Economy: MPC maintains status quo

At its meeting today, only a few days to the presidential election, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) left its monetary policy rate and stance unchanged.

This was widely anticipated by most economists, as any other move would have been interpreted as politically motivated. The MPC considered many variables in arriving at its decision, key factor being the inflation rate which had ticked up to 8.4% in February 2015.

Inflation expectations are still tilted to the upside as the impact of the seasonal planting of the second quarter is expected to heighten food price pressure.

This view is also held by J.P Morgan who went further to state that the effect of a weaker currency is expected to filter into the inflation rate through high import prices and a likely hike in transport fares. Meanwhile, the CBN had a mixed bag between market forces and administrative tools in managing inflation and the exchange rate.

Other considerations by the MPC include:

1. Oil price now $55pb has resumed its plunge after increasing to $62pb early in March

2. External reserves depletion to $30bn barely covering 4.5months of payments and imports

3. Expectations that the U.S. Fed may begin increasing U.S. interest rates

4. Nigeria’s export earnings and fiscal revenues have dropped by approximately 50% since June 2014

5. Security challenges and the adverse impact on farming and general agricultural output

The Nigerian economy and its financial system continue to face a myriad of challenges. Some of these are based on economic fundamentals arising from declining oil prices and the devaluation of the naira. Others include foreign investors’ divestment from the country and excess liquidity concerns. Hence, the need for measures aimed at restoring economic stability as well as enhancing investor confidence in the financial system.

Policy Comparison

Nigeria is not alone in this, as some other African economies have also maintained their monetary policy stance in the containment of inflationary pressures and management of money supply aggregates.

Implications

The MPC’s decision to maintain the status quo on its policy tools reinforces the institution’s determination to be seen as independent and autonomous of political influence. The marginal gain of the naira against the dollar since the scrapping of the auction shows that the currency is closer to its fair value. This will help reduce the rate of reserves depletion and boost investor confidence. Despite this development, the macroeconomic environment remains volatile as the recent gain in oil price is gradually being reversed due to increased non-OPEC supply.

Likely Market Response

The markets had already discounted the outcome of the MPC meeting, hence interest rates are likely to remain unchanged. Conversely, short term risk of excess liquidity concerns will increase the pressure on the naira. However, the CBN is likely to respond with increased administrative measures to stem this pressure.

What Next?

The MPC remains committed to its price and currency stability objectives. The continued insecurity in the north and high political uncertainty remain sources of concern, particularly the danger of violence after the presidential polls. This could spur capital flow reversal and increase speculative pressure on the naira. In addition, the impact of the currency devaluation on core inflation with the seasonality impact of food prices remains a threat to inflation.

Other factors such as the resumption of the plunge in global oil prices and likely reversal of portfolio flows are threats to government revenue and the external reserves level. In our view, the impact of the MPC decision on the economy and the markets in the near to medium term is expected to remain neutral. The probability of the U.S. Federal Reserve Bank increasing interest rates and its impact on foreign portfolio investors’ appetite have tempered the view of the CBN on its ability to slash interest rates in the near term. However, immediately after a transparent election, the markets and the economy are likely to witness a mild recovery.

The most important structural issue is that the closer we get to the real equilibrium exchange rate, the lower the adjustment required. This is because the exchange rate at N199/$ has arisen from the dismantling of the RDAS regime and is expected to engender investor confidence.

Therefore, in post-election Nigeria we expect the exchange rate to float around the N202/$ level at the interbank and N225/$ level at the parallel market. The impact of a higher price for dollar purchases should reduce the effective demand over time.

-Proshare

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