Domestic Monetary Policy: Where to from Here?

The Monetary Policy Committee (MPC) held its first meeting for the year on the 25th and 26th of January, 2016 where it reviewed the economic and financial market conditions in 2015 as well as the outlook for 2016. The meeting was held against the backdrop of a challenging global economic situation -- underscored by the heightened geopolitical tensions, China's growth concerns and persistently declining oil prices -- which resulted in a volatile open to the year across all financial markets and also dimmed global growth prospect with the IMF trimming its 2016 global growth forecasts by 200bps to 3.4%.

On the domestic front, the dovish stance adopted by the MPC since the 3rd Quarter of 2015 in a bid to spur credit to the real sector is having a slow pass-through to the credit market due to the prevailing macroeconomic headwinds which have deterred banks from lending. Credit to the Private sector contracted 0.9% in H2:2015 (to N18.7tn) and grew only 3.3% Y-o-Y in December 2015 relative to 11.9% Y-o-Y growth in December 2014. Similarly, falling oil prices which translate to reduced foreign exchange earnings as well as lower revenues for the government have stressed the Balance of Payment (BoP) position of the country as well as the assumptions under which the 2016 budget was drawn up. The pressures in the forex market have persisted into the New Year as the spread between the official (N197.00/US$1.00) and the parallel market rate (N304.00/US$1.00) has further widened. The resolve of the CBN to maintain the contrived stability in the FX market by placing restrictions on imports, freezing liquidity in the interbank market and easing domestic condition to stimulate output growth have not generated much result as Nigeria's trade balance was negative in all but one month in 2015 (aggregate trade deficit was US$5.6bn in 2015 from a surplus of US$15.6bn in 2014). Non-oil capital inflows have also dropped due to the high macroeconomic risks, thus external reserves has continued on a downward trajectory (declining 2.6% YTD to a 10-year low of US$28.2bn). Consumer prices have felt the pass-through of the lower exchange rate with inflation rate (9.6% in December) above the CBN's allowable band of 6.0-9.0%.

The rout in crude oil prices at the start of the year after sanctions on Iran were lifted indicated the need for more domestic policy adjustments to restore confidence and stabilize macroeconomic condition. This informed our expectation that the last MPC meeting would be centred on the current forex challenges as all the other monetary policy tools seem to have been implemented to full effect. The Committee however decided not to alter any of the policy variables suggesting more policy harmonization with fiscal authority and the Bank's desire to fine-tune its foreign exchange management framework to buoy liquidity in the market.

This could mean the Apex Bank is considering a more flexible exchange rate mechanism but it remains yet to be seen how that would be implemented without giving up on the Naira/Dollar peg as statements emanating from the Presidency this week further suggest that the authorities are not favourably disposed to an official weaker currency. Regardless, we believe we are already at the end of the monetary easing cycle, while the realities of funding the budget deficit and stimulating private capital inflows (as short to medium term outlook for oil remains bearish) could lead to a more conventional management of monetary policy in the medium term once the impact of the current monetary stance starts to fully reflect in aggregate macroeconomic variables.

The resumption of Open Market Operation (OMO) since the last dovish move of the CBN in November which has resulted in mop-up of N523.8bn between December 2015 and January 2016 - indicating a subtle and gradual shift in policy direction - further justify our expectation of a more conventional tightening before Q3:2016. Whilst in the short term we expect the administrative measures in the forex market to remain, the financial market (particularly equities) would remain pressured as unfriendly monetary policy around forex continues to keep FPIs locked out, driving negative sentiments on the market.

Afrinvest Research

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