Monetary Policy | |
Monetary Policy | |
7147 VIEWS | |
![]() |
Friday, October 25, 2019 / 07:45PM /by CardinalStone Research/ Header Image Credit: The Sun Nigeria
The Central Bank of Nigeria (CBN) recently
announced the exclusion of non-bank locals (individuals and corporates) from
participation in its Open Market Operations (OMO) at both the primary and
secondary market. The exclusion implies that only Deposit Money Banks (DMBs)
and Foreign Portfolio Investors (FPIs) can participate in OMOs, while everyone
else, including non-bank financial institutions, will have to shift focus to
T-bills and other investment options.
We believe the CBN's policy is largely in line
with its drive to divert liquidity away from risk free instruments to the real
sector. Prior to the current move, the apex bank instructed banks to prevent
customers with outstanding loans and recipients of intervention funds from
investing in T-Bills or OMOs. Restricted from participation in OMO
transactions, retail and institutional actors will have to seek alternative
destinations for their funds, creating extra liquidity in other assets. Below
are the likely implications of the restrictions on fixed income and equity
markets.
Fixed Income
The most suitable alternative for OMO bills will
be investment in government T-Bills as they are similar in tenor and have been
largely interchangeable in recent years. We, therefore, expect to see increased
demand in the bills market and at subsequent NTB auctions through the year,
given that c.27.7% of total OMO maturities (c.N1.2 trillion in November and
December alone) due to non-bank locals cannot be rolled over in coming months.
This, together with NTB maturities and other
autonomous inflows, is expected drive yields lower at the secondary market
(both the bond and money market). On average, yields declined by 15bps across
the bills curve and 4ps in the bond market yesterday, the first trading session
since the release of the circular.
An alternative destination for extra liquidity
could be fixed deposits, which currently yield between 6.7-13.0%. Increased
placements may, subsequently, force DMBs to proportionately grow lending in
order to meet the new LDR requirement. In our view, current term deposit rates
may also fall below current levels as yield environment softens and demand for
the product increases. This is likely to reduce the funding cost of banks. We,
however, note the potential offset from a likely moderation in asset yields.
Corporate bonds and commercial papers are the
other investment alternatives in this segment. Investors are expected to demand
a spread that partly reflects the relative illiquid nature of these instrument
as well as the risk of the issuer.
Equity
The restriction of key corporates, such as PFAs
and Insurance companies, from participation in OMO is likely to free up excess
investable cash for allocation to assets beyond fixed income alternatives. We,
therefore, see legroom for some flows into fundamentally strong equity names as
treasury yields moderate.
Our view is also buttressed by the high earnings
and dividend yields in the equity market space. For context, while some select
names (especially within the tier 1 banking space) boast earnings yield in
excess of 30.0%, the yield on the one-year T-bills is at 13.37%. In addition to
this, dividend yields are likely to average 9.9% across our select universe,
with the tier 1 banking names averaging 10.9%. High dividend yields are likely
to attract institutional investors such as PFAs. The potential for capital
gains in fundamentally sound counters further enhances the appeal of the equity
market.
We also note that a lower yield environment is
potentially positive for cash-strapped companies, as cost of financing working
capital and capex is likely to moderate. This is likely to positively impact on
earnings in subsequent quarters.
Conversely, cash rich companies that earn high
finance income will be adversely affected by expected moderation in near-term
yields.
Possible Macro Implications
The restriction of local corporates and
individuals from participation in OMO is positive for borrowing costs (for
corporates and the FGN) as yields are likely to moderate in the near term. The
clear delineation of OMO from other money market instruments also allows the
CBN to attract FPI's with higher rates (for currency management) at a lower
cost as the OMO sales are likely to reduce with the restriction placed on
domestic non-bank investors.
The segregation of OMO from the local fixed income
market substantially reduces the influence of foreign portfolio flows on local
yield environment, which have in recent past led to pro-cyclical monetary
policy.
The directive and others (including CBN's new
policy allowing banks to recoup payments by debiting the account of loan
defaulters) is positive for credit creation.
We see scope for slight increase in dollar demand
pressures as locals may increasingly source FX in a bid to latch on to the
likely higher rates at the primary and secondary OMO markets by disguising as
foreign investors.
Related News on OMO Auctions' Ban
Related News on Fixed Income
Related News on Equities and Markets
Related News on Monetary Policy
1. Monetary Policy:
Adapting to a Changed World - Speech by Gertjan Vlieghe
2. MPC Maintains
Status Quo - Surprise, Surprise
3. CBN Communique
No. 126 of the MPC Meeting - Sept 19-20, 2019
4. CBN MPC Retains
MPR At 13.5%, Calls on FG To Build Fiscal Buffers
5. Nigeria MPC
Holds Key Policy Rates Constant
6. MPC To Maintain
Accommodative Stance - To Balance Extant And Emerging Risks
7. Countdown to
September 2019 CBN MPC Meeting: Key Economic and Market Issues To Watch
8. CBN Reschedules
September 2019 MPC Meeting To 19th And 20th
9. Reflections On
Monetary Policy - Keynote Speech By Philip R. Lane
10. Monetary Policy
In Africa: Singing A Global Chorus?
11. The Growing
Challenges For Monetary Policy In The Current Int'l Monetary And Financial
System