September 28, 2022/CSL Research 

• The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) in another shocking move, further raised the Monetary Policy Rate (MPR) by 150bps to 15.5% from 14.0% at the end of its penultimate Monetary Policy Committee (MPC) meeting yesterday. The major considerations remained inflation and capital flows. 
• The MPC also raised the CRR to a minimum of 32.5% from 27.5% previously. However, many banks already have effective CRR significantly above 32.5%. With the increase in CRR, we expect the CBN to begin its frequent CRR debits and we expect this to weigh on banks’ profitability and mask the benefits of higher yields on their earning assets from an expected increase in rates. 

• We retain our view that a continuous hike in rate will likely constrain the country’s fragile growth while achieving very little in terms of combating inflation and attracting foreign inflows.

The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) surprised the market yesterday afternoon by raising the MPR further for the third consecutive time to 15.5% (highest level since 2006) from 14.0% previously. The CBN Governor noted that the committee deliberated on the impact of the widening margin between the current policy rate of 14.0% and the inflation rate of 20.52%. The committee was of the view that loosening will further widen the negative real interest rate gap and worsen financial market conditions, as this will discourage savings and investment inflows. The committee also believed that with the aggressive policy normalization in advanced economies, any cut to rate will lead to further capital outflows and hurt the exchange rate. A hold decision was also not considered as it would mean a continuous deterioration in Fixed Income real earnings. The MPC was of the view that a rate hike would consolidate the gains of the previous hikes, reduce capital outflows, and ultimately lead to the appreciation of the Naira.

Inflation: Inflation remained the major focus of the MPC. The MPC was concerned that within a four-month period, inflation had accelerated significantly by 280bps to 20.52% in August 2022. The Committee was of the view that given the primacy of its price and monetary stability mandate, it was expedient that significant focus must be given to taming inflation. The headline inflation reached a 17-year high of 20.52% in August 2022, driven both by food (+110bps) and core inflation (+94bps) and this was not ignored at the MPC meeting. For one, the CBN expects election spending to intensify in the coming months. The incoming price data for September (CSL estimates: 20.96%) is expected to remain high due to the impact of increased fuel costs on food prices, currency depreciation and elevated energy prices. We however expect a slight moderation in food prices as the harvest season commences. In our view, the rate hike will at best only help control inflation minimally since the supply-side factors remain dominant. Again, pass-through effect from rising transport cost will continue to add another layer of pressure amidst the worsening security situation. Overall, we expect headline inflation to close the year at 20.97% in December 2022.

Capital flows: On capital flows reversal, the committee noted that with the aggressive policy normalization in advanced economies, any cut to rate will lead to further capital outflows and hurt the exchange rate. The committee believes 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 expected further rise in interest rates would do little to attract FPI flows as foreign investors would likely remain sceptical of both FX liquidity and the exchange rate. That said, it may be successful in preventing further capital reversals. Moreover, many FPIs will rather stay on the sidelines till the elections are over and they can see a clear policy shift or otherwise. 

Economic Growth: Nigeria’s Gross Domestic Product (GDP) grew by 3.54% y/y in real terms in the second quarter of 2022, up from 3.11% in Q1 2022. The improvement in economic activities, we believed, will give the CBN some comfort, and it did. In our view, the aggressive rate hikes will likely constrain the country’s fragile growth while achieving very little in terms of combating inflation and attracting foreign inflows. The committee forecasts output growth will be sustained for the remaining part of the year, although at a subdued pace, in line with our view.

Stock Market: Out of the five MPC meetings held so far in the year, the equities market has closed negatively on four occasions post the meetings. While the news of a further and aggressive rate hike is expected to have a negative impact on the stock market, at this point, save for positive corporate actions and announcements, especially on the heavily weighted stocks that can boost investors’ sentiments, the equities market tilts towards a bearish trend. Besides, with the expectation of seeing more activities in the fixed income market, investors would only focus on fundamentally sound stocks. 

Impact on the banks 

CRR: The MPC also raised the CRR to a minimum of 32.50% from 27.5% previously. The CBN’s frequent and arbitrary discretionary CRR debits mean many banks already have effective CRR significantly above the previous 27.5% and the current 32.5%. In 2021, the constant CRR debits left many banks with intermittent liquidity problems, forcing banks to reprice deposits and forcing some to approach the SLF window and the interbank window. With the increase in CRR, we expect the CBN to begin its frequent debits. We expect the continuous CRR debits by the CBN, which sterilises funds which otherwise should earn interest to continue to weigh on asset yields and result in an increase in funding costs as banks reprice deposits to attract more funds. 

Rate hike:  Banks should continue to benefit from better yields on their investment securities portfolio and loans. Though we expect funding costs to also rise, we believe banks, especially the bigger banks will see faster growth in yields compared with funding costs as they have a large pool of cheap retail deposits. That said, the gains arising from yield increase will likely be subdued by possible illiquidity problems created by CRR debits.

Conclusion: At this point, the best caption that fits into this narrative is that new challenges bring new approaches. The current 15.5% rate is the highest rate the CBN has attained since 2006 when the Bank replaced MRR with the MPR. Within five months, the CBN has achieved a cumulative 400bps rate hike. Taking a cue from yesterday’s meeting, it is evident that the outcome of the next and last MPC meeting in November will depend on the direction of inflation and capital flows.