July 27, 2021/Cordros Report

In line with our expectation, the Monetary Policy Committee (MPC) voted to maintain the MPR at 11.5% alongside other key monetary policy parameters.  Like the May meeting, where there was uniformity in the voting pattern, a unanimous decision was reached among the Committee members. The outcome of the meeting is consistent with market expectation, given that the Committee has guided that its short-term objective is to drive a rebound in economic activities despite the stubbornly high inflation and pressures on the local currency. Consequently, the Committee also voted to retain the Cash Reserve Requirement (CRR) at 27.5%, liquidity ratio at 30.0% and asymmetric corridor around the MPR at +100bps/-700bps.
 
On domestic growth: Just as we envisaged, the Committee noted that their analysis of vital economic variables suggests broad economic improvement over the rest of the year on sustained fiscal and monetary stimulus. However, the Committee expressed concerns about the broad level of increased security challenges in the country, which has undermined farmland activities and made the business environment more hostile. Therefore, the Committee believed a strong need for the monetary and fiscal authorities to continue to consolidate administrative measures to spur economic growth. We align with the Committee given the recent rally in oil prices, continued impact of government intervention on the agriculture and manufacturing sectors amidst improving domestic demand. While the CBN estimates the 2021E real GDP growth rate at 3.50% y/y, we expect the economy to grow by 2.63% y/y.
 
On Inflation: The Committee expressed its delight that inflation has continued to trend downwards as seen from the three consecutive months of moderation in the headline inflation to 17.75% y/y as of June 2021. Although the inflation rate remains well above the Central Bank’s target of 6.0%-9.0% corridor, the Committee expressed optimism that the CBN’s intervention in the real sectors of the economy will further moderate the inflationary pressure as the negative output gap closes. Accordingly, the Committee expects the inflationary pressure to continue to ease as an improved supply of goods supported by sustained stimulus packages begins to offset the recovery in demand. Barring any significant shock to prices, we expect the base effect from the prior year to continue to slow down inflationary pressure over the rest of the year. Overall, we project average inflation rate of 17.26% y/y in 2021FY (2020FY: 13.21% y/y).
 
On Foreign Exchange: The Central Bank Governor stated that the Bureau De Change (BDC) operators had abandoned the objectives of their establishment, which is to serve the retail end-users who need USD5,000 or less. Instead, they have become wholesale dealers and illegally transact FX to the tune of millions of dollars per transaction. The Governor noted that the CBN sells about USD110.10 million per week to the BDCs (c. 5,500) – USD20,000 per BDC, translating to USD5.72 billion in a year. Accordingly, the Governor disclosed that the apex bank would immediately discontinue sales of dollars to the BDC operators, given that they have not fulfilled their obligations of only getting a little margin per FX transaction as agreed. Given the rent-seeking behaviour of the BDCs, the MPC decided with immediate effect to (1) discontinue the sale of FX to the BDCs, (2) allow the CBN to no longer process or issue new licenses for BDC operations in the country, (3) channel significant portion of weekly allocations of BDC allocations to the Commercial banks to meet legitimate FX demands and (4) instruct all commercial banks in the country to create a dedicated teller point in designated branches for the sale of FX for legitimate transactions. In the short-term, we expect the new development to lead to further pressure on the exchange rate in the parallel market given the (1) lag between commercial banks settling to adjust to the CBN’s directive and (2) knee jerk reaction from market participants induced by the urge to stockpile the greenback to mitigate an expected exchange rate pressure. Overall, we believe the effectiveness of the modalities in disbursing the greenback to the retail segment through the commercial banks would determine how much the current rates at the parallel market will diverge from the NAFEX rates.

Cordros’ View
 
The decision of the Committee to maintain the status quo on monetary policy parameters is consistent with our view (See report: MPC to Hold Rates Steady to Support Economic Recovery). More importantly, the outcome reinforces our view that the Committee is trying to balance supporting economic recovery and attaining price/exchange rate stability. In addition, we like the fact that the Committee reiterated to bring inflation closer to the upper band of the CBN’s medium target of 6-9% even though headline inflation has moderated for three consecutive months as of June. We expect that the MPC will lean towards an accommodative monetary stance until it is satisfied that substantial progress has been made in reviving the real sectors from the pandemic-induced slump in 2020. 
 
We see a strong possibility that the MPC will still favour a HOLD decision at its September meeting, particularly as the Q2-21 GDP figures would be flattered by a favourable base effect from the prior year. However, we think the Q3-21 growth numbers will be the deciding factor in influencing a rate hike in the November meeting. This is because it would give a better picture of the growth consolidation than the base effect induced growth figures in Q2-21. If the growth numbers surprise positively, we believe the MPC would likely shift grounds to its primary mandate of ensuring price stability and, by extension, stabilise the external sector. Thus, we envisage a 50bps hike in the MPR at the November meeting. In the meantime, we think the apex bank will sustain the use of its administrative measures and secondary “toolbox” such as the (1) Naira for Dollar Scheme, (2) CRR debits, (3) Loan-to-Deposit Ratio (LDR) and (4) direct intervention in the growth-stimulating sectors to manage system liquidity, enhance FX liquidity and sustain recovery in economic activities. 
 
Market Impact
 
Fixed Income: We do not envisage any fundamental changes in the dynamics of the FI market.  Bond investors are likely to maintain the strategy of playing at the short to medium segments of the yield curve with careful selective positioning on long-dated instruments. With the increased returns on fixed deposits and upside risks to inflation on the horizon, we expect investors to resist the DMO’s attempt to bring down rates at bond auctions substantially to improve inflation-adjusted returns. However, we believe the market will be paying close attention to (1) future data on inflation, (2) the FG’s financing plan for the recently signed NGN982.73 billion 2021 Supplementary Appropriation Bill and (3) the plan of the FG to secure FCY borrowings to determine the path of monetary policy and the extent of domestic debt issuances by the DMO. 
 
Equities: We expect a neutral reaction from equity investors, given that the outcome of the MPC meeting has already been priced in, and it is unlikely to cause any significant shift in trading patterns in the FI market.  In the interim, we believe the ongoing H1-21 earnings season will drive positive performance in the market as investors hunt for bargains in fundamentally sound stocks with a consistent history of interim dividend payment. With the MPC meeting out of the way, we believe the overall direction of the local bourse will be shaped by developments in the macroeconomic landscape and corporate actions.