Agusto & Co: Reflections on the May Monetary Policy Committee meeting

Committee holds key rate at 12%

In a largely expected move, the Central Bank of Nigeria’s Monetary Policy Committee (MPC) kept its benchmark interest rate at a record high in a bid to maintain price and exchange rate stability. This was the last MPC meeting before the new CBN governor – Godwin Emiefele assumes office in June. The committee voted to keep the Monetary Policy Rate (MPR) at 12 percent, though one member voted for an asymmetric corridor around the MPR, indicating the member’s inclination for a more flexible interest rate regime. The committee also voted to keep the Cash Reserve Ratio (CRR) on public sector deposits and private sector deposits at 75 percent and 15 percent, respectively, and the MPR corridor at +/-200 basis points.

In keeping these rates unchanged, we note the committee may be seeking a risk neutral approach ahead of Emiefele’s resumption. The decision could also have been borne out of the committee’s satisfaction with price and exchange rate stability since the last meeting – inflation and the naira/US$ exchange rate still remain within the single digit target and 155+/-3 percent band, respectively. Voting patterns of the committee have been quite unpredictable this year. In the January 2014 session, 11 members voted for a hike in CRR on public sector deposits to 75 percent, and in March 2014, four members voted for an increase in the MPR.

Market ignores negative headlines

Nigeria has been under the global spotlight in the last one month as a result of the escalation in the violence in the North-eastern part of the country. The country’s successful hosting of the World Economic Forum (WEF) even amid the bombings before the event typifies Nigeria’s wealth in paradoxes. Trading sentiments in the financial markets for now seem to have clearly ignored the tenuous security conditions in some northern states. The Nigerian Stock Exchange All Share Index (NSE ASI) has dipped by just a little less than 1 percent in the last one-month even amidst the negative headlines, while benchmark yields on government securities have held steady within the 11 percent – 13 percent range over the same period.

Agusto & Co. believes that the 2015 political season, which may have been subdued by the new focus on the insecurity, could weigh more on investors’ mind. We believe the political season could lead to a short-term re-evaluation and reduced exposure to Nigeria, especially by foreign portfolio investors (FPIs).

Single digit inflation to stay?

The consumer price index (CPI) rose to 7.9 percent in April 2014. Core inflation, which is closely watched by the CBN because it excludes the volatility inherent in farm produce, rose by 7.5 percent on a year-on-year (y-o-y) basis. The food index also rose by 9.4 percent in April 2014, due to the slow growth in farm inventories. The April inflation numbers suggest prices have been on the increase since February but still remain within the CBN’s single digit target of 6 percent – 9 percent.

In the short term, the reduction in fiscal buffers and pre-election spending are factors that could affect the CBN’s capabilities in reining inflation as well as maintaining exchange rate stability. The insecurity in the food belts across the northern parts of the country occasioned by terror activities and clashes between farmers and cattle herdsmen, is also expected to push food prices higher, thus setting the food index on an upward trajectory.

Despite these structural difficulties that hurt inflation targeting, the initial communiqué of the committee indicates that the ultimate goal of the CBN would be to transform Nigeria to a “truly low inflation environment.” Emiefele’s confirmation hearing at the Senate indicates he may be inclined towards monetary tightening. Based on the incoming CBN governor’s initial hawkish stance and the inclination of majority of the current MPC members towards monetary tightening, Agusto & Co. believes that the CBN would resort to an extended period of monetary tightening to achieve this long term inflation target.

Agusto & Co. outlook

The single-digit inflationary outlook anchored on monetary tightening and a stable currency goes well with FPIs. While this should continue to attract arbitrage into the Nigerian market, it could also create a new cycle, as capital inflows could then lead to compression in yields.

However, we do not see yields dropping to single digit levels in the short term for two major reasons. Firstly, emerging and frontier markets are still exposed to risks around the US Fed’s tapering plans. The US Fed’s decision to wind down its Quantitate Easing (QE) policy has increased the vulnerabilities of emerging economies as investors reduce exposure to these economies.