Do Nothing - An Option: MPC Considerations and Policy Options

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Friday, September 16, 2016 1:45pm /FSDH Research 

We expect the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) to hold rates when it meets on September 19-20, 2016. The current economic recession does not support an increase in rates; rather it supports rate cut to boost output. On the other hand, the rising inflation rate and weak currency do not support rate cut but a rate increase.  

However, given the stagflation the country faces at the moment, maintaining rates at the current level may be the best option. We expect the MPC to continue to use the Open Market Operations (OMO) to influence yields to achieve positive real yields on fixed income securities. At the end of its July 2016 meeting, the MPC increased the Monetary Policy Rate (MPR) to 14% from 12%, with the asymmetric corridor at +200basis points and -700basis points.  

However, it retained the Cash Reserve Requirement (CRR) and Liquidity Ratio (LR) at 22.50% and 30% respectively. The Organization of the Petroleum Exporting Countries (OPEC) asserts that the trend of the past years’ moderate global growth is likely to continue in both 2016 and 2017.  

The OPEC Oil Market Report for September 2016 revised down its 2016 global growth forecast to 2.9%, from 3% in the previous assessment. The economic growth forecast for 2017 was retained at 3.1%. OPEC added that after particularly low growth in the first half of 2016 in the US and Japan, these economies are expected to pick up in the remainder of 2016 and to show higher growth in 2017.  

It added that despite the continued contraction in Russia and Brazil, these economies are also expected to pick up and record higher growth in 2017. The Euro-zone, the UK, China and India are forecast to record lower growth in 2016. The weak global economic growth outlook portends a downward pressure on oil prices, which will mean additional pressure on the value of the Naira.  

Thus, a tight monetary policy is an appropriate response to mitigate the negative impact on the Nigerian economy. The Nigerian economy officially entered into a recession when the National Bureau of Statistics (NBS) released the Q2, 2016 Gross Domestic Product (GDP) figures.  

The real GDP contracted by 2.06% (year-on-year) in Q2 2016, compared with the growth of 2.35% in Q2 2015. The NBS earlier reported a GDP contraction of 0.36% in Q1 2016, leading to two quarters of GDP contraction (recession).  

The oil sector recorded a decline of 17.48%, compared with the decline of 6.79% recorded in Q2 2015. The oil sector contributed approximately 8.26% to the real GDP in Q2 2016, lower than the 10.29% contribution in Q1 2016.  

The non-oil sector recorded a contraction of 0.38% in Q2 2016, compared with the growth of 3.46% in Q2 2015; and the negative growth of 0.18% in Q1 2016. The Nigerian economy needs policies to stimulate it, and we think appropriate fiscal measures are needed to stimulate the economy. We recommend that the government at all levels to borrow to pay salaries of workers. It should also partner with the private sector to develop real estates and other key infrastructure. 

These measures will inject liquidity into the system and provide jobs. The government should also partner with banks to enable civil servants have access to loans to boost their spending power. 

The negative effect of inflation on consumption and investment decisions still persists in the Nigerian economy. The inflation rate trended higher in August to 17.61%, from 17.13% in July 2016. The cost-push factors that have been leading to higher inflation rate still persist in the Nigerian economy. We do not expect the MPC to raise rates higher to combat inflationary pressure because of economic growth concern. 

A surprise build in U.S. crude stocks, increasing supplies and worries about Chinese demand have recently been exerting downward pressure on prices. The output from Nigeria remains strained and below benchmark for 2016Budget.  

The price of Bonny Light crude oil increased by 5.43% to US$47.36b as at September 14, 2016 from US$44.92/b on July 26, 2016. The output shortages from militant activities continue to put significant negative impact on FGN earnings and weaken the ability of the government to reflate the economy.  

This has also limited the foreign exchange inflow into Nigeria. Thus, the CBN is left with tight monetary policy to attract foreign exchange from alternative sources. 

The anticipation of the influx of foreign exchange from the adoption of the flexible exchange rate by the CBN has not fully materialized. The foreign investors are still wary about the appropriate foreign exchange rate to bring in their funds, and the specific government policy in respect to foreign investment.  

The 30-day moving average external reserves declined by 4.27% from US$26.23bn at the last MPC meeting to US$25.11bn as at September 09, 2016. We expect the MPC to use OMO to drive its external reserves accretion objective rather than a rate hike. 

The foreign exchange market still faces supply shortages. The Naira recorded a gain of 1.02% in its value to US$1/N306.93 on September 15, 2016 from US$1/N310.07 on July 26, 2016. The premium between the interbank and parallel markets averaged about N40 after the last MPC meeting in July 2016.  

The divergence between the two rates is mainly from inadequate supply, as unmet demands at the inter-bank market are transferred to the parallel market. The parallel market rate depreciated by 11.84% to US$1/N426.50 on September 15, 2016 from US$1/N376 on July 26, 2016. A rate cut is not consistent with the short-term policy of the CBN to attract foreign investors into the fixed income securities market. The strategy is intended to increase supply of foreign exchange through Foreign Portfolio Investors (FPIs). 

The weak macroeconomic factors have put further upward pressure on yields in the fixed income securities market after the last MPC meeting in July 2016. The average yields on the 91-day, 182-day and 364-day Nigerian Government Treasury Bills (NTBs) increased to 15.81%, 19.50% and 22.70% in August 2016, compared with 12.45%, 14.91% and 18.67% respectively in July 2016.  

The last yields on the NTBs sold on September 14, 2016 were at 14.50%, 19.50% and 22.66% on the 91-day, 182-day and 364-day NTBs, respectively. The yield on the 16.39% FGN Bond January 2022 also increased to 14.94% in August 2016 from 14.58% in July 2016, while it stood at 14.88% as at September 14, 2016. We expect the MPC to maintain its efforts at achieving positive real yields via the use of OMO. 

The money supply and credits to the private sector grew in the first seven months of the year, and above the annualised target rates for 2016. The broad money supply (M2) increased by 10.75% to N22.18trn in July 2016, from N20.03trn in December 2015; an annualized growth of 18.42%. The provisional growth benchmark for 2016 is 10.98%.  

The narrow money (M1) grew by 7.69% to N9.23trn in July 2016, from the End-December 2015 figure. Net domestic credit (NDC) also grew by 16.41% in the same period; an annualized growth of 28.13%.  The provisional benchmark growth for 2016 is 17.94%. The credit to government fell by 3.77% during the period. 

Similarly, credits to the private sector grew by 19.53% in July 2016, compared with December 2015; an annualized growth of 33.48%. The benchmark growth for 2016 is 13.28%. We note that the growth in the money supply and credits could be attributed to the foreign exchange rate devaluation. Thus, the economy needs a major injection to stimulate economic growth. 


Looking at the economic developments in the country, we believe the MPC will vote to maintain rates at the current levels. The need to stimulate economic growth in Nigeria does not support a rate hike. 

Meanwhile, the need to tame the rising inflation rate also does not support a rate cut. The most appropriate policy option is to do nothing. 

 

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