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Emerging realities support CBN’s stance on MPR – Analysts

By on September 29, 2014

Last week, financial analysts who x-rayed the outcome of the last Monetary Policy Committee meeting, argued, that the desire of the Nigerian business community for more accommodating interest rate policy may wait until all the inherent risks in the financial system are fully addressed as they endorsed the retention of a high monetary policy rate, reports Festus Akanbi

One week after the last meeting of the Monetary Policy Committee of the Central Bank of Nigeria (CBN), the decision to leave the benchmark interest rate unchanged at a record high has continued to generate reactions from economic affairs commentators in the face of rising risks to the economy.
After exhaustive deliberations, the committee decided to retain the Monetary Policy Rate (MPR) at 12 per cent with a corridor of +/-200 basis points around the midpoint;
It retained the public sector cash reserve requirement at 75.0 per cent; and retained the private sector Cash Reserve Requirement at 15.0 per cent.
Financial analysts said the decision of the committee to maintain the status quo in spite of protests by the real sector operators, whose access to credit facility are being blocked by the regime of high interest rates, came as a shock.
Also disappointed were Nigerian fund users who were expecting the CBN Governor, Godwin Emefiele, to begin the implementation of his planned reduction of interest rates.
Unfortunately, however, the rising liquidity situation in the financial system has compelled the apex bank to maintain high monetary policy.

The Risks
Analysts believed that as the system is awash with liquidity, banks are not disposed to lending to critical sectors of the economy, a development that makes such liquidity toxic to the economy. Emefiele also confirmed this, saying over N300 billion is lying idle in banks. The challenge is made complicated by the tendency of banks to avail themselves of the opportunity in Standing Deposit Facility of the CBN, which affords them the opportunity of keeping their excess funds with the apex bank at 10 per cent interest rate.
The CBN is also worried that the expected release of N868 billion Asset Management Corporation of Nigeria (AMCON) funds in October is bound to worsen the liquidity crisis.
If these fears are not serious enough, the anticipated ending of Quantitative Easing by the Federal Reserve Bank of the United States of America in October is bound to trigger off capital flight in view of the normalisation of investment climate in the US.
The CBN also refused to lower the rates because of the sustained rise in inflation which was put at 8.5 per cent in August. For a country that targets single-digit inflation for 2014, it was believed lowering interest rates at this period could be counterproductive especially at a period when the nation is still grappling with the debilitating effects of the on-going war against terror.
Analysts were also mindful of the political situation and the fact that political victory in the country is often determined by the sheer size of war chests by the political office seekers.
However, one factor that raised a glimmer of hope in the readiness of the CBN to respond in case the risks get worsened was the pattern of voting at the last MPC meeting.
Five MPC members voted to increase the cash reserve ratio on private-sector funds from 15 per cent, while one wanted to increase the public-sector rate from 75 per cent. The MPC concluded by agreeing to retain both rates.

Weaker Oil Earning
In terms of pricing and output, proceeds from oil have been moderated in view of fall in prices of the nation’s oil grade, Bonny Light, which sold for $97.3 per barrel last week. However, on concerns over the downward trend in oil prices and the unabated fall in production, Managing Director, Head – Africa Macro Global Research, Razia Khan, explained that the scenario of a downward trend in oil prices at the international market coupled with unabated decline in crude oil production makes Nigeria susceptible to fiscal risk.
“The risk is even more eminent given the current oil prices at about $97.3per barrel compared to the 2014 budget benchmark of $77.5pb. This clearly signifies potential fiscal risk should the declining trend persist. The fiscal threat is even made more pronounced by virtue of the declining oil production to 1.89million barrel per day, a short-fall of about 0.32million barrel per day from the budget assumption of 2.3million barrels per day. That said, all these put shrinkage in government revenue from oil. This was reflected in Statutory Allocations to the three tiers of government which declined from N654.58billion shared in July to N611.76 billion for the month of August.

Excess Crude Account
“I also think the low level of savings in the Excess Crude Account as a buffer to cushion the effect of external shock is also susceptible should the declining trend in oil price and production persist. So, there is need for fiscal consolidation and sound economic management to insulate the domestic economy from this threat.”
However, Head, Research and Intelligence, BGL, Mr. Olufemi Ademola, in his analysis of the emerging scenario, said there was no cause for alarm as far as the situation in the oil sector is concerned.
According to him, “The oil prices are currently at an average of $95 per barrel which is still higher than the $75 budget price. In addition, our oil production is believed to have stabilised above 2 million barrels per day. The continued conflicts in the Middle East should also help oil prices and prevent it from a drastic fall. These conditions do not appear to put the country in any immediate risk and according to the MPC, the external reserves of $40.7 billion as at September 17, 2014 can cover about seven months of imports; hence there is no serious cause for an alarm at the moment.”
Commenting on Nigeria’s reliance on oil import, Head, Research & Investment Advisory at Sterling Capital, Mr. Sewa Wusu, said: “Given Nigeria’s reliance on oil as an export earner, it is vulnerable to any sustained downtrend in either price or production volumes. Although FX reserves of just less than USD 40bn provide some buffer, should oil prices drift closer to USD 90/bbl then the flow of new inflows into Nigeria is likely to slow.  Some investors may choose to exit at that point, so the pressure on the FX rate under such a scenario would be even more significant.  To safeguard stability, Nigeria might do well to adopt a crawling peg early on.  This would allow it to adjust the FX rate to pressures in oil earnings, but in a more predictable, controlled manner that is not subject to overshooting.”

