From the start of 2016, the macroeconomic policy environment has been plagued with uncertainty, disconnect between policy objectives and real variables as well as worrying economic data. This week, the economy got a healthy dose of reprieve in both monetary and fiscal sides of policy management as the belated passage of the keenly contested 2016 budget by the National Assembly finally occurred while there are good indications that monetary policy is being realigned to focus on its key policy goals, albeit slowly.
The week started with the National Economic Council (NEC) retreat where the Presidency, in anticipation of the passage of the 2016 Budget, communicated its plans for infrastructure development and sought the cooperation of sub-nationals in implementing these plans. At the conclusion of the 2nd CBN Monetary Policy Committee (MPC) meeting for the year on Tuesday, the Committee reversed from monetary policy easing to tightening, changing its policy language and target variables. Lastly, the week rounded up with the passage of the 2016 budget by the National Assembly after 2 postponements.
On the MPC meeting, the members admitted that the pressures in the domestic economy – as reflected in the sharp jump in inflation rate to 11.4%, rising unemployment rate (10.4%) and slowing GDP growth (2.8%) – are largely driven by structural weakness in the system and not liquidity overhang which is yet to have a pass-through on monetary aggregates. Surprisingly, the committee retreated from an overwhelming dovish stance communicated in past statements to a hawkish stance by taking the following decisions:
1. Increased the Monetary Policy Rate (MPR) upwards by 100bps from 11.0% to 12.0%
2. Narrowed the asymmetric corridor around the MPR from +200/-700bps to +200/-500bps
3. Increased Cash Reserve Ratio (CRR) from 20.0% to 22.5%
4. And, kept the Liquidity Ratio (LR) unchanged at 30.0%.
The decision of the MPC to tighten monetary policy was against a run of play as it came against broad analysts’ consensus of a hold on all policy rates. Afrinvest Research had projected a 100bps increase in MPR to 12.0% in our 2016 Outlook but we were particularly surprised that the MPC took the tightening course this early; especially given that: 1) the pressure on consumer prices, as admitted by the Committee, is as a result of structural and cost push factors which we believe could worsen if cost of funds go up with policy tightening and FX shortages are not addressed 2) the suggestion that increase in banking system liquidity is fundamentally driving the pressure on exchange rate is not also subject to fact as we have continued to see high subscription at CBN interbank auctions despite intermittent OMO mop-ups conducted and 3) exchange rate certainty has as much impact on foreign capital inflows as interest rate competitiveness and the current tightening is too mild to compensate for the high exchange rate risk.
Our intuitions from the MPC’s decisions are:
- that the tightening move is more of a precaution (than a correction of previous price spiral) to moderate the demand pressure for FX, goods and services that could arise from the liquidity impulse of the record expansionary budget. The 2016 fiscal year is expected to run on N6.06tn budget while deficit was retained at N2.2tn – 2.1% of GDP.
- it could be a signal that monetary policy, which had hitherto been the only game in town, will return to its conventional objectives of price and exchange rate stability while fiscal policy escapes from its tardiness to anchor the recovery. This could mean a return to inflation targeting.
If we assume price and exchange rate stability will become preeminent in future MPC deliberations, this would imply future tightening (more likely via OMO mop-ups) and possible move on the Naira to boost supply, hence we do not expect a reversal in this tightening stance in the medium term. We retain our forecast of a 2.0 – 2.5% upward adjustments in the yield curve, 3.5% GDP growth estimate and 15.0% to 20.0% devaluation of the Naira by FY:2016.
We have already seen a 19bps WTD increase in average yields while Cost of Funds (CoF) may likely rise for Tier-2 banks as interbank market adjusts to the tightening of liquidity. However, assets repricing of fixed income securities and other risk assets, would likely compensate for this. We retain our estimates on Net Interest Margins for our coverage banks as we monitor the pace of assets reprising. However, as the policy environment stabilizes and budget implementation gains traction, all ducks are being lined in a row to lift investors’ confidence; boosting the medium term prospect of a rebound in economic activities.