Ahead of MPC: MPC at a Crossroad …Economic Growth Vs. Price Stability


Thursday, July 21, 2016 4:02pm /Meristem Research

The Monetary Policy Committee (MPC) will reconvene on the 25th and 26th of July 2016 to consider the Nigerian economy, amidst anticipated slower global growth on the back of BREXIT, rising domestic inflation (16.5% in June), contracting Gross Domestic Product (GDP) (-0.36% in Q1:2016), continued insecurity and pipeline vandalism in the Niger Delta region, and the continued depreciation of the Naira (c.30% loss in value).

In this report, we review events in the global economy, as they relate to global growth outlook, drivers and drags, and the resultant impact of these on the Nigerian economy. Furthermore, we assess the Nigerian economy so far in 2016, with focus on key economic and political indicators, financial market performance as well as our expectations of the MPC’s considerations and consequent decision.

We believe that the CBN will seriously consider boosting US Dollar liquidity in the FX market by reviewing the Monetary Policy Rate (MPR) upwards, however, we opine that raising the MPR in a contracting economy will further drag economic activities. On a balance of factors therefore, we expect the MPC, given the available alternatives, to tilt more in the direction of stimulating economic growth, in the hopes that a resurgence of the Nigerian economy will help to attract foreign investors in the medium to long term.

International Economies & Developments
The International Monetary Fund (IMF), in the recently released World Economic Outlook (WEO), revised the global growth forecast for 2016 and 2017 downwards by 0.1% each to 3.1% and 3.4% respectively. The IMF expects weaker growth due to increases in economic, political and institutional uncertainties, following the outcome of the June 23rd referendum in favour of the United Kingdom leaving the European Union. This highlights the potential downside risks in advanced economies, and difficult macroeconomic realities in other global economies.

In advanced economies, the growth outlook was also revised downwards by 0.1% to 1.8%. The United Kingdom experienced the largest downward revision, post- Brexit, which may lead to weak domestic demand, dwindling consumer and business confidence, which should affect the outlook for the Euro area.

The outlook for emerging markets and developing economies remain relatively unchanged, with forecasted growth for China, Russia and Brazil revised upwards by 0.6%, 0.1% and 0.5% respectively for 2016, guided by recent policy support in China, relatively higher oil prices, which provided some relief to the Russian economy, and a milder contraction in GDP, than anticipated, in Brazil.

Closer to home, the outlook for growth in Sub- Saharan Africa differed significantly by - 1.4% from the April 2016 WEO, largely driven by a substantial contraction in the forecasted growth of the Nigerian economy by 4.1% to -1.8%, as the region continues to adjust to low commodity prices, foreign currency supply constraints, low power generation and weak investor confidence. We expect the developments in the global and domestic economy to be considered during the forthcoming MPC meeting, as the Committee highlights the impact of these developments on capital flows and the exchange rate.

Domestic Macros

Growth outlook remains dim …inflation hikes further

The Q1:2016 GDP numbers released by the National Bureau of Statistics showed a 0.36% decline in output during the first quarter of the year. The contribution from the oil sector waned by 1.89% YoY, following a decline in domestic production and low crude oil price (Brent) occasioned by the supply glut during the period. Similarly, the non-oil sector contracted by 0.18% YoY, dragged largely by the Financial Services (+11.28%), Manufacturing (+7.00%) and Construction (-5.37%) sectors. As we await Q2:2016 results, we note the subsisting low crude oil production (avg. 1.63mbpd in May 2016), following attacks by the Niger-Delta militant group, as well as depressed economic activities within the real sector.

Further clouding Nigeria’s outlook is the spiking inflation rate, which has advanced in five consecutive months this year. The recently released June inflation figures pegged Headline, Core, Imported Food and Food inflation at 16.5%, 16.2%, 20.0% and 15.3% accordingly. This was due largely to price spikes within the Housing, Water, Electricity, Gas and Other fuel and Imported Food divisions, and the pass-through effects from those spikes in other prices.

Also buttressing the gloomy outlook is the recently released WEO report by the IMF, and the World Bank’s growth projection of 0.08%. We expect the Committee to consider the anticipated Q2:2016 GDP numbers, current inflation rate, increasing operating costs and price levels in relation of the overall economic output in making its policy decisions.

