Wednesday, November 26, 2014 4:49 PM / FDC
The CBN in a show of independence, has finally taken the bull by the horn on its monetary policy stance. The 8.4% devaluation of the midpoint official exchange rate has effectively moved the exchange rate band to N159.6 - N176.4. This move follows a series of intervention measures already implemented by the CBN, one of which is the transfer of approximately 50% of forex transactions to the interbank market.
The good news is that the currency devaluation mitigates the impact of the 21% decline in oil receipts on fiscal revenue, resulting in an increase in FAAC allocations. The CBN also has more leeway to manage the exchange rate, while the bleeding in the stock market is expected to stop as market uncertainty wears off.
Find below an an in-depth analysis of the implications of the outcome of the MPC meeting on the markets, corporates and the Nigerian economy.
MPC Decision: The Unspoken Word
The monetary policy committee (MPC) met today at a time of plunging oil prices and heightened anxiety as to the direction of the exchange rate. It was anticipated that the MPC will alter its monetary policy stance, which it had kept unchanged since March 2014 when it raised the cash reserve requirement on private sector deposits to 15%.
According to Bloomberg, the regulator’s moves were more assertive than expected. Only three of the nine economists surveyed by Bloomberg estimated a rate increase, while 6 predicted the bank will hold at 12% p.a.
The Bold Decision
Breaking the tradition of previous meetings, the MPC took a very bold and emphatic step in a bid to maintain price and exchange rate stability in the economy. The decisions include:
• A 100 bps increase in the Monetary Policy Rate (MPR) to 13%p.a. from 12% p.a. whilst maintaining the symmetric corridor of +/- 200 bps around the MPR
• A 500 bps increase in the private sector Cash Reserve Requirement (CRR) to 20% from 15%
• Maintaining the public sector CRR at 75%
• A depreciation of the official exchange rate mid-point benchmark to N168/$ from N155/$ and an expansion of the flexibility band of the currency movement from +/-3% to +/-5%. The 3% band had been in place since 2005.
• Net open position was retained at 1% of shareholders’ funds
The Committee’s Mindset
The MPC’s decision has reinforced the Central Bank’s independence and autonomy, and has taken a more assertive posture than the fiscal authorities who have been rather mild in its austerity measures.
• Oil Price Dynamics: The MPC is of the opinion that the decline in oil prices is not a short term phenomenon and is likely to affect monetary policy well into 2015 and beyond
• Inflationary pressures are not apparent but the committee noted that the underlying pressures remain potent
• In reiterating its commitment to the monetary policy framework of explicit inflation targeting, the committee is now emphasizing a dual anchor of the MPR and exchange rate. In addition, it is using administrative tools and at the same time allowing for flexibility in the exchange rate. The increase in the exchange rate midpoint and the widening of the corridor provides more headroom for investors hedging against the dollar. This will allow the currency move towards its real equilibrium rate path.
The decision to raise the MPR and the CRR on private sector deposits, as well as the shift in the benchmark mid-point of the currency band are not without far-reaching implications. This sends strong signals to the market that the CBN is determined to maintain prices and exchange rate stability.
100bps Increase in MPR
The MPR has failed to be a signal rate and is used just as an anchor. It is unlikely to have any significant impact on banking liquidity. However, some fixed income instruments are priced to the MPR. Coupon rates of bond issues priced to the MPR and the cost of financing federal government debt will change.
5% Hike in Private Sector CRR
The 5% hike effectively quarantines N368bn of total private sector deposits of N7.38trn. This brings total sterilized private sector funds to N1.47trn, which is 9.72% of total banking deposits and 8.87% of money supply.
The cocktail of decisions is expected to push up interbank rates by 100-200bps in the short term. Borrowing costs will rise and banking sector profitability is set to take a hit as net interest margins diminish further.
Shift in the Midpoint from N155 to N168
The CBN has more room to tinker with the exchange rate. The currency adjustment has a direct impact on the cost of imports and may undermine the MPC’s efforts at ensuring price stability in a hugely import-dependent economy. The CBN Governor referred to the use of the floating rate to achieve the real equilibrium exchange rate path.
From the last meeting in September, we estimate that Nigeria’s oil receipts have decreased by 21.05% from $5.7bn to $4.5bn due to the falling oil prices. However, when this is translated into naira revenue, the 8.39% devaluation has reduced the negative impact of the decline in oil prices on fiscal revenue to 14.43%. This is illustrated in the table below.
Devaluation in the currency means a slowdown in the external reserves depletion. In addition, since the naira is closer to equilibrium, the need to intervene will be less.
· Slowdown in haemorrhage of the stock market as Foreign Portfolio Investors (FPIs) are expected to return to the market, and
· The MPR increase will result in a re-pricing of fixed income securities which might deter investors from equities. This is due to the higher yield on fixed income instruments.
Nigeria is not an outlier in the change in monetary policy stance. Ghana and Zambia also recently tightened further their benchmark interest rates to 21% p.a. and 12.5% p.a. respectively. On the other hand, Kenya and South Africa maintained the status quo on their policy stance.
With respect to the currencies, the Ghanaian cedi remains the worst performing currency in SSA, with a value loss of 26.27% y-t-d, while the Zambian kwacha has lost 11.86% y-t-d.
It is expected that the currency devaluation will reduce the pressure on the naira and on external reserves. This will hold off further drastic actions before the elections. However, this is also dependent on OPEC’s decision on November 27. In the meantime, the oil markets will remain a treacherous field for economic forecasts.