CRR Increase May Not Be An Appropriate Tool to Fight Inflation


Monday, January 27, 2020  /  01:52 PM  /  By CardinalStone Research / Header Image Credit: Youtube, CNBC aFRICA


Monetary Policy Committee swings hawkish wand

In a hawkish move, the Monetary Policy Committee (MPC) resolved to increase the cash reserve ratio (CRR) by 500bps to 27.5% at the end of its two-day meeting on 24 January, 2020. The policy tweak was a response to the liquidity glut, catalyzed by the OMO ban, and its purported impact on rising inflationary pressures. Specifically, given the MPC's stance that inflation rate above 12.0% (11.98% in December) is inimical to growth, the committee may have been uncomfortable with recent CPI trajectory. While an increase in monetary policy rate (MPR) may have been the orthodox approach to taming inflationary pressures, the weak passthrough mechanism of the MPR likely influenced the decision to tamper with the CRR in its stead.


MPC's tools are limited to taper current inflation

In our view, the MPC's recent decision was taken in cognizance of the fact that Nigeria's current inflationary pressure is partly monetary and partly supply side driven. We however note that while the increase in credit creation and liquidity may have played a part, the crux of the inflationary pressure likely stems from food inflation as evinced by the instantaneous surge in food inflation from the months following the land border closure in mid-August 2019 (August inflation: 11.02%YoY; December 2019- 11.98%). Given that the major drivers of inflationary pressures are structural/supply side, the CRR hike is unlikely to significantly mute domestic price pressures. Additionally, the MPC may have limited scope to combat the recent inflationary pressure as the MPR remains relatively tight at 13.5%. To our minds, therefore, improvements in the production of domestic substitutes of previously imported food/products and overall upgrade of infrastructure are likely to have more direct impact on Nigerian inflation.


What next for fixed income yields?

The bullish run sustained by the fixed income (FI) market has largely been liquidity driven as the OMO ban enacted in October compelled domestic investors to rotate into other FI instruments. The impact of the CRR increase on FI yields is likely to depend on its passthrough to system liquidity. Even though a few banks boast effective CRR that are in excess of 27.5%, our base case scenario is that the CBN would enforce the additional 500bps CRR on banks irrespective of their effective positions, in line with historical precedent. This, in addition to pressures from the new 65.0% LDR, is likely to leave banks slightly scampering for liquidity with potential knock-on effect on yields. To be clear, FG's recently announced plan to borrow c.N2.0 trillion from Pension Fund Administrators (PFAs) for infrastructure and the liquidity tightening impact of higher CRR are likely to drive reduced demand for FI instruments and stall yield moderation at the very least. We expect to see an initial repricing of yields higher as markets digest the policy decision and the modalities of the CRR implementation are made clearer.


CBN remains steadfast on currency stability

The rapid decline of reserves in H2'19 and the negative outlook watch placed on Nigeria by global ratings agencies drove investors to speculate about the possibility of a devaluation in 2020. In response to the concerns, the MPC reiterated its resolve to maintain a stable exchange rate in 2020. We expect the CBN to sustain its intervention in various currency windows and keep OMO rates elevated (and higher CRR could suggest CBN's desire to ensure decent carry trade) to retain the interest of foreign investors. Notably, FPI inflows, which dwindled in H2'19, appear to be returning with FMDQ noting a $1.5 billion inflows in January 2020 (the highest since June 2019).


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We believe that the attractiveness of the carry trade is important because of recent oil price shocks and relative attractiveness of peer nations such as Egypt and South Africa. In Egypt, the one-year T-bill yield rivals that of Nigeria at 14.1% and the nation has superior growth prospects. Notably, Egypt is expected to grow by 5.8% in 2019E and 5.9% in 2020, according to a Reuters poll that takes the median forecasts of 20 Economists. Notwithstanding, as discussed in our FY'2020 Outlook titled Treading Uncharted Waters, we believe that the question of devaluation is one of "when' not 'if" as key economic fundamentals remain weak and the naira stays overvalued.

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