had this to say: “There are arguments to support an increase and a hold in rates when the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) meets on July 25-26, 2016. Meanwhile, there is no argument in support of rates cut given the current economic situation.

“The impending recession in the Nigerian economy supports a hold in rates at the current level while the fiscal measures to reflate the economy are implemented. The current high double-digit inflation rate supports a rate hike.

“We, however, believe that the MPC and other government agencies will pursue growth and trade-off high inflation. “The Nigerian economy is moving towards a recession as economic activities have significantly slowed down. The GDP contracted by 0.36% in Q1 2016, compared with the growth of 2.11% in Q4 2015. The Nigerian economy faces risks from a shortage of foreign exchange and weak consumer demand.

“We expect a higher level of contraction in Q2 2016, when the National Bureau of Statistics (NBS) releases the Q2 2016 GDP figure on August 25, 2016. We believe that the impending further contraction in the GDP is the major risk the economy faces at the moment, and a hike in the MPR will worsen the outlook. A hold decision with complementary fiscal expansionary measures should stimulate the economy. “The inflation rate remains on an upward trajectory in 2016, with the momentum driven by both domestic and external factors. The inflation rate in June 2016 shot up to an 11-year high of 16.48%, from 15.58% in May 2016. We expect the inflation rate to remain high and in double digit in 2016. The current and short-term inflation rate outlook is higher than the CBN inflation rate target of 6%-9%. This should warrant a policy action in the form of a rate increase.

“However, the need to stimulate economic growth may prevent the MPC from hiking rates at this meeting. It may trade-off high inflation rate for economic growth. “The crude oil price has stabilised around US$45-US$50/b after the rally recorded in mid-April 2016. The price of Bonny Light crude oil decreased by 4.84% to US$47.16b as at July 19, 2016, from US$49.56/b on May 24, 2016. The Nigerian government did not benefit from the recent oil price rally because of the shortfall in production. The low oil earnings have significantly impacted the FGN revenue with its associated implications on the unemployment rate and higher prices. The government may have to borrow more to fund its 2016 Budget, which should force interest rates to rise.

“The pressure on the external reserves remains unabated since the last MPC meeting in May 2016. The external reserves have not received the anticipated boost from the adoption of a flexible exchange rate policy in June 2016. The external reserve is still strongly dependent on oil earnings, which has been inadequate because of the output shortfall. The 30-day moving average external reserves declined marginally by 0.49% from US$26.48bn at the last MPC meeting to US$26.35bn as at July 18, 2016. We expect the MPC to adopt a hold decision.

“The value of the Naira remains under strain but relatively stable at the inter-bank market after the implementation of the revised CBN foreign exchange policy in June 2016. The Naira recorded a 29.36% fall in its value to US$1/N281.85 on June 20, 2016, from US$1/N199.10 on June 17, 2016. However, after the adoption of the revised guidelines, the value of the Naira has depreciated by 9.21% to stand at US$1/N310.43 on July 21, 2016, from the start of the single market structure on June 20, 2016.

However, the parallel market still exists and at a wide variance from the inter-bank market. The long-term appreciation and stability in the foreign exchange rate depend on the ability of the Nigeria to grow its export base and attract both Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). The policies to drive these growths are outside the monetary policy.

“The yields on the fixed income securities increased between the last MPC meeting and July 2016, reflecting the macroeconomic risk in the economy. The average yields on the 91-day, 182-day and 364-day Nigerian Government Treasury Bills (NTBs) increased to 12.35%, 14.91% and 18.68% in July 2016, compared with 8.21%, 9.53% and 13.34% respectively in May 2016. The last yields on the NTBs sold on July 20, 2016, were at 14.46%, 16.78% and 19.72% on the 91-day, 182-day and 364-day NTBs, respectively. The yield on the 16.39% FGN Bond January 2022 also increased to 14.01% in June 2016 from 13.51% in May 2016, while it stood at 15.02% as at July 20, 2016. We believe that the use of Open Market Operation, OMO, to curb inflation is more effective than raising the anchor interest rate.

“The money supply and credits to the private sector grew in the first five months of the year below the annualised target rates for 2016. This represents a pullback in credit creation because of the perceived business risk in the economy. There is a need for better engagement of all stakeholders to restore confidence in the economy. The broad money supply (M2) increased by 3.46% to N20.72 trn in May 2016, from N20.03 trn in December 2015; an annualised growth of 8.29%. The provisional growth benchmark for 2016 is 10.98%.

“The narrow money (M1) grew by 9.57% to N9.39 trn in May 2016, from the end-December 2015 figure. Net domestic credit (NDC) also grew by 5.74% in the same period; an annualised growth of 13.77%. The provisional benchmark growth for 2016 is 17.94%. The credit to government grew by of 31.45% during the period. Similarly, credit to the private sector grew by 1.76% in May 2016, compared with December 2015; an annualised growth of 4.23%. The benchmark growth for 2016 is 13.28%. “Looking at the macroeconomic developments in the economy, we expect that the MPC members will vote to maintain the MPR, CRR and LR at the current levels. However, complementary fiscal measures are required to restore investors’ confidence and pull the economy out of recession”.

Afrinvest West Africa
Similarly analysts at Afrinvest West Africa, a Lagos-based research and investment house, took a critical look at the current economic trajectories requiring policy response from MPC and arrived at the following conclusions: “Accelerating general price level, bearish Q2:2016 growth outlook, weak credit expansion to the private sector, rising level of banks’ non-performing loans and volatility in the FX market have continued to pressure domestic economy and financial market. The feedback effect of reforms in the energy sector has taken a toll on price level as June inflation rose to 16.5% in amid higher fuel prices and electricity tariff. “Meanwhile, the implementation of the floating exchange rate regime in the currency market triggered a 41.1% depreciation of the naira as the equities market year-to-date, YTD, return rose to 7.0% in anticipation of the return of foreign players.

However, the cheery reception of the new interbank market framework was short-lived as the emergence of autonomous players in the FX market has not been as swift as anticipated. Likewise, the non-existence of the expected volatility in the new interbank led to speculations that an “invisible hand” had held the exchange rate in the market, until a week ago. The market has since been volatile with the naira depreciating 4.3% in the last one week at the interbank.

“In light of the above, we highlight the need for the monetary policy to be more proactive than reactive in its response to challenges in the economy. The need to regain investor confidence in the aftermath of the newly launched FX framework should be a paramount item on the agenda of the MPC. On the whole, we think the options on the table for the MPC will be either to;

Option 1:
“Increase MPR by 100bps to 200bps and keep other rates constant to attract portfolio capital inflows which are yet to respond to currency market flexibility. The CBN and DMO have guided towards this by aggressively mopping up liquidity at high rates. At the last treasury bills (T-bills) auction held on Wednesday, the 364-day T-bill was issued at 16.5%, a 7.2% hike from the 9.3% in January. Same as the OMO auction held the following day where the 364-day tenured OMO bills were issued at 17.0% marginal rate from 13.5% the previous month. Sales at both auctions were significantly higher than the offered amounts.

Option 2:
“Maintain status quo on all rates whilst reinstating the need to fully implement the currency market reforms to regain its credibility.
*Emeka Anaeto – Vanguard

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