May 25, 2022/CSL Research

• The authorities raised the Monetary Policy Rate (MPR) from 11.5% to 13.0%, in a surprising move. This, according to the committee is to moderate inflationary pressure, restrain the speed of capital flow reversal, provide incentives for foreign capital inflows, and sustain remittances.  
• The rise in the MPR is a signal that market interest rates will rise, to make Naira bonds attractive. The move also implies the government’s borrowing cost is set to rise.  
• Improved rates may be negative for the stock market. The NGX ASI, declined significantly by 1.82% yesterday when the news broke. However, banks should benefit from better yields on their investment securities portfolio.

The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) surprised the market yesterday afternoon by raising its MPR from 11.5% to 13.0% for the first time in almost six years while keeping other parameters constant. According to Bloomberg, only two of 10 economists in a Bloomberg survey forecasted an increase – one by 25 basis points and the other by 50 basis points, and we also held that view.

In the current circumstance, the Committee was of the view that it was confronted with the choice of either holding all policy parameters constant to allow previous policy measures to continue to support growth or tightening the policy stance to curb money demand growth and upward movement of domestic prices and prevent capital reversals. A loosening option which would likely result in increased liquidity,

intensify inflationary pressure, and worsen the FX situation was not on the radar. The Committee expressed great concern around the headline inflation at 16.82% in April 2022. The Committee noted that the current rise in inflation may be inimical to growth and expressed their belief that tightening would moderate inflationary pressure pass-through to exchange rate depreciation.

They also expressed concerns around capital reversals. As part of measures to address the supply constraint in the foreign exchange market, yields on domestic instruments must be competitive to moderate the speed of capital flow reversal. Lastly, the committee noted that
tightening could moderate government domestic borrowing.

‘Nigeria’s annual inflation rate accelerated for the third consecutive month to 16.82% in April 2022, from 15.92% in the prior month and this was flagged as a major consideration, in line with our view that it would not be ignored. While the MPC agreed that several supply-side factors, which cannot be abated by a rate hike, were responsible for the inflationary pressure, they also noted that emerging evidence showed that money demand pressure is on the rise.

To some extent, such a narrative can be considered valid. Despite the surge in the general prices of goods and services, demand for goods, especially for essential spending, remained unperturbed, which benefitted companies in the Consumer and Industrial sectors. The committee noted that election spending is likely to result in huge liquidity injections into the economy for the rest of the year and, as such, pose a threat to price stability. The CBN had previously applied unorthodox measures like the constant and arbitrary CRR debits to control money supply. In our view, the rate hike will at best only help control inflation minimally since the supply-side factors remain dominant.

Capital flow: On capital flows reversal, the CBN noted that the normalisation of monetary policy in the US, which is becoming faster, is largely responsible for the bearish trend in the capital market. Global central banks have turned hawkish after their prolonged covid stimulus packages to ease the impact on the economy that is beginning to have a ripple effect on inflation. The committee noted in the communique that tightening would moderate the speed of capital flow reversal and provide incentives for foreign capital inflows, with its complementary impact on exchange rate stability. In our view, the policy shift, if followed up with a rise in market interest rates, would have a fair chance of attracting domestic banks into the bonds market, and of attracting domestic pension funds, but foreign investors would likely remain sceptical of both FX liquidity and the exchange rate and we see very little impact on capital inflows. That said, it may be successful in preventing capital reversals and help retain what is left of foreign capital.

Government Borrowing: The committee noted that tightening could moderate government domestic borrowing, citing the government’s huge debt service cost. We believe the committee reasons that a high cost of domestic borrowing will discourage further government borrowing. What is clear is that the government will need to fund its ambitious 2022 budget either by borrowing locally or externally.

Rates at the Eurobond market are at record highs and borrowing externally will still come at a high cost. Either way, the government’s debt service cost is set to rise.

Economic Growth: Nigeria’s Gross Domestic Product (GDP) grew by 3.11% y/y in real terms in the first quarter of 2022, down from 3.98% in Q4 2021 The CBN governor noted that while it may seem contradictory to raise rates in the face of fragile growth, it is a dilemma that most central banks around the world today are grappling with.

According to him, reining in inflation is more urgent in the sequence of policy objectives. We reiterate our view that the factors driving inflation remain largely supply driven. Though we acknowledge the threat of more money supply through increased election spending. In our view, the shift in policy will likely constrain the country’s fragile growth while achieving very little in terms of combating inflation and attracting foreign inflows.

Also, when we consider the impact of specific events that occurred in Q2 2022 such as the barring of outgoing calls in the telecommunication sector and elevated operating costs for the manufacturing sector alongside the fading off favourable base effect, growth in Q2 2022 will likely moderate further.

Stock Market: It appears the local bourse negatively reacted to the news as the benchmark equity index, NGX ASI, declined significantly by 1.82% yesterday, the highest daily decline since the start of the year. The closest period to this negative level seen was on 01 December 2021 (-1.81%). Meanwhile, while the news of improved rates was negative for the stock market, banks should benefit from better yields on their investment securities portfolio. Hence, we see renewed investors’ interest in the banking universe, especially for companies that relatively have cheap valuations. Besides, with the expectation of seeing more activities in the fixed income market, investors would only focus on fundamentally sound stocks.

Conclusion:

Overall, in our last MPC review note in March 2022, we pointed out that the direction of the MPR highly depends on local and global happenings. Given the current domestic and foreign events, the MPC reacted with a 150bps rate hike. Looking ahead, we reiterate that the direction of the MPR at the next meeting in July is also contingent upon happenings in the local and global space.