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.

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:

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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