Culled—Proshare

January 26, 2017/ARM Research

In today’s cut-out of our core strategy document – The Nigeria Strategy Report, we continue with the review of Nigerian macroeconomic environment by examining movements in Money Supply aggregates over H2 2016 and delineating our expectations for same over the rest of 2017.

Following the currency-induced expansion in H1 16 (+8.3%), Broad money (M2) grew at a more subdued pace (+2.7% to N22.3 trillion) in H2 given the tamer USDNGN depreciation (9.1%) relative to the first half of the year (42%). That said, the annualized reading of 13.2% tracked above CBN’s target of 10.9% for 2016. Parse through breakdown isolates slower expansion in quasi money (annualized: +8.3% to N12.3 trillion), which dampened momentum in narrow money (M1) (annualized+20.3% to N10.0 trillion), as the source of slackening M2 growth. The strong M1 growth reading largely stemmed from a rebound in currency in circulation (H2 16: +8.4%, H1 16: -9.3%) as well as upswing in demand deposits (H2 16: +9.7%, H1 16: +8.7%).The gains in the latter emanated from higher private sector deposits at CBN (+51.1% to N2.7 trillion) which neutered lower private sector deposits at Commercial (-2.6% to N5.8 trillion) and Merchant (-38.4% to N16 billion) banks.

In response to CBN’s pivot to a hawkish monetary policy stance, which resulted in a 200bps hike in the monetary policy rate (MPR) in July and an over 500bps increase in the average clearing rate at its open market operations (OMO) to 18-18.5%, money market rates pushed higher over much of H2 16. In addition to monetary tightening, intermittent FX market interventions by the apex bank to clear dollar demand backlogs and the attendant impact on system liquidity levels provided short-lived interest rate spikes to multi-year peaks. Consequently, OBB and Overnight rates were on average 11.1pps and 11.6pps higher than H1 levels at 16.8% and 18.0% respectively over H2 16.

Going into 2017, base effects from the 45% increase in electricity tariffs in February 2016 and surge in national PMS prices have clearly set a high hurdle for CPI readings over 2017. Thus, the removal of the textbook cause for monetary tightening should permit the CBN resort to more conventional policy accommodation vs the backdoor monetary easing via on-lending programs and FG deficit financing. However, given lingering concerns on the FX market, we think the CBN, as in July 2016, could opt for a moderation in the marginal clearing rate at its OMO auctions as a way of signaling lower rates while keeping the appearance of policy tightening. In any case, the apex bank has to grapple with a sizable maturity profile over H1 2017, which as we observed in December 2016 rendered impotent the impact of any net OMO issuances leading rates lower.

Exchange rate movements dictate trends in monetary aggregates
Developments on the currency front played a pivotal role in the evolution of monetary aggregates in H2 16. As in H1 16, when 42% NGN depreciation in June drove spikes in aggregate credit and deposit growth, H2 16 saw impact of softer currency movement on monetary indicators. In addition, increased fiscal and monetary activities were also pronounced in the period evidenced the strong expansion in government borrowings and CBN’s interventions across the banking sector.

Following the currency induced expansion in H1 16 (+8.3%), Broad money (M2) grew at a more subdued pace (+2.7% to N22.3 trillion) in H21 given the tamer USDNGN depreciation (9.1%) relative to the first half of the year (42%). That said, the annualized reading of 13.2% tracked above CBN’s target of 10.9% for 2016. Parsing through breakdown isolates slower expansion in quasi money (annualized: +8.3% to N12.3 trillion) which dampened momentum in narrow money (M1) (annualized+20.3% to N10.0 trillion), as the source of slackening M2 growth. The strong M1 growth reading largely stemmed from a rebound in currency in circulation (H2 16: +8.4%, H1 16: -9.3%) as well as upswing in demand deposits (H2 16: +9.7%, H1 16: +8.7%).

The gains in latter emanated from higher private sector deposits at CBN (+51.1% to N2.7 trillion) which neutered lower private sector deposits at Commercial (-2.6% to N5.8 trillion) and Merchant (-38.4% to N16 billion) banks. We believe CBN’s aggressive clearing rates at OMO (mean: H2 16: 18.26%, H1 16: 8.76%) auctions induced private sector investors (particularly non-banking financial institutions) to reallocate funds from DMBs into the more attractive CBN’s fixed income instruments. As for quasi money, its modest expansion reflects lower time and savings deposits at Commercial (-2.5% to N12.0 trillion) and Non-Interest banks (-1.2% to N46 billion) alongside flat deposits at Merchant banks (+0.1% to N176 billion) over H2 16 which tempered growth in H1 16 (Commercial banks: +8.6%, Merchant Banks: +220%, Non-Interest Banks: +17%). The overall decline in time and savings deposits over H2 16 largely stemmed from faster contraction in naira denominated deposits (-3.5% to N7.9 trillion) as impact of currency weakness ensured foreign currency deposits held steady over the period (-0.5% to N4.4 trillion).

On the asset side, growth in net domestic credit (NDC) decelerated 2pps from H1 reading to 10% as slowdown in the pace of credit growth to the private sector (+7.7% to N23.1 trillion vs H1 16: 14.5%) neutered the effect of robust lending to the government (+28.1% to N3.7 trillion). Though as with most monetary aggregates in 2016, the translation impact of NGN depreciation on foreign loans in H1 16 implies that annualized credit growth of 28.7% tracked well ahead of CBN’s 2016 benchmark of 17.9%. Looking at the subparts of credit growth in H2 16 more closely, expansion in government lending reflects impact of a surge in CBN’s claims on FG (+138% to N1.5trillion) from the end of H1 16 and higher borrowings from the financial sector (+8% to N4.5 trillion).

