Naira notes
As the reality of the threats posed by the dwindling oil prices and erosion of the nation’s foreign reserves dawns on the financial authorites, the Central Bank of Nigeria (CBN) at its last week’s monetary policy committee meeting maintained its hold on the rates in a bid to save the naira, reports Festus Akanbi
Given the build-up to last week’s Monetary Policy Committee meeting of the Central Bank of Nigeria (CBN), it was easy for economic analysts to reach a near consensus on the direction of the nation’s monetary policy in the second half of the year. This is because apart from the unabated pressure brought to bear on the naira by the volatility in the global oil market, shortfall in the nation’s oil production and the erosion of the nation’s foreign exchange reserves, keen watchers of the economy had predicted the retention of rates by the apex bank’s committee.
At the end of the all- important meeting, the CBN left its benchmark interest rate on hold at 12 percent as expected but took measures to tighten liquidity to support the weakening naira. Nigeria’s monetary policy committee (MPC) chose to raise banks’ cash reserve requirement to 12 percent from eight percent and reduce net open foreign exchange positions to one percent from three percent to support the naira.
The State of Economy
The naira has been hit by a fall in the price of oil and global risk aversion and has weakened by almost three percent against the dollar since April. The naira closed at 160.7 against the US dollar last Tuesday, outside the central bank’s 150-160 target trading band. According to a Bloomberg report, currency weakness is aggravating inflation as Nigeria imports 80 percent of what it consumes.
Consumer inflation rose to 12.9 percent year-on-year in June, up from 12.7 percent in May. The central bank expects it to peak around 14 percent later this year. CBN Governor Sanusi Lamido Sanusi said at the end of last week’s meeting that there were serious risks to growth in the economy due to weaker global economic growth, lower oil output, a worsening security environment and high government spending. Sanusi also said Nigeria was unprepared for a potential oil price slump because government was spending the country’s savings, which are stored in the excess crude account. Nigeria’s economy grew 6.17 percent in the first quarter this year, down from 7.68 percent in the fourth quarter last year. The economy is projected to grow at 6.5 percent this year, down from 7.4 percent in 2011. The central bank has kept rates on hold since November, after six successive hikes last year, including a 275 basis point rise in October to 12 percent, to ward off speculation on the naira. The naira fell 4.5 percent against the dollar last year.
A financial advisory firm, Meristem Securities, said as economies globally grapple with declining growth prospect, interest rates will be reduced or remain flat to boost economic activity. Economic growth prospect remains weak and any increase in rate will impact negatively on it.
It noted that contrary to the projected inflation rate of 9.5% (as presented in the 2012 budget); inflation has been on the increase throughout the year. Major factors for the rising price level include rising food prices and rising cost of production owing to partial subsidy removal. Inflation has ranged between 11.9% and 12.9% so far in the year.
“Our position remains that inflation will stay high on the back of increased electricity tariff, increase tariff on wheat and other agricultural cereals. A higher inflation rate reduces the real interest rate which erodes the return on investment. At an MPR of 12%, yields on fixed income instruments still give a positive real return of between 137bps and 327bps depending on the maturity range. Any reduction in the MPR will lower or erode the positive real return,” Meristem said in its report.
However, not all economic experts supported the decision of the CBN to raise the CRR in view of the attendant effects of the action on interest rates.
Senior Consultant/Chief Executive Officer, Resources and Trust Company Ltd (RTC), a leading strategy and business advisory company, Mr. Opeyemi Agbaje, described the MPC decision as misguided. In an interview with THISDAY last week, Agbaje said: “I personally believe the CBN posture which seems to be perennially focused on preserving the value of the naira is misguided! I am convinced that the bank is repeating the errors of 2009/2010 when it frittered away foreign currency reserves in pursuit of naira value. I believe a more flexible and rational (rather than emotional) exchange rate management strategy will better serve the country’s long term interest.”
Agbaje explained that the increase in CRR further constrains credit to the private sector and is likely to continue the incongruous situation in which banks are simply investing their deposits in government securities rather than lending. This decision may reduce inflation, but at what cost in output growth, employment and reserves?
