CBN MPC Takeaways; Standing in Still Waters, As Regulator Decides To Wait and Watch

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Monday, July 20, 2020 / 08:o0 PM / By Proshare research / Header Image Credit: CBN


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Highlights

  • Cash Reserve Ratio (CRR) kept at 27.5%. The Central Bank of Nigeria (CBN) decided to leave the banking sector's cash reserve ratio (CRR) unchanged as it remained wary of increasing sector liquidity. The reluctance to reduce CRR, according to some analyst, may adversely affect the pace of economic growth in 2020 as banks face tight liquidity situations and narrow asset classes which have, over the last few months, limited the growth in their loan-to-deposit ratios (LDRs) even though banking sector-wide loans rose by +20% between August 2019 and June 2020, from N15trn in August 2019 to N18trn in June 2020. The organized private sector (OPS) would have preferred to see a reduction in CRR to encourage credit expansion at lower interest rates.

  • Liquidity Ratio left at 30%. The CBN decided to leave the liquidity ratio of banks at the previous 30%. The problem with holding CRR and liquidity ratios at their previous high levels is that while it constrains bank's access to cash it also affects the ability of banks to extend credit and therefore, their ability to meet their 65% LDR targets. The difficulty in meeting loans to deposit ratios is reflected in the fact that the CBN has debited banks at least twice in 2020 for not meeting the required LDR benchmark, but this has been complicated in recent years by the need for deposit money banks (DMBs) to maintain low non-performing loan ratios (NPLs) and ensure that capital adequacy ratios (CARs) are within statutory limits. The higher a bank's NPLs the more pressure that is placed on its shareholder's equity and subsequently on the bank's capital adequacy.

  • The Monetary Policy Rate (MPR) was held at 12.5%. The keeping of the MPR rate at 12.5% after a reduction from 13.5% at the last MPC meeting was widely expected. The 100basis reduction in MPR at the last meeting has had little effect on bank books except creating a situation where banks have reduced savings rates (currently at between 2 and 3%) and increased bank savings and lending rate spreads. The consequence quarter-on-quarter (Q-o-Q) is likely to be a rise in banks' net interest incomes and net interest margins.

  • Asymmetric Corridor of +200/-500 basis points Around MPR. The asymmetric corridor around MPR was kept constant, but analysts believed that a widening of the lower threshold would have allowed interest rates dip slightly helping manufacturers and other private sector agents borrower at lower costs, thereby helping to either improve corporate bottom lines or lower short-term funding expenses or both.

 

Illustration 1: MPC Policy Rate July 2020

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Illustration 2: Comparative Analysis

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Where Goeth Inflation?

 

Inflation uncertainty is becoming a growing concern for investors, savers and consumers alike as the domestic inflation rate in June 2020 settled at 12.56%. With the savings rate between 2.00 and 3.00%, the negative return on bank savings products floats between -9.56 and -10. 56%. The meaning of this is that within 7 years or by 2027 the amount in savers accounts would be worth exactly half of their values in 2020.

 

But need to tackle inflation in 2020 appears less of a priority for the monetary authorities as is the need to grow gross domestic product (GDP) to counter the rise in the jobless rate (no contemporary figures are available apart from the 23.1% presented by the National Bureau of Statistics (NBS) in Q3 2018) and corporate bankruptcies. The domestic Inflation rate has grown steadily for the last ten months and has more recently settled at its highest rate in the last twenty-four months.

 

Despite holding MPC policy rates constant for a term, the domestic inflation rate may not abate any time soon as supply chain challenges, rising import costs, falling purchasing managers index (PMI) at 41.1% as of June 2020, suggest cost-push inflationary pressures in Q3 and perhaps 4 2020 but reduced consumption spending caused by higher jobless rate and lower consumer disposable incomes may lead to less demand-pull strains. If the economy expands a bit in Q3 and Q4 2020 (as a result of an easing of lockdowns and restricted interstate transport movement) the domestic inflation rate may begin to taper downwards as GDP growth picks up a notch. The projected -4.2% shrink in Nigeria's GDP by the International Monetary Fund (IMF) may be off the mark by a few basis points as Q1 GDP growth of +1.87% was ahead of earlier IMF projections even though it was below the Q1 2019 growth of +2.1%.

