MON, JAN 27 2020-theG&BJournal– ‘’In a period where growth concerns seem to be on the front burner, we had expected that the outcome of the latest MPC meeting, vis-à-vis policy direction, would have been expansionary. This is despite the renewed inflationary pressure,’’ says Cordros Securities in their latest assessment of the last week’s Central Bank of Nigeria’s (CBN) rates decision.
The MPC sprang a hawkish surprise on the market, as 9 out of the 11 members of the committee elected to adjust the Cash Reserve Ratio (CRR) upwards by 500bps to 27.5% – a move last witnessed in March 2016. Meanwhile, the committee kept all other policy parameters constant – MPR at 13.5%; asymmetric corridor around the MPR at +200bps/-500bps; liquidity ratio at 30.0%.
In justifying its actions, the monetary policy authority argued that the primary reason for the CRR hike was to curb possible inflationary pressures that may arise from expected excess liquidity in the near term.
‘’While we understand that an upward adjustment in the CRR will, in fact, help rein in on excess liquidity, its negative impact on banks’ ability to lend to the real sector appears counter-intuitive in our view. Theoretically, there is a trade-off between economic growth and inflation protection,’’ Cordros said.
‘’Nigeria’s monetary authority would have to consider building on either the mandate of growth stimulus or price stability. Trying to eat its cake and equally have it sent an ambiguous policy signal to the investing community, the impact of which could drive continued aversion towards naira assets.’’
How Justified is theHawkish Turn?
After stating clearly that the primary driver of recent inflationary pressures is a structural one that requires fiscal rather than monetary intervention, we fail to see how a CRR hike will reduce the “price of rice” in the market.
According to Cordros, the 500bps hike in the CRR will sterilize between NGN1.00 to NGN1.50 trillion in liquidity from the system, further raising questions about the seriousness of the apex bank’s policy actions towards driving credit extension to the private sector.
‘’In our view, had the MPR made it clear that raising the CRR was to waylay speculative pressure on the currency, then that would’ve been understandable. This is because, the steady decline in the foreign reserves over the last few months, together with an elevated OMO and Treasury bills maturity profile, which could potentially speculate on an already pressured naira, is a stronger case for the policy action taken, and we believe that this ultimately contributed to the short-term policy shift. More so, given the fiscal reservations about the harmful short-run effects of a naira devaluation on the country’s populace.’’
Cordros also sees little benefits to the CRR hike. They believe that the CBN’s credit growth mandate will now take a backseat until the end of the elevated maturity cycle, after which the MPC will be forced to make a U-turn towards the previous dovish stance in our opinion.
The Market Implications Far More Reaching
‘’The clear shift in policy direction, and our instinct that the new course will likely be short term, has obvious implications for the market. With the scale and magnitude of changes, we suspect that it will take some time for the investing community to fully digest.’’
Currency: As stated earlier, the CBN’s pre-emptive actions towards potential exchange rate pressures should have a positive impact on reducing concerns about the potential of speculative pressure during this time.
‘’Thus, we maintain our view that the naira will remain largely range-bound.’’
Banks: The increase of the CRR has significant implications for banks in 2020, given that the sterilized funds attract no interest, which should exert downward pressure on income from interest-earning assets.
From our assessment, gross earnings growth will be pressured by 6.5% on a base case, which implies that without growing asset bases, banks would generate 6.5% less income from earnings assets. Given this, there will be a need to significantly grow their asset bases to generate more income in 2020.
Also, in the time since the minimum loans-to-deposits ratio floor was introduced, increased competition has resulted in compression in yields on assets from loans as banks have had to reprice loans to attract clients.
Cordros said they now expect additional pressure from the increase in the non-interest yielding portion of capital.
‘’This should immediately impact net interest margins as the adjustment to the cost of funding will take a relatively long period as banks aggressively re-price deposits to maintain margins.’’
As noted earlier, the increased CRR is counter-intuitive to the CBN’s LDR policy, in that there should be less capital available to be channeled towards risk asset creation. While the LDR measures loans to deposits, regardless of CRR, the fact that there is also a minimum liquidity ratio (30.0%) means that the available capital to maintain an LDR of 65.0% would be less than required.
Capital markets: Prior to now, we had posited that the sharp decline in fixed income yields, together with the elevated maturity profile over H1-2020, presented an exceptional case for an equities market rally.
Our prognosis has played out quite well with the All-Share Index up 10.4% YTD (24 January 2020), as domestic investors have accumulated risky assets in the face of the single-digit interest rate environment. That said, the liquidity sterilization we foresee now places a ceiling on the potential upside for the equities market in our opinion.
To add, the unimpressive macroeconomic milieu and lack of market-friendly reforms will continue to ensure offshore investors keep naira risk assets at arm’s length. Thus, our long-term view on equities isn’t as rosy compared to the start of the year. For the fixed income market, we expect a transitory effect on yields in the market, as investors reassess the market in the face of an impending liquidity squeeze.
This should impact the short-term performance of the equities market, as some investors may stay out of the market and take short-term positions in the fixed income market with the expectation that the interest rate environment would correct over the short term.
‘’We, however, maintain our view regarding the trajectory of yields for 2020. While the liquidity expected to be channeled towards assets is measurably smaller, we are of the opinion that it remains substantial enough to pressure yields downwards. Add to that consistent inflows from new funds (private and corporate), we still expect yields to come under pressure in the year, provided the CBN doesn’t reverse its segmentation of the OMO market.’’
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