January 23, 2021 / 10:40 AM / By Cordros Research/ Header Image Credit: Channels TV
The Monetary Policy Committee (MPC) is expected to hold its first meetings of the year on the 25th and 26th of January 2021. We expect the Committee to assess the developments in the domestic and external macroeconomic and financial markets since its last meeting in November and provide guidance on the path of monetary policy in 2021. Our view is that the Committee will keep policy rates unchanged and affirm the use of unorthodox measures such as CRR debits, Loan-to-Deposit Ratio (LDR), and direct intervention in employment-stimulating sectors to influence macroeconomic outcomes and ultimately attain macroeconomic stability.
Economic Recovery Likely to be Prolonged
On the domestic front, we believe the recent rise in new COVID-19 cases will be on the front burner given the potential to unwind gains from fiscal and monetary stimulus since the reopening of the economy in May 2020. However, we think the steps taken by the government to purchase vaccines will provide comfort to the committee. Elsewhere, factory activities slipped back into contractionary territory in December as the manufacturing PMI printed 49.6 points (November: 50.2 points) - the seventh contraction in the last eight months. In our view, the fact that festive induced demand failed to spur activities in the manufacturing sector suggests the (1) lingering FX challenges, (2) supply chain disruptions, and (3) rising inflationary pressure amid pre-existing infrastructural challenges have continued to drag activities in the real sector. Asides from the lull in factory and business activity, we note that the oil sector is yet to recover to pre-pandemic levels given Nigeria's continued compliance with the OPEC+ production cuts. Based on the foregoing, we believe domestic GDP is likely to record another decline in Q4-20 which negates the Committee's optimism about a rebound in output growth. Our baseline expectation is that the Committee will shift its belief of a return to positive growth further out into Q1-21.
Mounting Inflationary Pressures
Inflationary pressure has also intensified since the last MPC meeting in November (October 2020 Inflation: 14.23%). Consumer prices have since risen to 15.75% y/y as of December largely due to (1) underwhelming harvest season, (2) persistent security challenges, and (3) poor distribution network. We expect the committee to reiterate its earlier view that inflationary pressures are driven by these supply-side factors which are outside the control of monetary policy. Hence, tightening may not be an appropriate policy response given the need to support economic recovery. We, however, expect the Committee to cite the decision made by the federal government to reopen the land borders as a fiscal action that will ease pressure on consumer prices. Over the medium term, we expect headline inflation to continue to rise albeit at a slower pace due to (1) the low-base effect, (2) lingering security challenges, (3) higher transportation costs linked to an upward adjustment in PMS prices, and (4) hike in electricity tariff.
Preference to Keep Yields at Low Levels
We also expect the committee to reiterate its resolve to keep yields at low levels in the near term to compel deposit money banks to boost private sector credit while also easing deficit financing pressures at a time when revenue from oil and non-oil sources are pressured. With NGN2.55 trillion worth of OMO bills maturing in Q1-21 (Q4-20: NGN3.92 trillion), we believe system liquidity will remain elevated in the near term. In our 2021 outlook, we stated that the Committee's tolerance for excess liquidity is consistent with its forward guidance that monetary policy will remain accommodative until economic recovery gains a foothold. In light of this, we believe the committee members will leave the MPR at current levels, thereby reinforcing the expansionary stance of the apex bank.
World Bank Support and Higher Oil Prices Provide Succour to the FX Reserves
On the external front, conditions in the oil market and prospects for continued recovery in the global economy have brightened on the back of concerted efforts by policymakers towards vaccination and additional stimulus from the U.S. In the last policy meeting in November 2020, the committee expressed concerns about the second wave of the COVID-19 pandemic given its attendant impact on global oil demand as economies begin to re-introduce lockdown measures. Supported by the combined impact of (1) the OPEC+ decision to only reduce oil production cuts by 0.5 mb/d, (2) Saudi Arabia's decision to unilaterally cut output by 1.0 mb/d, (3) a gradual decline in U.S. shale production, and (4) positive news on the efficacy of COVID-19 vaccines, Brent price has risen by 27.2% to an average of USD54.29/bbl so far in January 2021 (November average: USD42.69/bbl). At current levels, we believe the committee will be somewhat optimistic about improved dollar inflows that will buoy the nation's reserves and enable the apex bank to step up its interventions across the various segments of the FX market. We note that the FX reserves have increased by USD1.02 billion (+2.9%) since the last policy meeting to USD36.48 billion as of 20th January 2021. We understand that the accretion has been largely due to the USD1.50 billion World Bank support to state governments.
However, we believe the reserves will remain under pressure in the near term given (1) the nation's compliance with OPEC+ production cuts which will limit export earnings, (2) increased demand for FX as economic activities normalise, and (3) subdued foreign portfolio Inflows.
Covering all Bases
Although rising inflationary pressures alongside fragilities in the balance of payments present a strong case for monetary tightening, we believe it is rather too early for such a stance given the need to support economic recovery. More importantly, it would contradict previous heterodox policies targeted towards improving the flow of credit to the real sector of the economy and prolong the recovery phase. Monetary policy tightening will also create severe financial market turbulence and amplify deficit financing pressures for the government. On a balance of factors, we believe the Committee will keep policy rates unchanged and affirm the use of unorthodox measures such as CRR debits, Loan-to-Deposit Ratio (LDR), and direct intervention in employment-stimulating sectors to influence macroeconomic outcomes and ultimately attain macroeconomic stability.