MPC Decision Review and Outlook: Growing Monetary Policy Dilemma

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Thursday, March 17, 2016 07:20PM / FSDH Research

MPC Meeting: Considerations and Policy Options


Growing Monetary Policy Dilemma

The Monetary Policy Committee (MPC) is faced with difficult monetary policy choices going by the current economic developments in Nigeria and the short-to-medium term outlook. There are arguments in favour of currency adjustment, interest rate hike, and reduction in interest rate. Notwithstanding the conflicting signals, the MPC needs to act quickly to boost investors’ confidence in the Nigerian economy.

The MPC of the Central Bank of Nigeria (CBN) will hold its second meeting for the year 2016 between March 21 and March 22, 2016. At the end of its January 2016 meeting, the MPC maintained the Monetary Policy Rate (MPR), the Cash Reserve Requirement (CRR), and the Liquidity Ratio at 11%, 20%, and 30% respectively. The MPC also maintained the asymmetric corridor at +200basis points and -700basis points. We continue to support Naira adjustment to around US$/N230-US$/N240 and measures to increase yield.

The MPC’s concerns at its last meeting about the weak and fragile global economy still persist. The Organization of the Petroleum Exporting Countries (OPEC) projects the global Gross Domestic Product (GDP) at 3.2% in 2016. OPEC revised its growth forecasts downwards across geographic regions, with the exception of the Euro-zone. It expects the U.S. economy to grow by 2.2% in 2016. The FOMC maintained its Federal Funds Rate at 0.25%-0.50% at its March meeting. This is positive for Nigeria.

The Nigerian economy grew by 2.79% in 2015, compared with 6.22% in 2014. FSDH Research earlier released a growth forecast of 3.07% for 2015.The oil sector recorded a negative growth rate of 5.45%, from the negative growth rate of 1.32% in 2014. The non-oil sector recorded a growth rate of 3.75% in 2015, lower than the 7.18% recorded in 2014.

In Q4 2015, the economy grew by 2.11% (year-on-year), compared with 5.94% in the corresponding period of 2014. The issues surrounding the shortage of foreign exchange in the country and the weak purchasing power were responsible for the sluggish growth recorded in Q4 2015. The current low GDP growth rate justifies monetary policy easing to boost growth. However, this will not support the current of rising inflation rate and weak exchange rate.

The pass-through effect of imported inflation from the weak Naira fed into the domestic prices in February 2016. The inflation rate in February 2016 increased to 11.38%, from 9.62% in January 2016. The upward pressure on the general prices is expected to continue in March 2016 and could push the inflation rate higher. Although the exchange rate has appreciated at the parallel market, the country is faced with violence in a food producing state. These factors coupled with the fuel shortages could push up food prices. The appropriate policy response to the rising inflation rate is to hike rates. This move may conflict with the growth objective of the CBN and Federal Government of Nigeria (FGN).

The discussions around production cut and the declining oil rig counts pushed up oil prices between the last MPC meeting in January and March 2016. The price of Bonny Light crude oil increased by 22.06% to US$38.67/b as at March 14, 2016 from US$31.68/b on January 26, 2016. The fundamentals of the oil market still tend towards lower oil prices in the short-term. Therefore, the revenue of the FGN and the value of the Naira still face significant external shocks. While the MPC does not have any control over oil price, an increase in rates and adjustment in the exchange rate may reduce speculative demand for foreign exchange.

The demand pressure on the external reserves was minimal between the last MPC meeting and March 15, 2015 as some foreign exchange funding moved to the parallel market. The 30-day moving average external reserves declined marginally by 1.31% from US$28.24bn at the last MPC meeting to US$27.87bn as at March 15, 2016. In the short-term, the adoption of an acceptable exchange rate that will attract foreign investors will boost the external reserves.

The premium between the parallel market rate and the official market rate at the foreign exchange market remained wide at an unacceptable margin. The exchange rate at the official market stood at US$1/N197 as at March 16, 2016 while it stood at US$1/N325 at the parallel market. This represents a premium of N128. The foreign exchange policy of the CBN drove demand to the parallel market. The development in the parallel market contributed largely to the spike in the inflation rate in February. The prices of consumer goods reflected the exchange rates at the parallel market.

The level of liquidity in the inter-bank market has dropped to an average of N250bn from an average of N850bn between January and February 2016. A combination of Open Market Operations (OMOs) and increasing demand for debt capital have reduced the liquidity level. The average yields on the 91-day, 182-day and 364-day Nigerian Government Treasury Bills (NTBs) increased to 4.96%, 7.94% and 10.14% in February 2016, compared with 4.19%, 7.57% and 8.69% respectively in January 2016.

The yields on the 91-day, 182-day and 364-day NTBs stood at 4.91%, 7.58% and 9.86% respectively as at March 15, 2016. The yield on the 16.39% FGN Bond January 2022 also increased to 11.82% in February 2016 from 11.77% in January 2016, while it stood at 11.72% as at March 16, 2016. The inflation rate at 11.38% means that most of the fixed income securities are trading at negative real yields. This is a disincentive for investment and calls for an interest rate hike.

Looking at the conflicting macroeconomic developments in the Nigerian economy, a combination of an adjustment in the exchange rate and an upward movement in yields are required. We maintain our exchange rate range of US$/N230 – US$/N240 while we expect the CBN to implement inflation adjusted yields to produce positive yields in the region of 200 basis points.

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