Politics and Security: The lingering menace of NDA
The lingering spate of attacks in the oil rich Niger-Delta region continues to pressure the country’s earnings capacity, as the Niger Delta Avengers (NDA) militant group remain a threat to the nation. After refusing dialogue with the Federal government, there are indications that a rival militant group, the Movement for the Emancipation of the Niger Delta (MEND) are extending talks to the NDA in a bid to getting them to dialogue with the government under a single umbrella tagged the “MEND Aaron Team 2 Peace Initiative”.

In the Northern part of the country, the Nigerian military has been actively engaged with the war against Boko Haram insurgents, with reports of ambush attacks being repelled in the period. We note that the continuing operations of the military in terms of mop up and clearance patrols will further boost the confidence of the natives of the war-ridden villages, as the government continues with the re-integration of Internally Displaced Persons (IDPs) to their locales.

Overall, we anticipate that the return of IDPs to their localities will boost economic activities in the North-East region over the medium term, while also expecting that the unfolding of the “MEND Aaron Team 2 Peace Initiative” will help restore the much needed peace in the Niger-Delta region.

Monetary Policy

Fall in money supply signals weaker economic activity

For the first time in 2016, Net Domestic Credit (NDC) declined by 1.76% to NGN22.85tn between April and May, after credit to government moderated by 3.32% to NGN3.80tn in the same period. In May, Credit to the private sector, although lower than the April level by 0.57%, remained the major contributor to total domestic credit. Similarly, Broad Money (M2) diminished marginally by 0.03% to NGN20.72tn, just as the reduced level of economic activity in the country was further buttressed by the 0.95% decline in Currency In Circulation (CIC) between April and May.

Given our expectation of a further decline in GDP in Q2:2016, coupled with the month-on- month declines in M2, NDC and CIC, we opine that the need to stimulate the Nigerian economy and drive domestic output through increased money supply to key growth sectors will be a key consideration of the MPC in their next meeting.

MPC must assert or review Monetary Stance
Against the backdrop of persistent increases in Inflation so far in 2016, depreciating Naira and expected economic recession , it has become imperative for the MPC to clearly outline its key focus for the economy, as the country strives to find its way.

In March 2016, the MPC was perceived to have reviewed its monetary stance after its surprise decision to increase MPR rate to 12% in addition to other tightening measures.

In May 2016, the Committee kept all policy variables constant as investors and other stakeholders waited to see the impact of the change on market yields, foreign funds flow, financial market as well as economic performance.

We believe the next MPC meeting provides the Committee with an opportunity to clearly state their policy focus and subsequently drive policy actions in said direction, regardless of the current economic shortcomings.

Reserves to remain pressured if CBN remains primary supplier
The country’s foreign reserves have declined marginally Month-to-Date (MtD), and since the last MPC meeting, paring marginally by 0.10% and 0.56%, respectively, while the YtD decline has been more marked, pegging at -9.40%.

With crude oil prices (Brent as proxy) trading at an average price of USD41.77/pb in the year so far, just as production levels have occasionally declined due to attacks by insurgents, US Dollar inflows have tempered. Given our expectation that crude oil prices may continue to trade around the current range USD46-48/pb as several price pressures crystallize (most significantly ramp up of Iranian production), we are not expectant of US Dollar inflows increasing markedly due to export proceeds.

Also, the recent institution of the more flexible FX framework is expected to boost Foreign Portfolio Investments (FPI), however, the CBN’s ability to remain the major seller in the market over the medium to long term remains doubtful, due to limited inflows from alternate sources to date. Hence, short term expectations remain that FPIs will be tempered, while weakening economic fundamentals (especially if the country falls into a recession) may also result in tempered Foreign Direct Investments (FDIs).

Summarily, we opine that reserves will remain pressured, as the CBN continues its daily market interventions amidst weak US Dollar inflows from oil receipts, and FPI and FDI inflows.

FX rate falls to record low at Interbank; NGN293.25/USD
The value of the naira had been relatively stable (c.NGN282 range) at the inter-bank market since the institution of the new FX framework by the CBN on the 20th of June, 2016. However, the value of the currency depreciated further recently, declining to NGN293.25/USD on the 19th of July 2016, as the CBN loosened its reins on the market. Consequently, the naira has now depreciated by 32.04% YtD from NGN199.3 at the end of December 2015.

