Ahead of MPC Meeting - MPC in a Dilemma …Growth Vs Price Stability

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Friday, September 16, 2016 12:49pm /Meristem Research 

The Monetary Policy Committee (MPC) will converge on the 19th and 20th of September, 2016 to assess the state of the Nigerian economy and thereafter decide on key monetary policy parameters, having considered the persistent inflationary pressures (17.12% in July), declining output (-2.06% in Q2:2016) and unabated FX scarcity.

In this report, we review events in the global economy and it’s implication for the domestic economy. In addition, we evaluate the state of Nigerian economy, focusing on key economic and political indicators, financial market performance as well as our expectations of the MPC’s considerations and consequent decision.

We recognise the need to stimulate foreign inflows in order to halt or possibly reverse the depreciation of the naira, which is the main driver of the inflationary spike. Nonetheless, we consider a further hike in rate by the Committee, less desirable due to the potential short-term drag on growth and the possibility of a lengthening of the recession.
 

On the other hand, a downward review of the policy rate, might call into question the rationale for the last MPC decision, in addition to increasing the level of uncertainty regarding future policy direction, which ultimately makes anchoring expectations a little more difficult.  

International Economies & Developments  

The 2016 projection for global growth, according to the International Monetary Fund’s (IMF) most recent World Economic Outlook (WEO), stood at 3.1% (a downward revision of 0.1% from the April forecast). The IMF’s downward revision stems froSm weaker growth expectations due to increases in economic, political and institutional uncertainties following Brexit. Most advanced countries continue to witness lackluster growth while the outlook for emerging markets, especially Brazil and Russia, remains modest.  

Quantitative easing to stimulate growth in the UK  

The Bank of England cut the Bank Rate by 25 basis points to 0.25% following its introduction of a package of measures designed to provide additional support to growth and a sustainable return of inflation to the target level. The measures also included a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.   

Probability of US Fed rate hike dims  

Although the probability of the US Fed hiking interest rates this September was initially high, the latest economic metrics (Unemployment at 4.9%, Inflation at 0.8%), coupled with the lack of signal from the FED suggesting a hike, has led to a gross reduction in the likelihood of an upward review of the policy rate.   

External economy poses downside risks to the Euro Area  

The European Central Bank at its September meeting opined that the growth of the Euro Area post-Brexit is expected to remain moderate but steady. The region’s path to economic growth is on the back on relatively low oil prices and support from the monetary policy measures in place. However, weak foreign demand and delays in the implementation of structural reforms arising from the uncertainty spurred by Brexit will most likely dampen the positive outlook projected for the Euro Area.   

China’s economic slow-down persists in Q3:2016 

The Chinese economy grew by 6.7% YoY in Q2:2016, mirroring the growth pace of the previous quarter. Although, economic growth was fuelled by the rebound of the property market and the supportive government policy, output expansion was dragged by the continuous slowdown in fixed asset investment, manufacturing and retail sales. Chinese authorities may resort to further stimulus to ensure that the economy meets this year’s growth target of 6.5% to 7.0%.   

Bank of Japan to intensify its easing policy 

Despite massive fiscal and monetary policy stimulus, slow implementation and the absence of decisive structural reforms in Japan, continue to curtail Japan’s ability to boost economic growth. A stronger Yen as well as the existing global economic uncertainties represent the major downside risks to Japan’s economic outlook. The (Bank of Japan) BOJ has however indicated its willingness to further ease its monetary policy.  

While we expect the Committee to consider the recent developments in the international economies, we do not expect its broad implications to significantly influence MPC’s decision considering the overwhelming domestic issues.  

Global oil price and outlook  

Global oil demand and supply has continued to play a major role in oil price volatility so far in 2016. Oil prices dipped below USD30pb at the beginning of the year due to increased supply following the ramp up of Iran’s production after sanctions were lifted in January 2016. Unexpected supply outages, however played a major role in price recovery.  

In the last two months, global oil price, measured by the Brent crude, has been volatile with an average price of c.USD47.04pb as at August 2016 driven majorly by news of decline in US crude inventory, weakening of the US Dollars, Niger Delta Militant attacks in Nigeria and the anticipated crude output freeze in Algeria.  

The scheduled meeting by oil producers on the sideline of the International Energy Forum (September 26th -28th) to discuss an output freeze is expected to impact global oil prices. Although we do not completely rule out a successful outcome in the meeting and the eventuality of a price rally, we however remain cautious bearing in mind the rate of uncertainty associated with oil prices.

