Pre-MPC Note: Blunted Policy Tools Call for Rollback of Administrative Measures

Next week Monday and Tuesday (21st and 22nd November), the Monetary Policy Committee (MPC) of the CBN will be holding its 6th and last meeting in 2017 to review major developments in the global and domestic space in order to make vital policy decisions. Since the last MPC meeting held in September, the global risk landscape and policy outlook have changed dramatically, underlined by the emergence of Donald Trump as the President-elect of the United States and the resultant shockwave in the global bonds market, risk-on appetite in the US and underperformance of Emerging Markets assets.

Global fund managers have interpreted Trump’s victory to imply a domestic pro-growth and expansionary fiscal policy agenda in the US and high probability of lower trade relations with Emerging Markets. With these, investors are overweighting US equities (with the S&P index reaching new all-time high), repricing bond yields higher while underweighting Emerging Markets assets - currencies, bonds and equities. In its December-2016 meeting, the US Fed is expected to hike rate to counteract prospect of an expansionary fiscal policy which has raised inflation expectation and also to protect its credibility – having foreguided on the possibility of rate hike in 2016. The impacts of these macroeconomic policy adjustments in the US and uncertainty regarding trade policies could have a definitive impact on global funds flow in subsequent months, putting emerging and developing countries at the risk of further flow reversals and currency volatility.

Yet, domestic macroeconomic challenges – negative growth, constraining fiscal space, high inflation and FX illiquidity – that remain the major downside risk to Nigeria’s medium term economic performance will dominate MPC deliberations. Key macroeconomic indicators have continued to show the sub-optimal performance of the economy and financial markets. Persistent rise in prices ensured inflation continued to gallop within the period as October Headline Inflation rose 48bps from 17.9% in September to 18.3% on the back of structural supply side factors. While the moderation in M-o-M inflation below 1.0% in the past two months is comforting and logically implies significantly lower Y-o-Y Headline Inflation in 2017 due to high base factor, inflation expectation implied from yield pricing remains high due to FX market illiquidity and likelihood of increase in power and fuel prices. Q3:2016 GDP data (anticipated to be released next week) is also expected to show that the economy remains in a recession, with high probability of a steeper contraction (Afrinvest estimates 2.3% contraction) due to weaker oil production volumes and downtrend in the services sector.

Capital market performance has also remained abysmal since the last MPC meeting as investor appetite remains weak, with the equities market declining 9.3% in the period whilst activities in the bonds market stayed soft. Notwithstanding the aggressive tightening by the CBN and the attractive yield environment, the return of foreign capital has not been as swift as anticipated as the lingering currency risk continues to weigh on foreign investor sentiment despite the attractive market valuation of financial securities and real assets. Latest capital importation report released by the NBS showed that total capital imported in Q3:2016 rose 74.8% Q-o-Q to US$1.8bn but significantly lagged medium term trend, falling 33.7% below US$2.7bn in Q3:2015 and 72.1% weaker than US$6.5bn in Q3:2014.

Yet, majority of the current challenges stem from the glitches in the operations of the FX market – which is mostly administrative since the MPC had sanctioned a move to a flexible regime at the May 2016 meeting. We believe the operations of the FX market will be on the forefront of discussions at the MPC meeting as failure to manage the protracted currency crisis will lead to:

  • Further divergence between the interbank and parallel market rates,
  • A hike in the pump price of PMS and
  • Further pressure on general price levels which will ultimately defeat the monetary policy objective of price stability.

Afrinvest Research believes that the committee will likely hold all rates constant whilst reinstating the need for the CBN’s hierarchy to properly implement the currency market reforms in order to regain waning credibility.

We expect that the committee will maintain status quo as monetary policy has already reached its limit in stimulating investor confidence whilst focus has shifted to administrative measures preventing a fully functional FX market. A higher rate environment would neither spur private capital inflow nor would a lower rate policy incentivize banks to increase their risk appetite in the credit market. The investment dilemma to foreign investors remains the current attractive yields in the market and the overhanging currency risks which might serve as a bottleneck in the repatriation of funds. We believe that the FX market needs to be “truly liberalized” not only in its operations but also in the demand and supply dynamics by rolling back capital control polices and reinstating transparent 2-way quoting system for FX.