November 25, 2020/Cordros Report

In line with market expectations, the Monetary Policy Committee (MPC), faced with the choices of tightening, loosening and maintaining monetary policy stance, unanimously elected to:

1.    Retain the Monetary Policy Rate (MPR) at 11.5%;
2.    Retain the Asymmetric corridor around the MPR at +100/-700bps;
3.    Retain the Cash Reserve Ratio (CRR) at 27.5%; and
4.    Retain the Liquidity Ratio (LR) at 30.0%.

At the 276th meeting of the Monetary Policy Committee (MPC) of the CBN, the members unanimously voted to hold the monetary policy variables hinged on its most pressing needs – (1) driving the economy back into growth, and (2) achieving medium-term macroeconomic stability.

On domestic growth: The Committee attributed the 3.62% y/y decline in GDP in Q3-20 to low oil prices as well as the lingering effects of the COVID-19 pandemic on the economy. Interestingly, the committee expressed optimism on output growth in Q4-20 due to expected gains from its dovish monetary policy and fiscal stimulus initiatives implemented by the government; it now expects the economy to recover from the recession by the end of 2020. In our view, this is optimistic as we expect the lingering impact of the COVID-19 pandemic and FX illiquidity to limit expansion in both the oil and non-oil sectors over the rest of the year. Overall, we expect GDP to contract by 5.61% in Q4-20 before reaching a trough in Q1-21. Sequentially, we expect the Nigerian economy to exit recession in Q2-20, implying a U-shaped recovery. 
 
On Inflation: The Committee reiterated that supply-side factors remain the predominant drivers behind the surge in inflation. It further highlighted that persistent security challenges across the country, as well as lingering structural deficiencies impacting the moving of food items from the rural to the urban areas, have amplified the upward pressure on domestic prices. Other factors highlighted include the recent hike in PMS and electricity tariff. It now expects inflation to moderate by the end of Q1-21 as domestic production is expected to recover following the resumption of economic activities post-COVID lockdown. We share a similar view on the drivers of inflation. However, we expect inflation to exceed 15.0% by end-2020 and maintain its uptrend beyond Q1-21, due to the sustained impact of higher energy prices and the closure of the land borders. The pressures from energy costs are expected to dissipate afterwards, particularly in Q2-20, and combined with the high base from 2020, will slow down the pace of price growth.
 
Cordros View:  Overall, the meeting reinforced the earlier held view that the predominant objective of the committee is to stimulate economic growth, thus, sacrificing the core mandates of price and exchange rate stability. Although the committee acknowledged that further loosening would amplify system liquidity and worsen inflationary pressure, we believe that inflation expectations also played a role in their decision, as any reduction in interest rates would push real rates further into the negative territory. In the event that external conditions do not show significant improvement in the medium term, the committee runs the risk of tightening aggressively which would result in financial market turbulence. Nonetheless, we think the committee is likely to revert to a slightly hawkish stance, if economic growth shifts back into positive territory, to resolve the imbalance in the external sector and attain macroeconomic stability. However, the lack of clear-cut guidance from the committee on how (1) FX liquidity constraints, and (2) the widening spread between the parallel market and NAFEX rates will be addressed will continue to hurt manufacturing activities. At the same time, this will put the nation at a disadvantage in attracting dollar inflows needed to stabilize the external sector.
 
Market Impact

Fixed Income: We do not envisage any fundamental changes in the trading pattern of the financial markets as the decision of the committee is broadly in line with consensus expectation. In the bond market, yields are already at all-time lows despite surging inflation and a widening fiscal imbalance. Consequently, we do not expect any substantial retracement in yields in the short term due to the limited issuance of domestic debt by the DMO. This, at least until the CBN and DMO increase the size and frequency of OMO and bond issuances, respectively.

Equities: We expect the depressed yield environment to engender portfolio rebalancing activities towards equities as yield-seeking investors are likely to reprice fundamentally justified stocks with attractive dividend yields.

Figure 1: MPR and Inflation (%)