July 28, 2020

Post-MPC View: A preferred Default Position

A recent report published by FBNQuest Research which covers the latest monetary policy committee (MPC) meeting disclosed that the MPC left its policy rate of 12.50% and other parameters unchanged. Two of the ten members voted for a rate cut. The committee might have been tempted to follow up the 100bp reduction in May with further easing and provide the textbook response to a deepening recession. It decided otherwise already deployed, a marginal improvement in the economic fundamentals and its wish to assess the impact of the reduction in May.

Headline inflation y/y has picked up each month since August and stood at 12.56% in June. The increases have been small, amounting to 155 basis points (bps) over the ten months. They have mostly been rises in food prices, although the core measure has moved into double digits over the period. ‘Legacy Structural factors’ have been largely to blame. The MPC’s communiqué also highlights challenges from the herder/farmer clashes, general banditry, poor transport and power supply provision, and the limited application of technology in the economy. The main conclusion to draw from the inflation data is that structural factors on the supply side, mostly food related, are holding the rate some way above the levels one would expect in view of the prevailing subdued state of household demand.

The report further highlights that fiscal policy is another victim of the virus. The CBN is leading the policy response to the headwinds, both through its own interventions and as regulator of the deposit money banks (DMBs) because the FGN is hamstrung by the oil price crash. The changes the FGN had to make to its 2020 budget proposals submitted in December highlight the fiscal squeeze.

Following its reforms of March/April 2017, seen at the time as the launch of a multiple exchange-rate regime, the CBN presided over FX stability for close to three years. In this environment the CBN tweaked its FX policy on 20 March in what President Buhari termed a ‘realignment’. It transacted at N360 (rather than N307) at its official rate for preferential deals, and at N380 with FPIs on NAFEX. It adjusted the official rate again on 07 July to N381 (although curiously the home page of the CBN website still shows N360). The rate on NAFEX has drifted to N388.50.

The CBN is under pressure due to the exit of FPIs and the weakness of the oil price. It has not supplied NAFEX since late March, so a large pipeline of delayed external payments has developed. These are mostly the repatriation proceeds of FPIs. On the surface, reserves have stabilized or at least the depletion has slowed. To arrive at the true picture, we should deduct the estimated pipeline from reserves. Estimates range up to US$5bn. In response to the pressure, the CBN has made few concessions. It adjusts/guides rates, as we have noted, when it no longer has any choice. Its mindset is to manage exchange rates with the help of administrative and other measures.

As for GDP growth, the first case of COVID-19 in Nigeria was announced at the end of February so GDP growth was still positive in Q1 2020. It grew by 1.87% y/y (5.06% for oil and 1.55% for the non-oil economy). Household spending had not recovered from the recession that ran from Q1 2016 to Q1 2017 before the latest hit from the virus and the oil price. The communique cites a CBN staff forecast of a -1.03% y/y contraction for Q2. This is too hopeful in our view for the quarter that coincided with the partial lockdown in Nigeria and the same in its main trading partners (other than China). The view for the year is that Nigeria may end the year in ‘marginal negative territory’ and has a strong recovery prospect for 2021.

FBNQuest Research