Effects on Banking Activities
THISDAY raised a fundamental question bordering on the implications of the MPC decision. How will the increase in CRR affect banking activities-deposit mobilisation and saving? Standard Chartered Bank’s London-based Head of Macroeconomics and Regional Head of Research for Africa, Razia Khan, explained that the withdrawal of liquidity from the banking sector would mean that banks will have to scramble even more for liquidity. “This is likely to mean a reversal of the recent decline in deposit rates, in order for banks to attract the liabilities that they need. So it should ultimately prove supportive of the naira, furthering the reach of financial intermediation and helping to mobilise savings in Nigeria.
“As the FGN yield curve reacts to tighter liquidity, it may also prompt the authorities to look at other means of reducing spending, as their borrowing costs are likely to increase with this move. This is not necessarily a bad thing, given that Nigeria’s oil earnings are from a finite source, and more should be saved for future generations. There is a need to boost overall efficiency in government spending. The challenges brought about by tighter liquidity conditions should help,” she said.
How it Affects Inflationary Targeting
THISDAY also sought to know the likely fallout of the present stand on inflationary trend in Nigeria and from the perspective given by the Standard Chartered chief, the rigid position of the CBN may have been informed by the desperation of the apex bank to put inflation in check.
According to her, “From the core inflation data released recently, it is clear that inflation remains a substantial problem in Nigeria. With the impact of July’s electricity and food tariff increases, overall inflationary pressure might be given an additional boost. Clearly there was a need to act, and this is what the MPC has done – in a much more effective manner than might have been the case had they relied on MPR increases alone. After all, the transmission mechanism of a straightforward MPR increase might not have been as potent,” she submitted.
Government’s Borrowings
Given the rush for cheap funds by the various tiers of government, another question posed was whether the new CRR will discourage banks from taking undue risk in terms of lending to government in view of the rising appetite of the various tiers of government for domestic borrowings. Khan said: “A hike in the CRR is very much a blanket form of tightening, without necessarily directing where credit should go. That is the domain of other policy including macro-prudential policy, which must still be developed further in Nigeria.
“Also, it’s not so much that banks will be ‘aware of the risks of lending to government’…but all players will have an understanding that the consequences of government action create a feedback loop. If spending is excessive and spending minimal, that feeds into higher inflation and foreign exchange volatility, and must be arrested through bold measures such as the CRR increase. This of course has implications for the domestic bond market, and a repricing of yields to reflect new, tighter liquidity is anticipated. It is a reminder that not even investment in government securities is risk-free, and maybe banks will weigh the risks of lending to sound private sector credits accordingly.”
Will Foreign Investors Still Come?
On the implication of the monetary policy on foreign investment inflow, Khan said: “No doubt higher yields will draw in some portfolio inflows, helping to stabilise the FX rate which should already benefit from the domestic tightening and change to NOP limits,” adding “The key implication is what happens to the exchange rate. Expect to see a significant rally in the NGN on the back of this, as the market digests the move, and FX is sold to comply with new NOP regulations.”
While the CBN warned of downside risks to growth as a result of the external environment, and of Nigeria-specific risks in the event of lower oil prices, it is clear that FX stability remains a key priority for the central bank. Although GDP growth recovered only modestly in Q2 (to 6.37% in Q2-2012 from 6.17% y/y in Q1), the CBN now views inflation risks – due to electricity tariff increases and higher government borrowing – as more pronounced. Khan noted that frequent Open Market Operations by the authorities had resulted in overnight rates typically exceeding the ceiling suggested by the MPR, adding that the latest move formalises some of the tightening that was already under way.
However, by raising the CRR a full 400bps, the resulting withdrawal of liquidity is expected to drive overnight rates even higher than their recent peaks, with the impact likely to be felt across the yield curve. And as Meristem put it, “We expect the naira to be the immediate beneficiary of the policy measures announced last week, with dollar-naira likely to trade lower on the interbank market, falling again within the CBN’s official +/-3% band around 155. In the absence of a more significant impact on Nigeria’s oil earnings, the peg is likely to be sustained, helped by the CBN’s latest tightening. However, global growth risks, and the impact on oil prices, will still have to be monitored. The CBN has consistently maintained the ‘soft’ nature of the naira peg. In the event of a severe global shock, the currency peg might still change. For now, it remains unchanged, supported by the latest policy action.