MPC Meeting Preview: Confronting Stagflation

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Tuesday, March 22, 2016 1:05PM /ARM Research

Today, the Central Bank of Nigeria (CBN) wraps up its two-day Monetary Policy Committee (MPC) meeting amid sizable deterioration in the domestic macro-environment. Firstly, the National Bureau of Statistics (NBS) in early March revealed that real GDP growth plummeted to fresh lows of 2.11% YoY in Q4 15 which drove annual GDP to a 16-year low of 2.8% YoY.

The NBS followed up with release of CPI numbers which showed inflation printing at a thirty nine month high of 11.4% YoY in February, driven largely by pressures in core inflation. Interestingly, despite significant volatility in currency markets over February, with parallel market premium averaging 66%, FX passthrough impact on inflation was limited by our estimates. In sum, supply side shocks played a large hand in driving the spike in February 2016 CPI.

Figure 1: Attribution analysis of MoM core inflation in February



On the fiscal side, delays in obtaining legislative assent to announced expansionary budget and persisting uncertainty over foreign leg of deficit financing for the budget, continued to inhibit the proposed expansionary fiscal policy response to the deteriorating economic climate. On balance across the domestic and external fronts, the key issues which should dominate the agenda for the March 2016 MPC are the emergence of ‘stagflationary’ conditions and sustained divergence in the parallel-interbank USDNGN premium.

Monetary easing to continue to accommodate expansionary fiscal Policy
Over the last three MPC meetings, amid a steady flow of mixed signals from GDP and inflation, the MPC has adopted a pro-growth bias which informed its adjustment to an easing stance. Nonetheless, the return of double-digit inflation well above CBN threshold would appear to stoke prospects for a monetary tightening. However, our prognosis about supply side driven nature of new upthrust, renders any hawkish stance of limited benefit, in our view, with negative wage growth over 2015, further weakening any argument for tightening.

Indeed, insights from looking at GDP data by expenditure approach, emphasize the need for fiscal stimulus to boost the economy. On this wise, lack of progress in obtaining foreign deficit financing suggests greater leaning on the naira leg to plug the budget gap.

This is particularly important given the theoretically implied need for fiscal stimulus and the importance of fiscal plans in actualising economic goals in 2016—its importance in our GDP forecast needs no repeating.

However, given on-going revenue constraints, as with 2015 and in-line with our expectations, monetary sources will need to underwrite this sorely needed fiscal boost if it is ever to materialise.

Nonetheless, given delayed budget passage, which should have set out the path for delivering the fiscal boost, monetary easing at this time would appear to be undirected. Hence, the MPC should retain current stance till May MPC when budget clarity should have been obtained for meaningful deployment of further easing measures.

Figure 2: GDP by expenditure approach

 



Easing of FX restrictions on the cards?
Beyond the quantitative easing posture, following sizable volatility in FX markets which has resulted in widening parallel-interbank premiums, CBN could make pronouncements on developments over the naira having kept mum on the currency in January.

On this wise, whilst sustained fiscal resistance to naira devaluation remains, recent comments by President Buhari during which the President conceded that transactions (with specific mention of school fees) outside the preference list (raw material imports, petroleum products, equipment and machinery) would be allowed to consummate at the parallel market hint at a thaw in current FX curbs.

Thus, we see the presidential concession as providing legroom for the CBN to loosen some restrictions to allow greater flexibility.In summary, we expect the CBN to retain policy parameters on all fronts while commencing admin measures aimed at easing illiquidity across FX markets.

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