Analysts see naira strengthen as CBN surprisingly tightens MPR to 14%

Analysts say they see the naira begin to firm up against the dollar, following a surprising announcement by the Central Bank of Nigeria (CBN) on Tuesday to jerk up the Monetary Policy Rate (MPR) by 200 basis points to 14 percent, in a tough decision to favour taming rising inflation as against pushing growth.

CBN governor, Godwin Emefiele said the tough rate hike upheld by five members of the Monetary Policy committee  (MPC) as against three who voted to hold rate was basically to encourage foreign exchange inflows into the economy, with the expectations that it would automatically help raise output and boost growth.

But the CBN retained the Cash Reserve Ratio (CRR) at 22.5 percent, Liquidity Ratio at 30 percent and the Assymetric Corridor around the MPR at +200 basis points and -500 basis points.

Analysts expressed surprise at the CBN”s tightening stance but were confident that the decision would encourage foreign exchange inflows and stabilise the naira.

The CBN in June, officially liberalised the FX market with a flexible regime that was expected to create market confidence and see the naira begin to strengthen.

Though analysts think it is still early days for the policy to begin to crystallise into intended outcomes, there are also concerns that the naira is yet to firm up both at the interbank and and parallel markets.

Emefiele had gone on a road show two weeks ago to convince investors about its recent flexible FX rate regime and woo them to bring more cash into the system.

Bismarck Rewane, CEO at the Financial Derivatives Company said technically, the naira should appreciate. “The optimistic scenario is that you could see the naira begin to move from say N310 to N295-N298.

“The short term evaluation of the policy impact, you are gone to see the naira appreciate, though not tomorrow, but may be in the next two weeks.”

“The parallel market will then move down and converge and that will bring some kind of monetary stability which will be the objective of the Central Bank.

Though the analysts see supply surge in short term FX inflow which is needed to take care of the backlog, they say “what must be done to keep supply going is to address those structural issues.”

Briefing on the outcome of the two-meeting, governor Emefiele said the CBN MPC was particularly concerned that headline inflation spiked significantly in June 2016, approaching twice the size of the upper limit of the policy reference band.

He said the Committee noted that inflation had risen significantly, eroding real purchasing power of fixed income earners and dragging growth and was further concerned that while the situation called for obvious tightening of the monetary policy stance, the technical recession confronting the economy and the prospects of negative growth to year-end needed to be factored into the policy parameters.

Analysts had widely acknowledged that the CBN was already facing two tough policy options but had tough the regulator would favour allowing more liquidity into the system to boost local.output and boost growth.

But the governor argued that the high inflationary trend which has culminated into negative real interest rates in the economy was discouraging to savings.

Besides, the negative real interest rates did not support the recent flexible foreign exchange market as foreign investors attitude had remained lukewarm, showing unwillingness in bringing in new capital under the circumstance.  Also there existed a substantial amount of international capital in negative yielding investments globally and Nigeria stood a chance of attracting such investments with sound macroeconomic policies, according to him.

“Consequently, members were of the view that an upward adjustment in interest rates would strongly signal not only the Bank’s commitment to price stability but also its desire to gradually achieve positive real interest rates.

“Such a decision, it was argued, gives impetus for improving the liquidity of the foreign exchange market and the urgent need to deepen the market to ensure self-sustainability. Members were of the opinion that this would boost manufacturing and industrial output, thereby stimulating growth which is desired at this time,” the governor told journalists as he briefed on the outcome of the two-day MPC meeting.

The governor particularly argued that the CBN lacked the instruments required to directly jumpstart growth, and being mindful not to calibrate its instruments in such a manner as to undermine its primary mandate and financial system stability, the balance of risks remains tilted against price stability.  Explaining the reasons behind the tightening at a press conference to announce the MPC decisions, took a lot of time to deliberate on whether to favour growth as against inflation.

The governor said the committee members acknowledged that the economy was passing through a difficult phase, dealing with critical supply gaps and underscored the imperative of carefully navigating the policy space in order to engender growth and ensure price stability.

“We felt that there was a need in line with Central Bank’s core mandate to look at price stability at the time, that if we we favour price stability and tighten to curtail inflation, a lot more stakeholders interests would have been sort of met, thereby encouraging in this case inflow of capital into the country, and what that does is to deepen the FX supply base and by that makes foreign Exchange available to end users, particularly the manufacturing, agricultural sectors who require raw materials to boost their industrial capacity and will also help to moderate prices.

“So this stance will create activity that will not just boost but will indirectly begin to push prices downwards,” Emefiele argued. He explained that some committee members’ arguments in favour of growth were anchored on the fact that the current inflationary episode was largely structural.

In particular, members noted the prominent role of cost factors arising from reform of the energy sector, leading to higher domestic fuel prices and electricity tariffs and prolonged foreign exchange shortages arising from falling oil prices leading to higher inputs costs, domestic fuel shortages, increased transportation costs, security challenges, reform of the foreign exchange market reflected in high exchange rate pass-through to domestic prices of imports.

Consequently, the current episode of inflation, being largely non-monetary but largely structural, tightening at this point would only serve to worsen prospects for growth recovery as the Bank had in June 2016, withdrawn substantial domestic liquidity through the foreign exchange market upon introduction of the flexible foreign exchange regime.

But a second argument, he said was raised at the meeting was that the negative effect of inflation on consumption and investment decisions and its defining impact on the efficiency of resource allocation and investment.

According to the governor, prolonged non-payment of salaries, a development which has affected aggregate demand and worsened growth prospects.

He also recalled that at the May MPC meeting, members weighed the risks of the balance of probabilities against growth and voted to hold, allowing fiscal policy some space to stimulate output with injections, but, unfortunately, “this has been long in coming.”

Onyinye Nwachukwu