By Samir Gadio, Emerging Market Strategist, Standard Bank Plc
MPC holds rates. The MPC left the MPR, SDF, SLF and the general CRR rates unchanged at 12%, 10%, 14% and 12%, respectively, at its 18/19 Nov meeting, in line with our expectations and market consensus. The CRR on public sector funds was also retained at 50%. Besides, the Committee held the banks’ FX net open position steady at 1% and maintained the liquidity ratio at 30%. Interestingly, the MPC voted nine to two to maintain the status quo.
Neutral policy rate outlook… We suspect the MPC is likely to maintain a neutral policy rate regime in the medium term given the prevailing macroeconomic and market environment and in the absence of any exogenous shocks. After all, there is limited incentive for the CBN to adjust a policy stance that appears to be working. Nevertheless, CBN Governor Lamido Sanusi also made it clear that the formal monetary tightening cycle was not necessarily over.
…amid more accommodative liquidity conditions. Yet the CBN has been less aggressive in its sterilisation efforts lately as evidenced by the sizeable NGN liquidity surpluses in the system. This seems to mirror the positive performance of the exchange rate, but also concerns about the liquidity position of some financial institutions should, for example, the CRR on public or private sector funds be increased. With further significant liquidity inflows expected from OMO and AMCON bond redemptions (unless the cash option is effectively eliminated as implied by the MPC communiqué and the AMCON notes are fully redeemed in the form of T-bills), the risk is that the NGN surpluses in the system will pick up qualitatively. In the absence of more aggressive new OMOs to mop up this liquidity, market yields may even compress and reduce the incentive to hold NGN assets. In this context, a move higher in the CRR on public sector funds and/or the general CRR at a later stage cannot be discounted as this would be the cheapest and most efficient way to squeeze excess liquidity (in fact, two MPC members voted for a hike in the CRR on public sector funds to 75% and 100%, respectively).
NGN remains resilient. The resilience of the NGN in recent weeks appears to have convinced the MPC that the current formal and effective monetary stance is appropriate for now. The CBN’s decision to reintroduce the RDAS and suspend the WDAS, impose a cap on the amount of USD sales by banks to the BDCs, as well as place further regulations surrounding FX cash importation by banks, contributed to the favourable NGN performance (USD/NGN stood at 159.0 on 19 Nov). Even though the MPC noted the wider spread between the official/interbank and parallel market (around 167) rates because of lower FX supply to the BDCs, it did not seem particularly concerned about this situation at present. Given the policy-determined nature of the exchange rate in Nigeria, the NGN has also suffered much less than emerging-market currencies from the volatility associated with shifting expectations of QE tapering in the US (this despite the heavy foreign positioning in the domestic fixed income and equity markets). In this regard, the likelihood that the FED will not start unwinding its QE programme before March 2014 should still support the NGN in coming months. Meanwhile, CBN Governor Lamido Sanusi reiterated at the Oct IMF/World Bank annual meetings in Washington that the currency would not be devalued as long as he remains in charge, as this would add little to external competitiveness in the oil exporting economy, but would weigh negatively on imported inflation, investment and foreign capital flows. With around USD45.3bn of FX reserves on 15 Nov, the CBN certainly has enough ammunition to address a temporary mismatch in USD demand-supply and defend the NGN for the time being. Yet the central bank realises that the accumulation of FX reserves until Q2:13 has been a product of large capital inflows between 2012 and early 2013 – rather than higher fiscal savings -, a situation which will only be manageable if the interest rate regime remains attractive enough.
Loose fiscal policy, a key concern. The MPC stressed the need to implement the Single Treasury Account reform to address existing inefficiencies in public sector cash flow management and constrain government borrowing, and also pointed to inherent fiscal risks ahead of the 2015 polls. Fiscal policy at the federally consolidated level is already quite expansionary, as illustrated by another leg down in the ECA balance to USD3.6bn in Nov (a mere 1.2%/GDP vs a fiscal savings median of 65%/GDP among major oil exporting countries), from USD5.1bn in July and USD9.0bn in Jan. This suggests that the actual fiscal breakeven point virtually exceeds the oil price itself and is much higher than the USD79 pbl oil price benchmark in the 2013 budget. It is true that crude oil output is down, but by about 8.3% y/y in Jan-Sep (1.9 mbpd in Sep on OPEC figures), while the average Bonny Light oil price has remained resilient (USD111.5 pbl YTD). As such, the magnitude of the decline in government revenue is unlikely to be only a product of oil theft. Although the current accounting methodology makes it difficult to derive the level of above-the-line expenditure and/or identify any potential leakages, we expect the overall fiscal position to deteriorate as the country moves closer to the 2015 polls. Even a relatively conservative initial draft of the 2014 budget (especially before it is revised upwards by the National Assembly) may prove counterintuitive. The consolidated fiscal slippage expected from next year will probably take the form of a further depletion of the ECA, an increase in bond issuance volumes from H2:14 and an accumulation of public sector arrears.
GDP growth recovers. On NBS figures, economic growth recovered to 6.8% in Q3:13, from 6.2% in Q2:13 and 6.6% in Q1:13, supported by positive base effects in agriculture and a better performance of the wholesale and retail trade, manufacturing and telecoms sectors. This probably reassured the MPC that a further deceleration in growth was less likely, but even in the opposite scenario it is questionable whether lower policy rates would foster economic activity or private sector credit (which expanded by only 10.4% y/y in Sep 2013) given the weak transmission mechanism in Nigeria.
Inflation remains subdued. Annual inflation has remained in firm single-digit territory in 2013 (7.8% y/y in Oct) underpinned by high base effects in Q1:13, but also benign, if not quasi-stationary m/m CPI figures in recent months. Should the lack of m/m CPI volatility persist in H1:14, it may well be that inflation stabilises with a 7-8% handle over that period, within the CBN’s new 6-9% inflation target range. That said, there are medium-term upside risks associated with pre-electoral spending – despite the weak money multiplier in the economy – which will push the MPC to maintain a cautious monetary stance going forward. Besides, a more sustainable single-digit inflation path in the long-run will be conditional on the rehabilitation of the power sector and meaningful infrastructure development.
How to play the market? Despite the yield compression experienced in recent weeks on the back of large liquidity surpluses (the 364-d tenor is currently trading around 12.7% in the secondary market), we continue to like the carry trade in Nigeria given the favourable exchange rate outlook for H1:14 and considering the degree of tradability of the debt and FX markets. It is also likely that an increasing number of investors concerned about the pre-electoral fiscal stance and the transition at the CBN post-June 2014 will want to play the short end rather than the long end of the yield curve. Interestingly, the 20 Nov T-bill auction will provide a good opportunity to lock in decent rates in the primary market (our bid guidance for the 182-d and 364-d tenors is in the 12.13%-12.24% and 13.03%-13.22% ranges). In theory, the positive liquidity environment, more supportive global risk picture and elevated real rates on offer should also support bonds. Yet a hypothetical drop in yields to sub-12% levels will probably push foreign investors to incrementally take profit and even local investors to lighten up their positions at the long end to avoid being caught in a sudden re-pricing of the curve, as has been the case in the past. As such, the yield downside potential for bonds appears to be limited after the recent rally.