MPC maintains status quo

At the end of its 2-day policy meeting, the 10 members of the Monetary Policy Committee (MPC) in attendance unanimously decided to leave key monetary policy rates unchanged. The Committee voted to: retain Monetary Policy Rate (MPR) at 14.0%; maintain the asymmetric corridor around the MPR at +200/-500bpbs; hold Cash Reserves Ratio (CRR) at 22.5%; and keep liquidity ratio at 30.0%.

Whilst the need to maintain a positive real return in response to spiraling inflationary pressure was the major motive for commencing a monetary policy tightening cycle in March, Mr. Emiefele alluded to the obvious at the end of July policy meeting, confirming that factors stoking inflationary flames are mostly cost-push, and out of the purview of monetary policy.

Nevertheless, the MPC still tightened monetary policy further, as attention shifted from fighting inflation to curbing excessing liquidity in the banking system and supporting the fledging FX market with growth concerns seemingly relegated to the background, despite vividly deteriorating macro fundamentals as confirmed by a raft of economic data recently released by the National Bureau of statistics.

Since the last MPC meeting, we do not think the desired FX impact expected from the further rate hike has come to fruition, at least not yet. Broadly, from June when the new FX policy was announced till date, FX reserves have declined c.6.1% to N24.8bn.  Even more instructive is the still disappointing turnover figures at the Official FX market both on y/y and sequential basis. Total turnover from June to date is N4.6trn c.35.0% lower than the comparable period in 2015. So it is not surprising that foreign portfolio flows into naira assets have been muted, despite attractive yields on naira FI assets (one of the highest amongst frontier markets) which is a direct consequence of higher interest rates from a tight monetary policy stance and aggressive OMO issuances. A similar pattern is evident in the equities market.  While FPIs were net buyers of naira equities in the month of July (N2.6bn), the quantum of m/m inflows declined 44.8% to N23.4bn.

Recent comments by the Finance Minister suggests the fiscal authorities intend to continue to pursue its strategy of reflating the economy via higher spend on capital projects, with plans to raise money from the foreign debt market as well as domestic pension fund industry now in the pipeline. This, together with recent downgrade of Nigeria to junk status by S&P, suggests the government debt service ratio is set to rise further and raises questions about the appropriateness of further monetary policy tightening at this time especially seeing that the FPIs still appear unconvinced about the strength of the underlying macro fundamentals as well as the pricing of the naira and will likely remain on the sideline in the near term.

In our view, there appears to be a disharmony between fiscal and monetary policy objectives at this time and therein lies the MPC dilemma, which could have been avoided through more consistent policy choices, with firm objectives in mind. Specifically, going into its last meeting for 2016 slated for 21st November, the Committee now has to make the crucial decision of whether to continue to jettison growth concerns by maintaining a tight monetary policy stance in a bid woo the foreign money managers and stabilize the FX market, or return to a monetary easing mode which will align more with the fiscal objectives of the government, effectively completing a one-year cycle of monetary policy flip-flop.

Overall, what is clear at this junction is that there will be no easy way out, with the quality of macro data to be released in the coming months likely to continue to exert pressure on policy makers. That said, lessons from events in 2016 suggests the economy would be better-off, if the fiscal and monetary policies reach a compromise and settle at some middle point, with the optimal policy mix.

We do not expect significant changes to current dynamics at the equities and fixed income markets, following outcomes of this MPC meeting. The equities market will likely continue to oscillate between the bulls and the bears in the near term, with investors likely to continue to lean more towards short term tactical play, pending further clarity on the domestic macro and policy fronts. Also, yield in the FI market is set to remain elevated, with trajectory to be shaped by system liquidity gyrations, pace of OMO issuance by the CBN and inflation expectations.