Tightening in effective monetary conditions
MPR unchanged. The MPC left the MPR, SDF and SLF rates unchanged at 12%, 10% and 14%, respectively, at its 22/23 July meeting, in line with our expectations and market consensus. Although the risks to the MPR had moderately shifted to the upside given the persistent pressure on the NGN since May, a hike in the policy rate was not our core scenario, especially after inflation reached a multi-year low of 8.4% y/y in June. Interestingly, the MPC voted nine to one to keep the MPR on hold. Additionally, the CRR for private sector funds was unanimously retained at 12%.
50% CRR on public sector funds. The key issue at this MPC was whether liquidity would be tightened via the CRR and/or other administrative measures. This is because the CBN was concerned about the build-up in excess liquidity in the financial system and a vicious cycle where banks sourced large amounts of public sector funds and subsequently lent them to the government by purchasing T-bills and OMOs. Such risks have now materialised, with the introduction of a 50% CRR on public sector funds. Clearly, this is a sharp tightening in effective monetary conditions that aims to squeeze liquidity. Public sector funds in the banking system were close to NGN2.5tr in Q1:13, of which an extra 38% (NGN950bn) will be provided to the CBN as CRR proceeds. In contrast, today’s liquidity balance in the system was NGN360bn, which means that the market will be in repo mode tomorrow.
USD/NGN, still the key consideration. Despite a persistent rumour suggesting that the midpoint of the WDAS USD/NGN range (+-3% around 155) could be shifted to 160, the MPC stressed the commitment of the CBN to defend the exchange rate in a context characterised by less favourable external market conditions and a drop in revenue. As we had anticipated, it was unlikely that the central bank would depart from its FX stability stance and adjust the USD/NGN band. Doing so would have just pushed up interbank USD/NGN to the upper end of the new FX band from where the upward pressure on the unit would have resumed in the absence of meaningful capital inflows. The MPC also indicated that the NGN weakness was not unique in the sense that most emerging markets face the same dynamics amid the uncertainty surrounding the pace of QE in the US. While USD/NGN has consistently traded above 160 lately, the foreign selling of Nigerian assets has dissipated and a further move up in the exchange rate looks unlikely. Besides, the CBN has stepped up its WDAS FX sales and continued direct FX sales to the banks to support the NGN, even at the expense of FX reserves which fell slightly to USD46.9bn (shy of 11 months of import cover) on 22 July. Overall, we suspect the squeeze in public sector liquidity should impact positively the NGN by reducing USD demand domestically and making the carry trade more attractive.
Oil production slides. Even though GDP growth is estimated at 6.7% y/y in Q2:13 on preliminary NBS estimates, oil growth remained in negative territory over the period (-0.7%). The latter reflects continued oil theft and limited new investment in the sector in recent years, and a tangible drop in output in H1:13 (1.86 mbpd in June). Perhaps the good news in our view is that the Bonny Light oil price seems to have firmed up (USD110.0 pbl on 23 July), but the MPC sounded more bearish, citing the discovery of shale oil and an uncertain global commodity environment as downside risks.
Fiscal laxity is a concern. Nigeria’s federally consolidated fiscal position is still largely expansionary, as illustrated by the marginal balance of the Excess Crude Account (only USD5.3bn in May 2013) and the absence of a credible codified framework to accumulate oil savings. As such, Nigeria will remain vulnerable to long-run oil boom and bust cycles. Additionally, we think the risk remains that a new leg of fiscal expansion will materialise ahead of the 2015 elections. The MPC highlighted that the fragile fiscal position and decline in government revenue are key stress points, with the potential to threaten macroeconomic stability.
Inflation remains under control. The MPC estimated that the CPI outlook was benign and that inflation would stabilise in single digits in H2:13. Perhaps some risks come from fiscal laxity, excess structural liquidity pre-MPC and any further potential pressure on the currency. Our CPI forecast is also broadly dovish given the low m/m prints recorded lately, but in-house projections suggest that inflation will temporarily reach low double digits in Aug (10.6% y/y) and Sep (10.3% y/y), before reverting to sub-9% levels in Q4:13.
Market implications. The tightening in liquidity conditions will most likely lead the short end of the yield curve to shift up in the immediate future and result in a repricing of the long end, but will probably weigh positively on the NGN. While the magnitude of domestic selling of T-bills may be somewhat contained by the banks’ access to the CBN repo window, an initial spike in short dated yields should generate attractive entry points at tomorrow’s 3-m, 6-m and 12-m auction, making the NGN carry trade even more appealing. It also implies that investors will be able to source bonds at higher yields in coming days after a preliminary sell-off. More importantly, we expect NIBOR rates to surge in the aftermath of the MPC meeting and the related squeeze in liquidity.