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Fiscal and Monetary Responses to COVID-19 Menace: Racing Against Time

Fiscal Policy	2381 VIEWS
Fiscal Policy
2381 VIEWS

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Tuesday, March 24, 2020 /12:50 PM / by CardinalStone Research / Header Image Credit: BCL

CBN pushes the FX button; activates monetary stimulus packages

In addition to its six initial policy response to the COVID-19 menace churned out on 16 March 2020, the CBN announced a N1.1 trillion stimulus to support local manufacturing & boost import substitution (90.9%) as well as ensure that laboratories, researchers, and innovators work with global scientists to patent and produce vaccines (9.1%). The CBN also quietly devalued the naira by adjusting its FX intervention rates at the I&E (-5.6%% to c.N380/$) and BDC (-5.0% to c.N378/$) markets, amongst others, in response to Nigeria's weakening external position and buffers. At the official window, the naira was also repriced lower to c.N360/$ from N307/$, resulting in a narrower spread between the official rate and the rates in other FX market strata. Elsewhere, the apex bank revealed plans to activate the N1.5 trillion Infraco project and redirect oil & gas dollar sales to itself instead of the NNPC. The former is expected to boost infrastructure while the latter is aimed at ensuring continued funding for petroleum imports and supporting the new policy on fuel price modulation.

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Policy responses are likely to provide a calming effect.

We believe the soothing measures could help manufacturers cover important obligations and keep plants running to meet domestic demand without inordinately raising prices to account for the rising cost of raw materials. The measures to support pharmaceutical and healthcare companies are also positive, given the shutdown of countries across the globe, ongoing spread of the COVID-19 virus in Nigeria, and sustained panic buying of pharmaceutical products domestically. However, measures to boost liquidity and economic activities may cascade to some pressures on the naira, which has been well sold in the last two months (CBN intervention: February - $2.1 billion; March - $1.8 billion). These pressures, and continued moderation in oil prices, are likely to offset gains from the mild naira devaluation implemented by the CBN. In addition, even though the FX rates across the I&E and BDC markets are now priced closer to the long-run real effective exchange rate of N382/$, we believe our fair value estimate of c.N437.20/$ better captures the realities of sustained double-digit inflation and twin deficits across fiscal and current accounts. That said, the recent narrowing of FX spreads across the currency markets could imply CBN's growing acceptance of the need to reprice the currency to reflect the state of fundamental variables in challenging periods.

MPC may highlight CBN's growth resolve with a 50bps rate cut.

Although the monetary policy rate (MPR) scarcely dictates yield movements in Nigeria, the Monetary Policy Committee (MPC) is likely to use it as a signaling tool for the second time in less than twelve months, at its ongoing policy meeting. Precisely, we expect the MPC to reduce the MPR by 50bps to 13.0% and, possibly, expand its differentiated CRR net to encourage bank lending. For clarity, while we do not expect another CRR adjustment, the CBN may become more accommodative in its discretionary implementation of the CRR to motivate banks to key into its growth campaign. Our prognosis is largely in line with CBN's responses to the 2008/2009 global economic crisis and the extended oil price crash that resulted in Nigeria's 2016 recession. Importantly, CBN's increasing dovishness is likely to cap scope for significant interest rate increases in the domestic market but could fail to stall FPI outflow in isolation. Among other things, FPIs may feel that the mild currency repricing does not sufficiently compensate for the increasing risk of credit rating downgrades amidst weaker oil price and production outlook. On this wise, the CBN may likely leave carry trade opportunities attractive enough at the OMO market.

Fiscal intervention may be needed to stimulate demand

As part of measures to prevent a meltdown of the Nigerian economy, we anticipate more fiscal responses from the Federal Government. These measures are likely to complement already announced monetary policy initiatives and fiscal drives. In our view, CBN's stimulus (c.2.1% of GDP) may not be weighty enough to offset potential shocks from the current crisis. We hold the view that a significant stimulation of consumption and direct intervention in healthcare from the fiscal authorities may be more impactful on households. For instance, we believe the direct reduction of PMS price to N125/litre from N145/litre, to reflect the fall in oil prices, could lead to cost savings and higher consumption for consumers in coming months. Other than this, we see other plausible fiscal initiatives likely to be rolled out:

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Budget review could mean record fiscal deficit in 2020

The Federal Executive Council (FEC) recently approved a N1.5 trillion cut to Nigeria's 2020 budget amid the recent crash in oil prices to $20/barrel levels. Notably, FG revised its oil price benchmark to $30.00/bbl (from $57.00/bbl), while leaving its oil production target unchaged at 2.18 mbpd. The resultant reduction in oil revenue and projected non-oil revenue cut1 may result to a 45.0% decline in budgeted revenue for 2020. Similarly, government expenditure was reduced by N1.5 trillion after capital expenditure projection was cut by 20.0% and recurrent expenditure was surprisingly slashed by 25.0%. For us, the budget review was a necessity given recent oil price shocks. However, we believe that the government is still likely to underperform its revenue target for two reasons. Firstly, we see significant risks to oil production forecast of 2.18 mbpd as deep offshore production (c.40.0% of Nigeria's oil production) may be disincentivized if prices remain around current levels of $20/barrel (vs. average upstream production cost of $30/barrel). Secondly, we believe that the initial budget overestimated potential revenue from other non-oil sources such as FGN balances in special levies account, FGN share of actual balance in special accounts, and Signature bonus/Renewals revenue.

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