Domestic Economy   

Rising inflation amidst declining GDP  

The Nigerian economy slid into recession in Q2:2016, after real GDP contracted by 2.06% due to spillovers from shocks in the oil and gas sector. According to the National Bureau of Statistics (NBS), the oil sector declined by 17.48% in real terms, owing to continued coordinated attacks on oil assets in the Niger Delta region. During the review period, oil production was estimated at 1.69mbpd, down 19.91% from 2.11mbpd as at Q1:2016. This outcome, although anticipated, affirmed the lackluster state of the economy.  

In line with the IMF’s forecast of -1.8% growth for FY:2016, having considered the declining consumption due to falling household real income, and unabated attacks in the Niger Delta region, we expect this trend to somewhat subsist for the rest of the year. Similarly, inflation for the month of July surged by 0.64% month-on-month to 17.12%, its highest level since 2005. This was driven mainly by the 1.44% hike in Housing, Water, Electricity, Gas & Other fuel.  

Considering the lingering FX scarcity, likelihood of further hike in fuel price due to unsustainable exchange rate assumption for price setting, we expect the inflation uptrend to persist, albeit at a slower pace. In our opinion, the seemingly weak and vulnerable state of the economy somewhat necessitates a downward review of the policy rate, however, we do not anticipate a rate cut given the strong potential of the Committee to tilt towards addressing price stability.  

Fiscal Policy   

Plans for Offshore Borrowing in the Offing  

The Federal Government of Nigeria, in a bid to restore the economy to the path of growth, is expected to raise domestic and foreign debts to finance its budgeted revenue shortfall. As at September 13 2016, about NGN600bn has been raised from the domestic market, while the government is still making efforts to obtain low-cost external debts to stimulate growth in priority sectors such as power, agriculture and the mining.  

While the FG awaits debt funds, declining oil output and poor corporate earnings continues to weigh on internally generated revenue, thus, hampering fiscal strength. We note also that the rally in oil prices to c.USD47.04pb, despite the mixed sentiments in August, has not impacted positively on revenue, as oil production still remains relatively low at 1.47MMbpd versus 1.52MMbd in July and budget benchmark of 2.20MMbpd.  

Given the potential for continued attacks on infrastructure and the resultant impact on oil proceeds, we expect the Committee, in arriving at their decision, to consider the impact of the policy rate on government’s cost of debt given the declining revenue levels.   

FG and Niger-Delta militants meeting still inconclusive  

The discourse between the Niger-Delta militants and the Federal government persists as the country continues to witness loss in revenue due to pipeline vandalism within that region. On the 13th of September, 2016, the Niger Delta Greenland Justice Mandate, attacked an oil delivery line belonging to the Nigerian Petroleum Development Company in the Afiesere- Iwhrenene community in Delta State and threatened further attacks should their request not be met.  

While the government is still in negotiations phase, total crude oil production per day has fallen to a low ebb, thus, putting pressure on the country’s revenue despite the slight resurgence in the global crude oil price in the period. In addition, the clashes between Fulani herdsmen and natives of some Southern and North central villages have heightened the safety and security concerns in those region, as well as economic losses in terms of farmland and the potential agricultural produce. Both the federal government, security agencies, host communities and significant national leaders continue to search for a lasting solution to quell this upheaval.  

Finally, we note that the current administration has made some marked improvements in its fight against Boko Haram insurgency in the North Eastern part of Nigeria, therefore, we anticipate that the same level of effort should be adopted to tighten security in other areas being affected by activities of Niger Delta Militants and the Fulani Herdsmen. In our opinion, we believe that developments in national security would bring about a boost in economic activities in the affected region, while also impacting positively on the country’s revenue levels.   

Monetary Policy   

Credit to Private Sector Grows by 4.44%  

Net Domestic Credit (NDC) advanced by 3.46% to NGN22.85tn between June and July. Although credit to government declined by 3.77% to NGN2.78tn, credit to the private sector, which is the major driver of lending increased by 4.44% to NGN22.38tn. Despite the advancement in NDC, credit to government declined, having the lowest contribution to NDC since the beginning of 2016 (11.07%).  

However, credit to the private sector as a proportion of NDC increased by 0.83%, and still remains the major contributor to domestic credit. Broad Money (M2) increased by 2.29% to NGN22.18tn, while Currency In Circulation (CIC) declined by 1.20% between June and July.   

Declining Oil Production drags Reserves  

In the period since the last MPC on the 25th of July, the average Brent crude oil price advanced by 3.22% from USD44.72pb to USD46.16pb. Nonetheless, according to OPEC, average crude oil production in August pared by 3.42% to 1.47mbpd, down from 1.52mbpd in July.  