 

Analysts expect inflation to rise at a slower pace over Q3 and Q4 2020 as long as farmgate produce is allowed to move to urban centres and transport costs do not escalate. Energy costs are not expected to rise until Q1 2021 (see Chart 1).

 

Chart 1: Nigeria's Inflation Rate

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Source: NBS, Proshare Research



The Incredibly Shaky GDP; Looking for A Bootstrap

 

GDP will likely slip in Q2 2020 as slowly reawakening manufacturing activities; weak recovery of supply chains and slow consumer spending will combine to drag down GDP growth. To make matters worse low international oil prices and a cut in oil production as advised and monitored by the Organization of Petroleum Exporting Countries (OPEC) in both Q3 and Q4 2020 will hurt Nigeria's oil revenues over the next few quarters. Although the CBN has noted that NPLs in the banking sector declined to 6.4% at the end of June 2020 from 9.4% in the corresponding period of 2019, the narrative may change shortly as the banking sector becomes hard hit by the fall in international oil prices (The largest part of tier 1 DMB credits go to the oil sector). In this context, banks may become more conservative as they de-risk their balance sheets and gradually unwind their oil & gas exposure.

 

The rise in domestic inflation rate has rattled real disposable income and local consumption, thereby nibbling down on growth in Q2, Q3 and possibly Q4 2020. With the forecast decline in investment in the real sector, Nigeria's GDP is expected to contract further in Q2 2020 dropping from N350bn in Q1 (see Chart 2).


 

Chart 2: Nigeria Yearly GDP 2010 - Q1 2020 ($'bn)

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Source: NBS, Proshare Research

 

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Of Trade Wars and Current Account Imbalances

 

A grey area which the CBN failed to address during the MPC was the outlook for the exchange rate. The CBN said it would unify its multiple exchange rates has resulted in the devaluation of the naira in the I & EF window to N381 to a dollar. The persistent rise in inflation and the devaluation of the naira would most likely worsen Nigeria's trade balance. This means that companies in Nigeria that depend on the import of raw materials in their local production value chain would pay higher costs for inputs (see Chart 3).

 

Chart 3: Nigeria's Import, Export and Trade Balance (N'trn)

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Source: NBS, Proshare Research


 

Going Forward

 

CBN will face a tough task keeping the economy on an even keel over the next two quarters as the higher rate of domestic inflation, falling fiscal revenues and foreign exchange earnings and rising jobless rates would conspire to make weaken monetary policy as the CBN has little headroom for further policy adjustments. The fiscal authority also has a slim wiggle room as the country's high debt service profile and escalating debt size means that the borrowing window for the fiscal authority is slowly closing shut.

 

Top of on the agenda of the CBN's next MPC is likely to be issues around the exchange rate, the persistent rise in inflation and the likely contraction of the economy. As noted in its MPC, the CBN decided to retain its MPR at 12.5% citing the need to allow time for the transmission effect of its policies to permeate the economy. However, the shape and pace of the economy over the next few weeks would prove instructive to economic stakeholders as the CBN's still water approach to key policy metrics would have begun to leave notices of policy strength or weakness. To be sure, doing nothing at times could prove to be a brilliant counterpoise to doing the wrong thing.


 

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Related News

 

1.      CBN Communique No. 131 of the MPC Meeting - July 20, 2020

2.     A Pause to Assess the Cut in May?

3.     Fragile Macro Conditions to Hinder Loan Creation

4.     Coronanomics (26) - CBN's Vexing Trilemma

5.     Coronanomics (25) - A Regulator's Burden - CBN's Tale of Heterodoxy

6.     The World Congress of Central Bankers

7.     Personal Statements By The MPC Members At The 130 MPC Meeting of May 28, 2020

8.     Implications of CBN's Debits on Banks for CRR Compliance

9.     Still Very Weak Lending to the Real Economy

10.Acute Weakness in Private Credit and GDP Ratio

 

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