SAT 18 SEPT, 2021-theGBJournal- The Monetary Policy Committee (MPC) voted to maintain the MPR at 11.5% alongside other key monetary policy parameters at its recently concluded meeting. Contrary to our expectation of divergence in voting pattern, we note that a unanimous decision was reached among the Committee members. Nonetheless, the outcome of the meeting is consistent with our expectation, given that the Committee remains confronted with achieving the competing goals of price and exchange rate stability and supporting economic recovery.
Consequently, the Committee also voted to retain the Cash Reserve Requirement (CRR) at 27.5%, liquidity ratio at 30.0% and asymmetric corridor around the MPR at +100bps/-700bps.
On domestic growth: The Committee noted significant improvement in economic growth in Q2-21 on account of the rebound in the Service sector and continued growth in the Agricultural sector. The Committee also highlighted the moderate improvement in the Purchasing Managers Indices (PMIs) in August even though they were still below the 50-points that separates growth from contraction. Nonetheless, the Committee expressed optimism that the Nigerian economy would continue to improve in the short to medium term given the (1) current level of monetary and fiscal stimulus and (2) efforts to increase vaccination and contain the pandemic. However, the Committee called on the Federal Government to step up efforts aimed at tackling security challenges so that it would not hamper business sentiments and derail the fragile recovery. Overall, the CBN forecasts the economy to grow by 2.86% y/y in 2021FY compared to our growth forecast of 2.68% y/y.
On Inflation: The Committee expressed delight at the continued moderation in the headline inflation for the fifth consecutive month to 17.01% y/y in August (July: +17.38% y/y) supported largely by the marginal decline in the food component from 21.03% y/y in July to 20.30% y/y in August. However, the Committee noted that the inflation rate remains well above the CBN’s corridor of 6.00% to 9.00%, indicating that the objective of price stability remains far off. Nonetheless, the Committee expressed optimism that increase in food production underpinned by the sustained intervention by the bank will help in moderating the headline inflation. Thus, the Committee urged the fiscal authorities to build on earlier efforts to articulate a clear strategy to attract private sector involvement while improving critical infrastructure to improve the ease of doing business. Barring no significant shock to prices, we expect the base effect from the prior year to continue to slow down inflationary pressure over the rest of the year. Overall, we project average inflation rate of 17.14% y/y in 2021FY (2020FY: 13.21% y/y).
On Foreign Exchange: The Committee did not mention anything specific about the exchange rate situation at the parallel market. However, the CBN Governor stated explicitly that the apex bank does not recognise any other rate in the FX market apart from what is obtainable in the Investors and Exporters Window (IEW). Meanwhile, the Committee urged the CBN to continue to restructure the FX market and pursue all current policies targeted at sanitising the market to (1) improve transparency and proper functioning of the market and (2) eliminate illegal FX dealers in the country. For us, we see scope for improved liquidity at the IEW over the medium term given (1) Eurobond issuance, (2) IMF SDR allocation and (3) improved FPI sentiments on account of the country’s increasing FX reserves. The accretion in FX reserves should also improve the ability of the CBN to increase supply to the commercial banks over the short to medium term.
The decision of the Committee to maintain the status quo on monetary policy parameters is consistent with our view. Though the Committee has left rates unchanged at this meeting, the apex bank has moved gradually to the tightening phase with its balance sheet management. Our view is substantiated by the low level of liquidity in the interbank market, a development that has kept the overnight lending rate elevated since January (average of 12.5% YTD as of 17th September vs 8.3% YTD in September 2020). We believe the CBN will continue to use CRR debits, OMO auctions and its special bills to monitor system liquidity and nullify the indirect and direct channels through which system liquidity amplifies inflationary pressures. Furthermore, we expect the apex bank to continue direct intervention in the growth-stimulating sector sectors to support its pro-growth objective. In addition, we think the CBN will continue to prioritise allocating FX to legitimate needs to ease liquidity constraints in the economy.
Despite growing talks among global central bankers regarding trimming their asset purchase programme alongside upside risks to domestic inflationary pressures, we do not think the Committee will tweak any of the monetary policy parameters at its December meeting. Our view is premised on the fact that global systemically important banks have ensured inflation expectations are well anchored to prevent high volatility and rising bond rates, unlike the case in 2013 during the famous episode of the taper tantrum. In addition, we think uncertainty regarding the evolution of the pandemic will cause the U.S Fed to proceed cautiously with winding down its asset purchases. Finally, we believe concerns about stagflation will compel the MPC to push back hiking rates until H1-22, when the Committee may feel that substantial progress has been made in supporting economic recovery.
Market Impact
Fixed Income: Since the last MPC meeting held in July, bullish sentiments have dominated the market. Specifically, the average yield declined by 164bps to 5.9% in the treasury bills market, following the significantly lower supply of bills at the OMO segment and lower stop rates at NTB primary market auctions. Similarly, in the bonds market, the average yield contracted by 74bps to 11.3% due to (1) large investors such as PFAs returning to the market after yields on competing money market instruments moderated and (2) investors cherry-picking attractive instruments across the benchmark curve, particularly the long end.
In the treasury bills market, we envisage lower average yields as the DMO winds down its domestic borrowing plans, including the supplementary budget for the year, and reduces its supply (net issuances this month: NGN71.34 billion vs August: NGN254.97 billion). Although the recent increase in the stop rate of the 1-year bill (+40bps to 7.2%) at the NTB primary market auction triggered sell pressures in the secondary market, we believe that the bill is currently trading at a resistance level (c.8.0%) and do not envisage further expansion. At the longer end of the yield curve, the bonds market is also expected to trade with bullish sentiments following the anticipated lower supply of debt instruments given the approved Eurobond issuance of USD3.00-6.12 billion expected in October. In addition, we believe deliberate efforts by the DMO to reduce borrowing costs for the government will keep yields at sub 14.0% levels.
Equities: Despite the broadly decent earnings delivered by companies during the H1-21 earnings season, it has failed to inspire strong buying interest from equity investors. Since the last MPC meeting in July, the ASI has recorded a meagre gain of 0.3% as of 16th September. In our view, the outcome of the MPC meeting has already been priced. Hence, we expect a neutral reaction from market participants. However, we still see scope for the market to deliver positive returns in Q4-21, given (1) our expectation that yields will trend southwards, (2) investors positioning in dividend-paying stocks ahead of 2021FY dividend declarations in Q1-22 and (3) increased activities from FPIs supported by improved liquidity conditions in the IEW.-Analysis is Provided by Cordros Research
Twitter-@theGBJournal|Facebook-The Government and Business Journal|email: govandbusinessj@gmail.com
