September 25, 2024/CSL Research
Contrary to general consensus and our forecast, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) raised the Monetary Policy Rate (MPR) by 50bps to 27.25% from 26.75% at the close of its 297th Monetary Policy Committee (MPC) meeting on 24 September 2024. The Committee also raised the Cash Reserve Ratio (CRR) for Deposit Money Banks (DMBs) by 500bps from 45.00% to 50.00% and the CRR for Merchant Banks by 200bps from 14.00% to 16.00%. The asymmetric corridor was maintained at +500/-100 basis points around the MPR while the liquidity ratio was retained at 30%.
The Governor of the Central Bank of Nigeria (CBN) explained that this decision was necessary to address persistently high core inflation, driven largely by rising energy costs which have been undermining price stability. Although headline inflation moderated year-on-year in July and August, mainly due to a decline in food inflation, the MPC highlighted that overall inflation remains elevated. The ongoing increase in energy prices also signals persistent inflationary pressures in the economy. The Committee also highlighted several risks that could push food inflation higher, including flooding, increased energy prices, fuel scarcity, and, most critically, insecurity in farming communities.
The increase in the CRR to 50% will constrain the liquidity of Deposit Money Banks, limiting their ability to generate interest income, which may in turn lead to higher borrowing costs, tighter credit conditions, and reduced profitability. The broader economic impact could include slower credit growth and a more cautious approach to lending, potentially hindering investment and economic activity. We anticipate that the Central Bank of Nigeria (CBN) will maintain the current levels across all monetary parameters at its November 2024 meeting.
At yesterday’s Monetary Policy Committee (MPC) meeting, the MPC raised the Monetary Policy Rate (MPR) by 50 basis points, moving it from 26.75% to 27.25%. The Governor of the Central Bank of Nigeria (CBN) explained that this decision was necessary to address persistently high core inflation, driven largely by rising energy costs, which have been undermining price stability. Although headline inflation moderated year-on-year in July and August, mainly due to a decline in food inflation, the MPC highlighted that overall inflation remains elevated. The ongoing increase in energy prices also signals persistent inflationary pressures in the economy.
Inflation: Expected near-term uptick in Headline inflation
The primary objective behind the Committee’s decision to raise the MPR is to ensure price stability by further curbing inflation. The MPC observed that, despite the recent decline in food inflation, core inflation—which excludes volatile farm produce—remains elevated, largely driven by rising energy costs. The Committee also highlighted several risks that could push food inflation higher, including flooding, increased energy prices, fuel scarcity, and, most critically, insecurity in farming communities. These factors are expected to continue exerting pressure on the food supply chain, from farms to markets. While the MPC acknowledged the exchange rate’s impact on imported food prices, it emphasized that the federal government’s zero-import duty and VAT exemption policy on staple food items is expected to have a positive effect on food prices in the near to medium term. However, the delayed implementation of this policy as of the end of September could significantly reduce its anticipated benefits.
The Committee also highlighted the rising money supply in the financial system as a key driver of inflationary pressures. Additionally, the MPC noted the link between the monthly disbursement of FAAC funds and increased demand in the foreign exchange market, arguing that the combined effects of the MPR and CRR hikes would help mitigate the anticipated pressures associated with future fund releases. We agree that increasing these parameters will help absorb excess liquidity in the system and, by extension, reduce inflation. However, the extent of the impact remains uncertain, as a deeper analysis reveals that current price drivers are more cost-push than demand-driven. We expect two more months of year-on-year headline inflation increases before a decline resumes, largely due to factors such as the recent rise in petrol pump prices and flooding in key food-producing regions of the North. These developments are likely to offset the usual price relief from the harvest season for crops like beans, yam, soybeans, and ginger. We project inflation will moderate to 31.86% by year-end, with an average of 32.61% for FY 2024.
Capital flows: Impact anticipated to be positive
The hike in the MPR is expected to positively impact the attractiveness of yields on Nigerian fixed-income instruments. The resulting repricing, particularly at the short end of the yield curve, could provide an incentive for foreign portfolio investors seeking higher returns through carry trade, especially given the recent rate cuts by the U.S. Federal Reserve. However, we caution that these inflows could quickly turn into “hot money” outflows if certain conditions are not well-managed: 1) the recent progress on exchange rate harmonization must be sustained to maintain investor confidence, and 2) the anticipated benefits of selling crude oil and purchasing petrol from the Dangote refinery in Naira must translate into improved exchange rate stability and strengthened FX reserves. Without these, the stability of foreign investments may be jeopardized.
Economic growth: Real sector growth to be pressured
The pass-through effect of the MPR increase on the real sector of the economy is expected to be largely negative. Higher interest rates will lead to an increase in borrowing costs for businesses, raising operating expenses and squeezing profit margins. In response, businesses may pass these costs onto consumers, which could further fuel inflationary pressures across the economy.
In Q2 2024, Nigeria’s real GDP grew by 3.19% year-on-year, up from 2.98% in Q1 2024 and 2.51% in Q2 2023. However, the non-oil sector, a major contributor to GDP, remains vulnerable to price pressures. The sector’s growth, at 2.80% year-on-year in both Q1 and Q2 2024, reflects a stagnation that is likely to persist in the current high-interest rate environment. Projections for Nigeria’s 2024 GDP growth vary, with estimates of 3.38% from the CBN, 3.76% from the federal government, and 3.1% from the IMF. We expect that elevated interest rates and foreign exchange pressures will continue to constrain short-term growth, though these measures are aimed at creating a stable environment that will support long-term economic expansion by addressing inflation. Our forecast for Nigeria’s real GDP growth in 2024 has been revised downwards to 3.24% year-on-year, from an earlier projection of 3.32%.
Increase in the CRR: Banks’ financial intermediation role to reduce
With the CRR now at 50%, banks must set aside half of their total deposits with the Central Bank. This means a significant portion of their funds will be further immobilized, reducing the liquidity available for lending to businesses and consumers. With less money available to lend, DMBs will see a reduction in the income generated from interest on loans. Since lending is a primary source of revenue for most banks, this could negatively impact their profitability. As a result, DMBs will have less room to extend credit, constraining their ability to support economic activity. With more funds locked up with the Central Bank, banks may face tighter liquidity conditions and may need to rely on more expensive sources of funding. This could lead to an increase in the cost of funds for banks, prompting them to raise lending rates to cover these higher costs. As banks face higher funding costs and reduced liquidity, they are likely to increase lending rates, making borrowing more expensive for businesses and individuals. To counterbalance the higher CRR, banks may attempt to attract more deposits from customers by offering higher interest rates on savings and fixed deposits. This could increase competition for customer deposits within the banking sector.
Capital Market: Effect to be more pronounced in the debt space
The recent increase in the Monetary Policy Rate (MPR) is expected to have a significant impact on debt instruments in the fixed income market in the near term. We anticipate a fair level of repricing along the fixed income curve, particularly at the short end, as investors seek to capitalize on higher yields from new primary market debt offerings. Additionally, interest rates are likely to remain elevated in the money market due to the MPR hike and its relation to the asymmetric corridor, alongside the gradual “mop-up” actions associated with the increased Cash Reserve Ratio (CRR).
In the near term, we do not expect an immediate pass-through effect on the equities market. Currently, trading activities are being influenced by positive corporate disclosures and we believe this will remain the driver of the equities market in the near term. However, we believe that maintaining a high-interest rate environment for longer than anticipated will continue to compress profit margins for listed companies, especially manufacturing companies, which could negatively affect returns for shareholders.
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Post-MPC Review – MPC stays hawkish; hikes MPR by 50bps.pdf
