MPC Preview - Threading the Needle

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Monday, September 24, 2018 06:27 PM / ARM Research 

Today, the Central Bank of Nigeria (CBN) commences its two-day monetary policy meeting amidst worries on both the global and domestic front. On the global front, there has been apprehension over the recent trade spat between the US and China. In addition, the US has continued to hold on to its monetary tightening stance. 

Elsewhere, slower economic growth in Q2, jerk in inflation reading and persisting capital outflows remain a case for concern on the domestic front.  We attempt to examine the direction of each member in the last two MPC meetings. At the last meeting, 7 members voted to keep the MPR unchanged while 3 members voted for a hike compared to only one member at its May meeting. The major concerns highlighted by the members that voted to hike revolved around elevated liquidity profile over the rest of the year and concern over lingering capital outflows. 

The recent uptick in headline inflation (+9bps to 11.23% in August), concerns over impending liquidity in the system and lower capital flows will leave the MPC threading the needle. 

However, we believe the MPC will retain its monetary stance and keep all policy parameters unchanged. To add, we believe the current level of real interest rate is appropriate to balance the objectives of exchange rate stability, price stability and output stabilization.

 

Table 1: Decision of MPC members in the last two MPC meetings

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Headline inflation resumes the uptrend

In the month of August, the CPI index rose for the first time in 18 months to print at 11.23% YoY, 9bps higher than 11.14%. The increase was driven by waning base effects coupled with sustained slow deceleration in MoM headline inflation (-8bps to 1.05% vs. 5-year historical August MoM of 0.66%).

 

The pressure point stemmed from food inflation which rose 2bps to 1.40% due to the ongoing lean season alongside the herdsmen and farmers crisis which affected food production in the Middle Belt.

 

On the core sub-index, MoM inflation declined 3bps to 0.78%, reflecting moderation in key subcomponents, specifically HWEGF and transport inflation which declined 25bps and 30bps to touch three-year lows of 0.45% and 0.61% respectively, despite a 1.79% MoM increase in the price of Diesel – according to data by the NBS.

 

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FEWS NET expects food prices to decline from September as harvest activities increase however, we do not envisage a material deceleration as we expect the aftershock of the herdsmen/farmer conflict as well as incidences of flooding in the south-south region of the country to keep food prices above average levels. 

We also believe there is a lagged impact of the increase in diesel price on HWEGF, transport as well as food inflation which we expect will reflect in the subsequent month. 

Overall, with dissipating base effects, we expect September headline inflation to print at 11.5% (+ 22bps from 11.23%) with full year 2018 inflation expected to hover around 12.3% (vs. 16.5% in 2017).

 

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The sporadic exit of hot money from Nigeria has created a dip in the nation’s external reserve. Over the last three months (July till date), net draw-down from the reserves amounted to $2.7 billion. Excluding $500 million for settlement of maturing Eurobond in July, the balance of $2.2 billion was expended on meeting demand by offshore investors repatriating capital and returns. 

By our estimate, total outflow by offshore funds over the same period summed up to $6.7 billion, with the CBN providing $2.5 billion while the remaining $3.7 billion was settled by inflows from offshore funds and local corporates. 

Also, the apex bank stepped up its intervention across other markets in a bid to ensure stability, with total sale of $5.9 billion. Accordingly, overall apex bank outflow at the IEW and special interventions stood at $8.5 billion over the same period. 

 

Figure 3: Foreign Currency flows via the CBN ($’Million)

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Figure 4: CBN inflow, net flow and Gross Reserve position

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Going by recent data, foreign holding of maturing local fixed income instruments for the rest of the year is estimated at $7.7 billion. Assuming a worst-case scenario, wherein the total maturity is repatriated over the cause of the year, we estimate a further drawdown in reserve to $39.3 billion (which adjusted for the Eurobond issuance of $2.8 billion should rise to $41.2 billion). 

However, we do not believe the full extent of the maturity will leave the country and assume a 50% repatriation. Accordingly, we expect average monthly outflow from the CBN of $4.6 billion with average reserve drawdown estimated at $665 million over the rest of the year, which should pressure a further depletion in the foreign reserve to $43.2 billion (which adjusted for the Eurobond issuance should rise to $45 billion). 

Consequently, despite concerns of capital flight and impact on exchange rate, we are of the view that the CBN is in a much more comfortable position to support the Naira and thus we expect relative stability in the currency over 2018.  

CBN tinkers OMO rates

Despite our view of MPC holding its rates unchanged, we believe the aforementioned worries on impending liquidity and capital outflows will drive the CBN to mop up excess liquidity at a higher rate. 

For emphasis, the last one week has been one with a difference in the Nigeria’s fixed income market with average yields currently at a peak of 14.9% this year. Unlike prior weeks where selloff across varying long dated instrument drove uptick in fixed income yields, the pressure points this time stemmed from short end yields which came under pressure following a switch in CBN’s monetary stance to a more hawkish one.  

In line with our views in our August Fixed income monthly update, CBN eventually succumbed to investors thrust for an upward revision in OMO rates by raising rates for the 190 Day OMO bills by 35bps to 12.5% and introducing a new 324 Day paper at 13.2%. This is unsurprising as investors’ aversion for OMO instrument at 12.15% has continued to weary the apex bank. For context, aside the “No Sale” showing in two of its recent auctions, the CBN has been grappling with thin demand over Q3 18 (bid to cover of 0.55x in Q3 18 vs 1.29x in the prior quarter) despite pent up market liquidity. 

In fact, the recent uptick in NTB stop rates at the last auction (Average stop rate: +120bps MoM to 12.25% in September) further propelled investors upward repricing of OMO bids which forced a shift in CBN’s monetary stance.  

Furthermore, investors demand for higher rates also mirrored elevated interest rate in the developed markets that has stoked wide sell-off across various EMs debt counters. Similar events beset Egypt’s fixed income market as foreign investors and banks demanded a higher rate for taking on treasury bonds following weak appetite for global EMs assets. This forced Egypt’s central bank to call off its treasury bond auction three times in the past few weeks as investors elevated bids of around 18.8% mars government’s aim to achieve an average interest rate on government debt instruments of 14.7% in 2018.  

Figure 5: Trend in OMO Net Issuances and rates

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Higher yields in the offing

On balance, the gradual collapse of base effects as well as prospects for elevated food prices stemming from herdsmen conflict and flooding provides scope for uptick in inflation over the rest of the year. 

Overlaying this with the recent depletion in FX reserves (dipped $769 million to $45.1 billion so far in September) coupled with sustained sell-offs in Nigeria’s Fixed income market, we could see the monetary authorities tinker monetary policy to address likely inflationary and currency pressures. In doing this, we are of the view that the CBN will keep OMO rates elevated over the near term while leaving MPR unchanged at 14% over the rest of the year. 

Overall, given the confluence of expected inflationary pressures, elevated OMO rates and higher FG borrowings over the rest of the year, we expect a further uptick in yields, albeit marginal (+50bps).

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Research 234 (1) 2701653  research@armsecurities.com.ng

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