While a major reason for the institution of this framework was to boost US Dollar inflows, the impact in this regard has been muted, which we believe will be a major concern of the MPC during this meeting. And so, given the need to boost inflows, in the face of static export proceeds, we expect the MPC will consider revising the monetary policy rate upwards to attract ‘yield seeking' money.

Although this will by no means guarantee significantly increased inflows (as investors adopt a ‘wait and see’ approach regarding the FX market), it could potentially result in improved inflows provided the yield environment is significantly affected.

However, we expect further depreciation of the currency over the short-term, before a period of stability thereafter, provided increased inflows result from the monetary stance of the Committee.

Financial Markets

Inflation rate continues to dictate the yield environment

Yields on fixed income instruments across all tenors continued its upward trend in the period since the last MPC meeting, as market participants continued to demand positive real return on investment, given the rising inflation rate. The average yield on Treasury Bills increased by 4.78% from the last MPC meeting to settle at 13.14%.

Similarly, the average Treasury Bond yield declined by 5.06% across all tenors, in the period since the last MPC meeting in May 2016. Also, inter-bank rates appreciated during the period, advancing by 5.83% across tenors to peg the average rate at 17.30%. Also, low system liquidity (average of c.NGN364.04bn) in the period contributed to the higher yield environment, although there was a slight resurgence relative to the last MPC meeting.

The recently released June inflation figure, which stood at 16.50% YoY, represents the fifth (5) consecutive increase in the year, and the highest since November 2005. We expect this trend to be sustained for the rest of the year, but at a slower pace going forward. 

Equities Market takes a breather, as events stifle investors’ mood
The Nigerian equities market sustained an upbeat mood for most of the period since the last MPC meeting. This shift in sentiment was largely driven by the institution of the new flexible foreign exchange system. Following the announcement of this decision, domestic investors took positions in anticipation of the return of foreign investors to the equities market.

However, this was short-lived, as the decision of the United Kingdom (UK) to exit the European Union (EU) after voting through a referendum, triggered panic sell-offs across markets, including Nigeria.

We opine that investors reassessed expectations of funds inflows given that the UK is a major capital importer into Nigeria (c.40% to total FPI into Nigeria in the past 2 years), and inflows amidst the economic uncertainties would be expected to temper. As we advance closer to the earnings season, we expect companies performance scorecards to dictate investor sentiments in the market.

Given the weak financial performances recorded far, which likely signals the expected performance of other companies, we imagine this current negative mood may linger.

On a Balance of Factors…

The past few years have been trying ones for the Committee, as they meet once more at a time when they have to make policy decisions to guide the economy with little to no support from fiscal policy.

The Committee will be faced with a choice of increasing the benchmark interest rate to boost US Dollar inflows, needed for better liquidity in a flexible FX market, and the realization that raising the policy rate in a contracting economy will exert further pressure on output growth.

The debate nowadays oscillates between; what the Committee should or will do, as the country has moved passed the point when conventional policies would have an immediate impact, even if the pass-through mechanism was instantaneous.

We believe that boosting US Dollar liquidity in the FX market is crucial, particularly considering the maturing USD4bn forwards over the next 2 months , however, we opine that raising the monetary Policy Rate (MPR) would have a detrimental impact on the Nigerian economy, which has most likely fallen into a recession.

We posit that the MPC, given the available alternatives, will be inclined to tilt more in the direction of stimulating economic growth, in the hopes that a resurgence of the Nigerian economy will help to attract foreign investors in the medium to long term.

We believe that this approach charts a more certain, albeit longer path to FPI inflowsrather than an immediate reaction, which may not eventually result in foreign funds repatriation, and would possibly only stifle economic growth further.

Also, the current happenings in the banking system are a cause for worry, as deteriorating asset quality will continue to be an issue given the current state of the economy. While the Committee will allude to the issue in the sector, we do not expect a policy revision to the liquidity ratio or CRR as this would exert more pressure on the banking system, which would lead to weaker profitability, and consequently weaker investor’ confidence.

Given these considerations, we expect the MPC to make the following decisions:

·         Maintain the MPR at the current level
·         Maintain liquidity ratio at 30%.
·         Maintain the asymmetric corridor at +200bp/-500bp.
·         Maintain the CRR at 22.5%.

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