Nigeria: What next for Monetary Policy?
By Samir Gadio & Ayomide Mejabi, Standard Bank
Critical MPC meeting on 24/25 March – The Monetary Policy Committee (MPC) will meet on 24/25 March to discuss the recent global and domestic developments pertinent to the outlook for price stability in Nigeria and determine the most appropriate monetary stance going forward. This MPC meeting is likely to be even more closely monitored by onshore and foreign investors than usual for a number of reasons.
- First, the Central Bank of Nigeria (CBN)’s decision(s) will come amid a period of upward pressure on USD/NGN, which has produced a sustained erosion of FX reserves, capital outflows and weak domestic confidence. Clearly some drastic measures are urgently required to ease the pressure, and as such this challenging environment will test the MPC’s resolve to ensure macroeconomic stability.
- Second, it takes place following the suspension of Governor Lamido Sanusi on 20 Feb 2014, which most market players believe is related to his criticism of the opaque oil revenue management framework in Nigeria.
- Third, the MPC decision will provide a clearer idea of the CBN without Sanusi at the helm. So far Acting Governor Sarah Alade and the CBN have continued to support the NGN via active FX interventions, while emphasising the continuity of price stability policies.
- Fourth, the market is still seeking more clarity on the FX and interest rate stance of CBN Governor designate Godwin Emefiele. His Senate screening, which is likely to begin later this week, should provide more colour on his views.
- Fifth, and perhaps most concerning, is a plan for the Senate to amend the CBN Act which will see the CBN Governor answerable to the CBN Board Chairman appointed by the President (and cleared by the Senate).
USD/NGN stabilises in 164-165 area… The NGN has remained under pressure in recent weeks amid capital outflows and a persistent domestic positioning against the NGN. That said, the CBN has continued to provide USD liquidity directly to the banks, pursued regular Retail Dutch Auction Sytem (RDAS) FX sales – and even resumed FX forward sales -, and as a result managed to cap the interbank exchange rate in the 164-165 area (164.3 on 18 March).
…while FX reserves continue to drop – But with FX reserves continuing to slide (30-d moving average at USD38.4bn on 17 March), concerns are rising over the sustainability of the CBN FX stance (which is now to contain the spread between the interbank and RDAS rates). In a heavily managed exchange rate, such a trend in FX reserves is often the prelude to a devaluation and sometimes a proper run on the currency if the public loses confidence in the FX regime. Still, of the USD17.5bn or so of remaining foreign holdings in the Nigerian market, we suspect further portfolio outflows will probably not exceed USD4-5bn in a base scenario, as a number of real money investors and index trackers will reduce their exposure, but not exit the market entirely. Besides, a large majority of offshore holdings are now in equities, and a downturn in this sub-balance would reflect both actual outflows and the intrinsic contraction in valuations. Meanwhile, it appears that equity investors are more worried about the trajectory of USD/NGN than specific stock valuations at this stage, even though the frontier market and Africa-focused funds’ positioning will remain more resilient and place a floor on the NSE index.
Robust oil price saves the day – On another mildly positive note, the robust Bonny Light price (around USD110 pbl) should be a supportive factor and theoretically offset capital outflows, but fiscal policy at the federally consolidated level is already on the edge suggesting that the country cannot even afford a modest drop in the oil price. In fact, the fiscal breakeven point appears to exceed the Bonny Light price itself and is well above the USD79 pbl oil price benchmark in the 2013 budget (USD77.5 pbl expected in 2014).
We recommend a sharp tightening in monetary policy – The “shock therapy” package would include a 200 bps hike in the Monetary Policy Rate (12%), Standing Lending Facility (14%) and Standing Deposit Facility (10%) rates (the latter is the natural floor for the 91-d T-bill yield), coupled with an increase in the Cash Reserve Requirement ratio on public and private sector funds to 100% and 15%, from 75% and 12%, respectively, but also a new wave of aggressive Open Market Operations to keep liquidity in check. This will push up T-bill yields to levels where foreign interest gradually resumes and contribute to greater USD/NGN stability, with the potential to slow or even end the decline in FX reserves. In a sense this is also a favourable time to act for the CBN, as the weakness and re-pricing in emerging market FX and rates seem to have eased in recent weeks, and even partially reversed, so a tightening in monetary conditions in Nigeria would bridge the value gap versus peers more effectively. If there is a neutral monetary policy outcome at the MPC, it is however likely that the market will react negatively, and the pressure on Nigerian assets will continue exacerbating upside risks to USD/NGN.
Risks from an adjustment of the FX band – There remains a risk that the CBN moves the mid-point (155) of the RDAS FX band slightly higher. However, the probability of such an announcement at next week’s MPC is extremely small, and in fact the CBN continues to publicly reiterate its commitment to exchange rate stability. Moreover, any shift in the actual RDAS rate (currently 155.7) would simply push up the interbank rate higher, with the pressure on the exchange rate likely to re-emerge at these new levels. Because oil accounts for 95% of total exports, a devaluation of the exchange rate would foster extremely limited external competitiveness or import substitution gains at the expense of higher imported inflation and a possible downturn in investment.
Better fiscal sustainability and transparency is needed – Nigeria continues to post a large current account surplus, but the authorities have been unable to accumulate any decent oil savings in recent years. The ECA balance fell to USD2.1bn in Jan 2014 before picking up slightly to USD3.5bn in March. Clearly the lack of NGN confidence is at least partially due to the loose federally consolidated fiscal stance and alleged oil revenue leakages. Remarkably, the Nigerian National Petroleum Corporation recently suggested that around 109m barrels of oil were stolen in 2013 (the equivalent of c.USD11bn).
How to play the market? Market rates have trended higher in recent weeks, especially at the short end, with the 364-d T-bill yield reaching 15.1% on 19 March. We feel that the T-bill curve will still need to re-price on the upside to compensate offshore investors for FX risk, and we will potentially consider re-entering the market with yields firmly in the high teens. We are less constructive on the long end despite the persistent single-digit inflation path (7.7% y/y in Feb), in particular as bonds have not sold off as aggressively as T-bills because of the constant bid from domestic pension funds. Should the short end push up further, we see bond yields rising, albeit more moderately, and still resulting in duration-related losses. The other medium-term investor concern is the possibility that bond issuance volumes in the primary market will increase closer to the 2015 elections.