Pre-MPC Note: Maintaining Status Quo to Consolidate Recent Economic Gains

The Monetary Policy Committee (MPC) will be having its second meeting for the year next week (20th - 21st March, 2017) to review major global and domestic economic developments since its last meeting. This meeting will be coming on the back of a continuous decline in the nation’s domestic output, Inflationary pressures, weak earning scorecards and FX market challenges, though some improvements seem to have been recorded in fiscal policy and foreign exchange administration.

On the Global front, the US Fed raised its benchmark interest rate by 25bps (benchmark rate now at 0.75%-1.00%) while investors anticipate the possibility of at least two more further rate hikes before the end of the year. This has far reaching implications for frontier and emerging markets with volatile currency as the decision will likely strengthen the greenback with global fund managers rush for safer investments; resulting in funds outflow. Although we do not expect this to have significant impact on Nigerian markets given the paucity of foreign capital in the economy post the delisting of Nigeria from JP Morgan and Barclay’s Emerging Market Bond indices.

In the domestic economy, the National Bureau of Statistics (NBS) released FY: 2016 GDP report. The report showed economic output declined for the fourth consecutive quarter by 1.3% Y-o-Y in Q4:2016. As a result FY: 2016 GDP figure contracted by 1.5% Y-o-Y (the first annual GDP contraction in over 2 decades). Also, Inflation report for the month of February indicated a moderation to 17.8% Y-o-Y from 18.7% in January 2017 though we witnessed higher pressure from Food Inflation which deteriorated by 1.5% M-o-M in February from 1.0% in January 2017. On the other hand, Core inflation for February 2017 moderated to 16.0% Y-o-Y from 17.9% in January 2017 and also fell 0.7% (from 0.6% in January 2017) on a M-o-M basis.

According to the NBS, the major increases were recorded on all components of the COICOP (Classification of Individual Consumption by Purpose) division with Housing, Water & Electricity, Gas and Other Fuels, Education, Food & Alcohol, Clothing and Transportation fuel, Beverages and Foot wear services recording the highest increases. The lowest increases were recorded in Communication; Recreation and Culture. Although the drop in Headline Inflation was in line with our expectation of a moderation due to high base effect but came in above our forecast (17.2%). This however does not translate to a nominal reduction in goods & services or increase in household real income nor purchasing power of consumers given the pressure on the price of food items which is mainly driven by food importation (Imported food item grew 1.3% M-o-M and 18.8% Y-o-Y) as Nigeria remains reliant on imported products for consumption. We expect a further moderation going forward Y-o-Y to 17.3% (Afrinvest projection). However, on a M-o-M basis, we anticipate further rise to 1.8% (Afrinvest projection) given that food and energy items which are the highest component of the index continue to be pressured.

In a cheering development however, the Federal Government of Nigeria released the much awaited Economic Recovery and Growth Plan (ERGP) which is planned to run from 2017 to 2020 and is designed to lift the economy out of recession if properly implemented. ERGP forecasts the economy to recover from a 1.5% contraction in FY: 2016 to a 2.2% expansion in FY: 2017 whilst Inflation should moderate from 18.6% in 2016 to 15.7% Y-o-Y in 2017.

The foreign exchange market has also recently witnessed increased liquidity on the back of a rise in Foreign Reserves (US$30.3bn as at 16/03/2017) which we link to a combination of deliberate effort by the Central Bank of Nigeria (CBN) to shore-up the reserves and the improvement in global oil prices (currently at US$50.05/b) as well as gains from improved domestic oil output, which has seen production improved to 2.1mb/d (according to NNPC). The CBN’s new FX directives to Banks, to provide PTA and BTA within 24 hours and Medical and School Fees within 48 hours to meet demand, has also eased some of the pressures in the parallel market with exchange rate appreciating 14.3% since announcement. Whilst we believe the successful implementation of the new FX directive has eased pressure in the parallel market, flexibility in pricing and allocation of FX at the interbank market remains a sine qua non to restore confidence in the system and reinstall a market framework that would lead to a gradual normalisation of rates and also attract the much needed foreign capital into the economy.

As the Committee sits to deliberate on Monday and Tuesday, we are of the view that the MPC will maintain status quo on all rates whilst reiterating the need for the CBN to focus on improving FX liquidity in the Foreign Exchange market especially as hinted by the new ERGP document. Whilst the Fiscal authorities pursue an expansionary policy (2017 proposed budget expenditure is estimated at N7.3tn compared to 2016 estimates of N6.1tn) in order to reinstate the economy on sustainable growth path, we believe in the absence of a truly flexible FX market, a dovish stance by way of rate cut or reduction of CRR may not only fuel further monetary induced inflationary pressures while toing the line of the fiscal managers may also discredit foreign capital attraction into the country especially given the recent US Fed Fund rate hike. Similarly, a rate cut could dampen CBN’s efforts in squeezing excess liquidity from the system which could hamper the stability of the Foreign Exchange market. On the flipside, a hike in rate may also be sub-optimal at this time as this may further squeeze out liquidity from the banking system as banks may deploy funds towards investment securities while also constraining growth potentials, thus worsening the economic conditions.

Therefore, on a balance of considerations, we think the MPC will maintain status quo on all rates while trying to consolidate on the gains of recent improvements that have been recorded in inflation, parallel market FX rate, increase in oil production and the release of ERGP by the fiscal authority. Thus, we project that the MPC will:

I. Retain the MPR at 14.0%;
II. Retain the CRR at 22.5%;
III. Retain the Liquidity Ratio at 30.0%; and
IV. Retain the Asymmetric Window at +200 and -500
The implication on the markets, should the MPC maintain status quo, is expected to be neutral given that most foreign investors are staying on the side-line at the moment against the backdrop of an inefficient foreign exchange market. Currently, the equities market remains quiet and driven only by short term speculative trading and fundamentally attractive earnings release. In the fixed income market, we expect investor appetite to remain tilted towards shorter term government securities given the high yield offering which tends to off-set current inflation risk and also inflation expectation.