CCR On Public Sector Funds Increased to 75%
By Samir Gadio, Emerging Markets Strategist, Standard Bank
MPC hikes CRR on public sector funds – The MPC left the MPR, SDF, SLF and the general CRR rates unchanged at 12%, 10%, 14% and 12%, respectively, at its 20/21 Jan meeting, in line with our expectations and market consensus. It also indicated that a reduction in interest rates was unlikely before the next electoral cycle. That said, the CRR on public sector funds was increased to 75%, from 50%, which implies a mop-up of around NGN657bn. Overall, the CBN reiterated its commitment to exchange rate stability, but highlighted a number of key upside risks to USD/NGN, including the transition at the CBN in H1:14, the start of QE tapering in the US, as well as the marginal level of oil savings in Nigeria which weighs negatively on market confidence. Interestingly, the MPC voted five to three to raise the CRR on private sector funds.
Controlling market liquidity – The CBN has been less aggressive in its sterilisation efforts in recent months as evidenced by the abundant NGN liquidity in the system (over NGN700bn last week; about NGN1.044tr today) which offset the impact of the initial introduction of a 50% CRR on public sector funds. This stance reflected the favourable performance of the exchange rate in Q4:13 which made further tightening in effective monetary policy less urgent at the time, but also the elevated cost associated with OMO operations. Thus the increase in the CRR on public sector deposits highlights the fungibility of liquidity management policies used by the CBN, since the current approach will allow to gradually end the vicious cycle of OMO issuance to mop up previous OMO bills while reducing the cost of sterilisation. The decision to raise the CRR on public sector funds also has a pre-emptive character in addressing a likely fiscal slippage later this year. Moreover, it allows the CBN to gradually achieve the liquidity management benefits of the proposed – but never fully implemented – single treasury account reform through the backdoor.
Commitment to exchange rate stability – The central bank reiterated its commitment to exchange rate stability, adding that a potential devaluation would have negative consequences on the economy and inflation (which we expect to remain in single digits in H1:14). This would indeed lead to a pick-up in imported inflation and depress investment, even though Nigeria’s external competitiveness would most likely not improve since oil accounts for 95% of total exports and given persistent infrastructure bottlenecks. While the BDC segment of the FX market is less relevant in terms of size compared to the RDAS and interbank markets, the CBN expressed concerns about the widening gap between the parallel and official and interbank USD/NGN rates in recent weeks. It also called for measures to contain the move higher in the parallel USD/NGN exchange rate, including steps to curb money laundering activities in coming days.
Fiscal savings remain critically low – Even though oil theft has partially impacted government revenue, this cannot explain the magnitude of the shortfall in oil receipts and the sustained depletion of fiscal savings, especially considering the robust oil price. Such dynamics point to potential systemic leakages in the oil sector. The balance of the ECA now stands at a mere USD2.5bn (less than 1% of GDP vs a fiscal savings-to-GDP ratio median of 65% among major oil producers) which will continue to make Nigeria vulnerable to oil boom and boost cycles.
Less favourable foreign positioning – FX reserves have trended lower in recent months (USD42.8bn on 20 Jan), albeit modestly and gradually, a situation reflecting the depletion of fiscal buffers, but also the lack of new capital flows into Nigeria. Granted we have not seen large portfolio outflows lately despite the start of QE tapering in the US, and there is still plenty of global liquidity which needs to be invested, but international investors are less likely to add to their NGN positions given the uncertain political climate in Nigeria and may be tempted to repatriate FX proceeds after their holdings mature.
A smooth transition at the CBN? Governor Sanusi had previously requested that the name of his successor could be announced in March, so that an orderly transition takes place allowing the market to price monetary policy and institutional risk adequately. Investor concerns are mounting as the recent political imbroglio in the ruling party and the forthcoming electoral cycle increase the chance that the next CBN Governor will be less independent (or more closely associated with the current administration), with the potential to influence monetary policy towards a lower rate regime. Perhaps this will be mitigated by the limited change in the composition of the MPC in the post-Sanusi period and also the likelihood that the authorities will be forced to tighten liquidity conditions again should a shift to a more accommodative rate regime trigger some initial upward pressure on the NGN, as a currency devaluation would certainly be politically counterproductive ahead of a challenging election.
How to play the market? The initial squeeze in liquidity with the introduction of the 50% CRR on public sector funds in late July 2013 resulted in a sharp short-lived increase in NIBOR rates, but a much less aggressive repricing of T-bills. We suspect NIBOR rates may display further – albeit temporary – volatility in coming days, especially as the banks the most exposed to government funds cope with liquidity shortages. The reaction of the yield curve will however be modest and will not fundamentally alter our general market calls anyway. We continue to recommend the carry trade given the moderate upside risks to USD/NGN in 2014, but are less constructive on duration amid a likely pick-up in bond issuance later this year and more risk-averse positioning in the Nigerian market.