Owing to the decline in crude oil production, FX reserves trimmed by 4.15% in the period, settling at USD25.16bn as at the 14th of September, 2016 (vs. USD26.25bn as at the 25th of July, 2016).  

During this period (22nd July to 14th September, 2016), the FX rate at the interbank market appreciated marginally by 1.15% to NGN306.33/USD (vs. NGN309.84/USD as at 22nd July). Contrarily, the FX rate at the parallel market depreciated by 10.85%, settling around NGN424/USD as at the 14th of September, 2016, from NGN378/USD on the 25th of July.  

In our opinion, the decline in the country’s external reserves may be linked to the disruptions in Niger Delta, which have resulted in a decline of the country’s crude oil production output. Also, we expect that the disparity between the interbank and parallel rates will be bridged by the dollar sales to BDCs.  

Financial Markets   

How further high can the yield environment get?  

Yields across fixed income instruments have trended upwards since the last MPC meeting, given the re-pricing of assets which followed the recent upward revision of the MPR to 14%. The average T-bill yield increased by 2.61% to 18.52%, while average bond yield advanced by 0.46% to 16.30%.  

Similarly, interbank and money market rates have also advanced in the period since the last MPC meeting, as investors have seemingly taken advantage of the high rate environment, consequently resulting in much tempered system liquidity.  

Hence, the average NIBOR increased by 9.30% to peg at 23.29%, while the average money market rate advanced by 12.26% to 16.13% since the last meeting. In our opinion, the higher rate environment has had a muted impact with regards to driving capital inflows from foreign sources, and any further upward revision with the same motive would not only be speculative but would hamper growth.  

Therefore, we do not expect MPC to increase the benchmark rate at the upcoming meeting, which should see rates pegged around the current level over near future periods.   

Mixed sentiments permeates the Equities Market  

The Nigerian equities market has recorded a mixed performance since the last MPC meeting in July, with a marginal gain of 0.04% and the YtD at -3.49%.  

The release of the most recent economic data, (-2.06% growth in GDP, July inflation at -17.12%) did not sway market activities, as most investors had already priced in expectations of the economy contracting prior to the release of the results.  

As we advance closer to the third quarter earnings season, we expect companies’ performance scorecards to dictate investor sentiments in the market.  

Given the weak financial performances recorded so far in the year, which may likely signal the expected performance of companies for the rest of the year, in the absence of any major policy change or positive news inflow, we imagine this current negative mood may linger.  

On a Balance of Factors…  

The MPC, at its July sitting, was faced with two policy options; growth stimulation or inflation moderation. While they expressed concern for the negative growth and the prospects of it persisting till the year end, they equally reflected on the high inflation, its impact on consumption and investment, and the negative real return it implied, which was not encouraging for foreign capital inflows, and therefore decided to show commitment for price stability and positive real rate of return by a tightening stance.  

The pursuit of price stability as a macroeconomic policy objective and the wide adoption of inflation targeting framework is based on empirically proven relationship between low inflation levels and stable growth path. By implication, achieving price stability is aimed at promoting growth but when the former appears to constrict growth especially in a recessionary period to which lower policy rate has been proven a good antidote, recourse to elevating the latter objective might be more optimal.  

While the Committee adduced to the ultimate impact of price stability on growth – via improving dollar inflows, and liquidity at and deepening of the FX market, which would boost manufacturing and industrial output thereby stimulating the desired growth, – the transmission appears quite longer than the recession might be able to accommodate.  

This therefore increases the odds of a likely truncation in the transmission especially by developments in the external environment that increases risk aversion to emerging and frontier economies. The current recession and other downside risks in the economy has increased the risk premia of investing in Nigeria and thus, put an upward pressure on the optimal riskadjusted rate that will be desirable by foreign investors.  

We however view a further hike in rate, that can stimulate foreign inflows to the extent that it will help halt or possibly reverse the depreciation of the naira, which is the main culprit for the inflationary spike, less desirable due to the potential short-term drag on growth and the possibility of a lengthening of the recession.

Judging by the premise of the last rate hike, a downward review in rates, on the other hand, might call into question the rationale for the initial decision in addition to increasing the level of uncertainty about future policy direction, which ultimately makes anchoring expectations a little more difficult.  

Given these considerations, we expect the MPC to make the following decisions:  

·         Maintain the MPR at the current level

·         Maintain liquidity ratio at 30%.

·         Maintain the asymmetric corridor at +200bp/-500bp.

·         Maintain the CRR at 22.5%.  

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