Interest Rate
Ademola argued that the hawkish posture of the MPC members appears to directly contradict the desire of the CBN to lower interest rates. Low interest rate, he said, is expected to lead to increased liquidity that could be channeled into productive use.
He said: “If at the moment, the increased banking liquidity is not been put to that use, then it appears that the planned pro-growth ideal of the CBN is not been met. “However, a combination of lower interest rate and increased tightening at the operational levels via increased OMO and Treasury operation among others may help to achieve the pro-growth objective. A low interest rate may lower yield on fixed income investment; making it unattractive to banks who may now seek higher yield from loans creation while targeted regulatory mop-up of excess liquidity not invested in risk assets could also support in achieving the same objective,” he said.
On her part, Khan said: “The hawkish position cannot be linked to the CBN desire to lower interest rate in the immediate term. This is not plausible for now because the current monetary environment does not support lowering interest rate, given the concern over the current and anticipated increase in banking system liquidity owing to 2015 election spending and its potential effects on inflation and the naira exchange rate.”

Price Stability
Khan added: “The CBN will have to balance both the external and domestic factors to achieve its goal of price and exchange rate stability. There is the threat of capital reversals emanating from the US Fed’s Quantitative Easing by October which may potentially cause a run on naira denominated assets.
To protect the economy against this external shock, the CBN will have to adopt a hawkish position. I see a likely hawkish posture coming by November at the last MPC meeting for the year to sterilise excess liquidity.”
In his estimation, Wusu, the Sterling Capital official, said the MPC in its present form is certainly a mixed committee.  He said: “We shouldn’t be too surprised. Reading through previous MPC statements, Dr Sarah Alade, Dr Kingsley Moghalu, Dr Doyin Salami and other members had expressed concern over price stability. Ahead of the AMCON maturities in October, we think they would have been considering the potential impact on market liquidity. We would not be surprised if they – as well as two other members of the MPC – advocated a rise in the private sector CRR.  This might be the most sensible response to further liquidity pressure, as it does not cost as much as OMOs, but it deals with the issue in a more effective way than – say – a hike in the monetary policy rate might be able to do.”
He added that the willingness of five MPC members to raise the private sector CRR further will also provide some reassurance to investors who have exposure to Nigeria, saying “They might consider their FX-adjusted returns to be ‘safer’ if there are MPC members who indicate that they will favour tightening if the NGN comes under pressure.”
Wusu said the anticipated hawkish MPC position will be naira positive. “It will curtail excess liquidity in the system and reduce speculative attack on the domestic currency. You can see from the hindsight that past hawkish moves have created stability in the currency. The MPC alluded to this fact in their last Committee meeting.”

Who Stands to Benefit
And on who stands to benefit from the present monetary policy, the Standard Chartered Bank chief said “If policy is tight, or has a credible tightening bias, all of Nigeria benefits as inflation should be kept relatively stable. As inflation is a regressive tax, it is the poor who will benefit the most when policy is tightened to keep inflation low and prices stable.
‘If on the other hand – let’s say for the sake of argument – policy is loosened prematurely – interest rates are cut in order to stimulate lending, and faster inflation becomes more of a risk.  Under such a scenario, it is those who have access to credit (typically the wealthy) who will benefit more than the poor.  Eventually though, with higher inflation, everyone loses – but the welfare of the poor will be most impacted.
“Those who advocate easier monetary policy might claim that more lending to the private sector as a result of lower interest rates will boost employment, therefore growth and welfare too.  Unfortunately, this is not yet grounded in empirical experience.
There are still a number of reasons why lending to the real sector may not happen even in a low interest rate environment.  The employment gains may be elusive too, if those sectors are not labour-intensive.
So it is not a good enough reason to give up price stability – which involves a more certain welfare loss to all Nigerians.”

Robust Debate
She said the fact that at least five members were ready to tighten further will still lend some support to the naira – even if the CBN has not yet tightened the policy.
Khan explained that in the long-run, the best safeguard of a low-interest rate environment, in which much more private sector lending can take place, is the credible achievement of low inflation. In order to get to this point, she said policy will need to be hawkish whenever stresses are seen to increase.
She warned that the loss of that anti-inflation credibility will raise the robustness demanded by investors, and so ultimately raise borrowing costs as well.  This is why policy credibility should never be sacrificed for what looks like a quick win, concluding that the CBN would do well to lower interest rates only when conditions actually allow for it.  Arguably, that time is not now.
On who stands to benefit from the present position of the MPC, Ademola said, “Since there are no changes to the policy decisions, the situation remains the same. The banks, institutional and foreign portfolio investors continue to benefit without significant risks.
The high liquidity in the banking system means large resources for investment while the high interest environment provides them with low risk assets to invest in attractive yields. Institutional and portfolio investors also benefit from the high yield on fixed income instruments. Although the equity market should also benefit from the high liquidity, the higher required return to compensate for the higher risk limits its benefits.”
He said the decision leaves everything unchanged hence not significant impact will be felt on the naira exchange in the immediate term. However, as noted by the committee, the continued insurgency in North-eastern Nigeria is leading to the switch to imported goods to fill the gap in domestic food demand and could affect foreign reserves negatively and ultimately, the value of naira. The planned ending of QE by the US in October could also lead to capital reversal and pressure on the naira exchange.

 

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