Pre-MPC Commentary- CBN likely to stay put amid rising headwinds   

21 November 2018 : At its final meeting of 2018, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) will deliberate on how best to navigate choppy external waters and re-emerging inflationary threats ahead of the 2019 elections. The MPC has often reiterated its goal of maintaining price and exchange rate stability in pursuit of economic growth, and these three variables will assume centre stage as the rate-setting committee weighs up the decision to hike interest rates or to hold.


CBN to preserve monetary autonomy, will burn through reserves 


The external environment Nigeria faces in the near-term is rather unwelcome. Interest rates in the U.S. are projected to rise further, oil prices have fallen sharply recently, and the burgeoning U.S.-China trade dispute casts a shadow over economic growth in emerging markets. Despite all these (and fairly tepid domestic economic performance), the naira has remained relatively stable in 2018, even in the NAFEX window. The upper bound of rates in the NAFEX window only increased from NGN363/USD in January 2018 to NGN365/USD in October 2018—barely a 1% depreciation. The reason for this is simple: the CBN has burned through its reserves, which have tracked as follows in the same period: $39 billion in January, $48 billion in July, and $42 billion in October. 

In essence, the CBN has selected the “capital flows” horn of the monetary trilemma, retaining its control over monetary policy despite operating a de facto fixed exchange rate by permitting significant capital reversals. It is unclear whether this is a sustainable policy. On one hand, the Federal Government recently raised almost $3 billion worth of Eurobonds which should support reserves accretion, and even at $40 billion, reserves still cover about 17 months of imports, according to the CBN. However, CBN intervention in the foreign exchange market has become more pronounced, and the apex bank’s growing participation in the notionally autonomous NAFEX window is a particular concern. Analysts expect increased speculation amid devaluation fears in the run-up to the elections, which may be exacerbated by reserves falling beyond a psychological threshold (e.g. the 12 months import cover level). Should the CBN’s defence of the naira ultimately prove unsuccessful, it can tackle either of the other two horns: cede monetary policy autonomy or free the exchange rate. 


Minimum wage poses threat to price stability 


After reversing an 18-month disinflation trend with a 20bps rise from July to September (11.3% y/y), Nigeria’s inflation is expected to keep rising. The primary drivers of this would be fiscal injections due to electoral spending in the coming months and a possible increase in the national minimum wage from N18,000/month to at least N22,500/month. The national tripartite committee on the minimum wage recommended a N30,000/month figure which labour unions and the Presidency accepted, but Nigerian governors have pushed back, stating that they can only afford N22,500/month. The issue is likely to become more politicised as elections approach, making it difficult to determine when the change would be made. Moreover, any agreement would need to be enshrined in a new bill signed off by the National Assembly. 


Therefore, concerns over the effect of a minimum wage hike on inflation may only apply post-H1’19. Of course, you could argue that monetary policy should adjust in advance to anchor inflation expectations, a sentiment shared by Adeola Adenikinju when he voted to hike rates by 25bps at the September meeting. “I am of the opinion that a marginal adjustment in the monetary policy rates will serve a strong signal to stakeholders that CBN will not condone any resurgence of inflation. Waiting for any of the upticks to inflationary pressures to manifest would require stronger monetary policy adjustments,” he said. However, it is unlikely that this signalling argument would sway other committee members, whose previous MPC statements point towards more reactive monetary policy. 

One issue that is only just brewing is the growth in money supply and its impact on inflation. Although M2 (Broad Money) grew at just 4.47% annualized, below the 10.48% benchmark for 2018, M3 growth has been more aggressive—11.79% annualized vs the same benchmark. M3 is a seasonally adjusted measure of broad money introduced a few months ago to more accurately measure liquidity outside the banking system. MPC member Mike Obadan described it as “M2 plus OMO bills discounted by deposit money banks” while another member argued that the rise in M3 signified an underlying monetary impulse which may stoke inflation. Although the use and measurement of the different monetary aggregates is more of an art than science, the threat of monetary inflation is untimely ahead of the elections. 


Differentiated CRR regime opens door to baseline CRR hike 


The CBN still worries that further tightening would squeeze Nigeria’s weak economic growth, but the committee members are less worried following the roll-out of the real sector support facility, particularly the differentiated cash reserve ratio (CRR) regime. In fact, the program arguably motivated a few MPC members to call for a hike in the baseline CRR. Explaining his decision, Mike Obadan said, “Against the backdrop of the extant policy of lower cash reserve requirement (CRR) for banks that are willing to lend to agriculture and manufacturing at single digit interest rates, the CRR for the other banks can be reviewed upwards in order to simultaneously address the issue of growth and employment and concerns about inflationary expectations.” Nevertheless, concerns over weak economic growth would continue to dissuade the MPC from further tightening. 


HOLD verdict expected 


Overall, inflationary and FX headwinds point towards the need to tighten monetary policy, but the MPC and CBN are likely to eschew this in favour of reserves and liquidity management, particularly ahead of the 2019 elections. Analysts envisage a closer voting margin at this week’s meeting, but do not foresee enough committee members changing their minds to swing the vote towards the hawks. 

Verdict: HOLD 


Reporting for EasyKobo on Wednesday , 21 November 2018 in Lagos, Nigeria


Source: Vetiva Capital Management Limited


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