The latter reflects higher debt issuance as the FGN grappled with lower fiscal receipts while the former harks to recent noise by the former CBN governor over elevated CBN monetization of fiscal deficits. On the other hand, decomposing movements along the sub-components of Credit to Private Sector (CPS) reveals an uptick in CBN lending to the banking sector (+16.9% to N6.3 trillion) from the end of June largely underpinned growth in the item. The rise in CBN loans to the banking system stems from more widespread deployment of intervention programs (PAIF, CACS, RSSF, ACGSF, MSMEDF, ABP and YEDP). Credit growth by the banking system rose 4.5% to N16.6 trillion which, as in H1 16, largely reflects translation impact of naira weakness on FCY share of loan book. Overall, monetary aggregates were influenced by the confluence of currency depreciation, tightening monetary policies as well as elevated government borrowings.

Hawkish monetary policy pushes money market rates to the summit
In response to CBN’s pivot to a hawkish monetary policy stance, which resulted in a 200bps hike in the monetary policy rate (MPR) in July and an over 500bps increase in the average clearing rate at its open market operations (OMO) to 18-18.5%, money market rates pushed higher over much of H2 16. In addition to monetary tightening, intermittent FX market interventions by the apex bank to clear dollar demand backlogs and the attendant impact on system liquidity levels provided short-lived interest rate spikes to multi-year peaks. Consequently, OBB and Overnight rates were on average 11.1pps and 11.6pps higher than H1 levels at 16.8% and 18.0% respectively over H2 16.

Tracking patterns sequentially, after rising to a 10-month high in June post naira floatation, interbank call rates declined over July (-110bps MoM to 13.3%) reflecting tempered monetary tightening. Particularly, in contrast to June where nearly N1trillion (net bill issuance: N161 billion, Dollar debit: over N800 billion) was culled from the banking system, net bill issuance2 was much smaller in July (N77 billion) with the latter including net OMO repayment of N146 billion (June OMO net repayment: zero).

However, CBN’s resumption of liquidity mop-up measures evidenced by net paper issuance of N743.7 billion3 (August) and N153.4 billion (September) pushed interbank OBB and Overnight rates 476bps and 272bps MoM higher to 18.1% and 20.8% respectively. Though the CBN continued to tighten in October with net OMO issuance of N572.4 billion (thirty-five-fold higher MoM) more than offseting net NTB repayment of N290.5 billion, sales of $313 million two-month forwards to clear backlog of dollar demand which resulted in another debit of nearly N100 billion drove fresh spikes in the money market. Accordingly, money market rates jumped to record highs of 153.50% (interbank call rate) and 151.67% (OBB rate) over the month nudging average rates to a 20-month high of 31.33% (+10.53pps MoM) in October.

However, the release of Q3 16 GDP which revealed a deepening economic recession resulted in a pause in monetary tightening in November. Specifically, despite net NTB repayment of N123 billion which would ordinarily have resulted in further liquidity mop up by the apex bank, the CBN lowered its net OMO issuance (-85.8% MOM to N81.4 billion), which provided the system with ample liquidity. Hence, interbank call rates fell at its fastest pace in 15 months (-14.52pps MoM to 15.48%) in November.

Over the last month of the year, though the CBN returned to tightening with net OMO issuance of N200 billion (net NTB issuance: N274 million), money market rates declined (interbank call rate: -8.35pps MoM to 7.97%, OBB: -8.25pps MoM to 7.23%) following influx of N153.01 billion the FG paid to states for refund of debt service over-deducted between 1995 and 2002 and redemption of the N112 billion LCRM 2017 bond. Overall, money market rates largely tracked the scale of monetary tightening for most of H2 16 before succumbing to liquidity pressures in December.

Figure 2: Average OBB and Overnight rates

Mounting liquidity burden and tamer inflation expectation underpin dovish rate outlook
Going into 2017, base effects from the 45% average increase in electricity tariffs in February 2016 and surge in national PMS prices set high hurdles for CPI reading to maintain current trajectory over the first half of 2017. Thus, the removal of the textbook cause for monetary tightening should permit the CBN into resorting to more conventional policy accommodation vs the backdoor monetary easing via on-lending programs and FG deficit financing. That said, it remains unclear as to how the CBN is going to deal with the naira given the expansion in parallel market premium and persisting interbank dollar liquidity which leaves scope for the apex bank to continue to justify some form of monetary tightening in a doomed quest to attract FPI flows.

Thus, while we see increased prospects for easing as real yields expand in H1 17, the opaque naira policy could drive official policy inertia. As a sort of middle ground, we think the CBN, as in July 2016, could opt for a moderation in the marginal clearing rate at its OMO auctions as the way of signaling lower rates while keeping the appearance of policy tightening.

In any case, the apex bank has to grapple with a sizable maturity profile over H1 2017, which as we observed in December 2016, rendered impotent the impact of any net OMO issuances leading rates lower. In between the periods, tremors from the illiquid interbank market should continue to drive intermittent spikes as the CBN attempts to improve dollar liquidity during its special interventions.