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Pre-MPC Commentary - MPC to Shun Policy Tweak for the Fourth Time

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Tuesday, March 21, 2017/9:42 AM /Vetiva Research

The first three months of the year have been a mixed bag for the Nigerian economy. On the one hand, the struggles of 2016 (FY’16 GDP growth: -1.5%) have persisted into the year, namely, fiscal sluggishness, inflationary pressure, and weak consumer & business confidence.

That said, a successful $1 billion Eurobond sale (coupon: 7.875%) has been paired with higher oil earnings which have boosted the Central Bank of Nigeria’s (CBN) external reserves.

The Monetary Policy Committee (MPC) of the CBN must take stock of recent economic developments and near-term expectations as they mull their policy options at this week’s meeting.

U.S. rate hike unlikely to interest MPC
Given the quasi-dollar peg in operation, the recent 25bps hike in the U.S. Federal Reserve benchmark interest rate could call for a similar move from the MPC – in line with action taken by Saudi Arabia and Kuwait.

But the magnitude of prior capital flight from Nigeria and existing liquidity challenges in the country weaken this argument as capital outflows are less likely to induce pressure on the value of the naira.

In the current situation, the FX market is relatively insensitive to interest rate differentials between Nigeria and the U.S. That said, the U.S. rate hike may lead to higher borrowing cost in the global market, a point the MPC may note in light of the $500 million Eurobond proposal.

The release of the Economic Recovery & Growth (ERGP) makes concessionary loans highly likely at this time, offering a cheap alternative to the higher borrowing costs in both domestic and international markets.

All things considered, there is little reason for the MPC to alter rates in response to the Federal Reserve’s decision.

FX policy more crucial to spurring real sector
Notable recovery in oil price (Brent ytd average: $55/bbl vs. 2016: $45/bbl) and consequently, rising external reserves (current: $30.27 billion vs. $25.85 billion at end of 2016) have encouraged the CBN to boost dollar liquidity in the FX market.

The apex bank has sold roughly $2 billion (Vetiva estimate) since the end of February. Amidst this, economic weakness has endured (February Manufacturing PMI: 44.6) and fiscal policy remains reticent, despite the release of the ERGP, with the 2017 Budget remaining unpassed.

Therefore, monetary tightening would constrict an economy that is yet to find the route to recovery. Meanwhile, a rate cut would not directly target the structural challenges afflicting the economy. Maintaining an adequate supply of dollars to the wider economy would better serve this goal.

In short, on the monetary front, improvement in FX liquidity remains critical for kick-starting economic recovery, with interest rate pass-through too inexact to bank on at this time.

Inflation trending down though price pressures remain
Although February annual Inflation was dragged lower by base effects (17.8% vs. 18.7% in January), the uptick in month-on-month inflation (1.0% to 1.5%) is alarming.

In fact, February m/m inflation is the highest since June 2016 (1.71%), just a month before the MPC hiked interest rates by 200bps. Inflationary pressures are widespread, stripping out volatile food and energy elements, m/m inflation still rose from 0.7% to 1.1% in February.

This re-emergent inflationary pressure presents the first real case for a rate hike just two months after the MPC intimated towards looser monetary policy this year.


 

On this note, the monetary policy rate (MPR) may be too blunt an instrument to tackle this inflation.

Directly targeting food prices (through greater FX availability and the Anchor Borrowers Programme) would lead to greater marginal gains as Food Inflation is still the biggest culprit (2.0% m/m).

Boosting FX supply should also help moderate the prices of many petroleum products. Nevertheless, we highlight sticky inflation numbers as a likely candidate to derail the intended direction of monetary policy this year – even with base effects.

Hold verdict but with a murkier outlook
Nigeria’s high inflation rate is still the MPC’s primary concern but raising rates now will not address the cost pressures driving it.

Meanwhile, fiscal policy and improved FX liquidity will be more potent at addressing issues related to economic recovery and business confidence. This leaves the MPC in a familiar position with regards to its conventional monetary policy levers.

We foresee a rate hold at this week’s meeting as the MPC monitors the deceleration in annual inflation and waits for the opportune moment to support fiscal endeavours to reflate the economy.

And considering the rate of recent liquidity mop ups, we do not expect the MPC to adjust any policy levers even as it upholds its tight monetary policy stance at this time.

Verdict: Hold



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