Monetary, Fiscal, Credit, FX Policies add to Macroeconomic Instability
Bolaji Balogun, Chief Executive Officer, Chapel Hill Denham
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Monetary, Fiscal, Credit, FX Policies add to Macroeconomic Instability

Analysts have said that monetary, fiscal including credit and foreign exchange policies of the government added to macroeconomic instability in the country today.

Chapel Hill Denham made this submission in its response to the recent reduction in the monetary policy rate cut.

Economic data shows that inflation rate has been on ascendancy for 12-month straight as the yields on fixed income market have plunged, significantly.

 With the rate cut, analysts believe that the apex bank stance to sustain trend in the fixed income market may lower foreign investors’ participation in the economy.

Monetary, Fiscal, Credit, FX Policies add to Macroeconomic Instability
Bolaji Balogun, Chief Executive Officer, Chapel Hill Denham

It would be recalled that the Monetary Policy Committee (MPC) of the Nigeria’s central bank hacked benchmark interest rate by 100 basis points to 11.5% on Tuesday.

The MPC lowered the discount window rates, by adjusting the asymmetric corridor around the MPC to +100bps/-700bps from +200bps/-500bps.

This effectively lowered the Standing Deposit Facility (SDF) rate by 300ps to 4.5%, and the Standing Lending Facility (SLF) rate by 200bps to 12.50%.

In the post-MPC review, analysts explained that the September MPC meeting was held against the backdrop of significant deterioration in the CBN’s twin mandates of foreign exchange rate and price stability.

The naira has weakened against the United States dollar by 5.5% in the investors and Exporters Window since March, while parallel market premium remains high at N79.

This high disparity in FX rate has been sustained despite the recent resumption of sale to the Bureau De Change (BDC) segment.

In addition, the nation’s headline inflation rate printed at a 29-month high of 13.22% year on year  in August.

Chapel Hill Denham said inflation is expected to hit 14.5% by year-end after the recent reduction in energy subsidies.

“With the MPC’s decision to cut benchmark policy rate for the second time in 2020, the CBN has effectively reinforced its pro-growth stance of supporting households and businesses against the COVID-19 shock, while relegating the importance of its primary mandate of FX and price stability”, analysts said.

Indeed, Chapel Hill said in arriving at its decisions, the MPC observed the need to take a bold stance of loosening monetary policy and stabilising the exchange rate, considering fiscal policy is constrained by weak revenue, lack of fiscal buffers and high burden of debt service.

While the easy monetary policy stance should help counterbalance the recent fiscal tightening (indicated by the removal of energy subsidies), there are probably negative feedback effects on macroeconomic stability in the short term and domestic savings rate in the long term, the investment firm stated.

Chapel Hill however said the recent reduction in minimum savings rate to 10% from 30% of MPR, the 100bps cut in MPR effectively translates into a 10bps reduction in minimum savings rate to 1.15%, despite rising inflation expectation.

The firm explained that the CBN tacitly shelved responsibility for the elevated inflationary pressures, suggesting that available evidence does not support the view that the rise in inflation was due to monetary factors, but rather driven by structural rigidities and supply shocks.

“The CBN’s argument has some merits, considering it has maximised the use of CRR debits to mop-up excess liquidity.

“As at July 2020, bank reserves with the CBN stood at a record of ₦11 trillion, up 2.1x from N5.1 trillion in July 2019.

“However, on closer inspection, some anecdotal evidences also suggest that monetary, fiscal, credit and exchange rate policies may have contributed to the macroeconomic instability in recent months”, Chapel Hill stated.

The investment firm explained that the CBN has been aggressively pushing a credit growth agenda, through the use of intervention funds and unorthodox policies such as the minimum LDR.

This yielded a 24% year on year expansion in credit to the private sector as at July 2020, and analysts express view that the credit impulse is contributing to demand-side pressures on the exchange rate.

Chapel Hill explained further that Nigeria’s current account balance has been steadily deteriorating since 2018, due to ballooning fiscal deficit largely monetised by the CBN.

It added that the protectionist policies and lack of FX liquidity, have weighed on food and core inflation recently.

Specifically, the firm said imported food inflation is currently at the highest level since April 2017, suggesting that weak FX liquidity, due to COVID-19 shock and lack of flexibility in the pricing of the FX rate, is contributing to surging food inflation.

Analysts stressed that the CBN Governor did not offer any guidance on the outlook for the currency and FX management framework, indicating that the apex bank will continue playing the waiting game while hoping for a rebound in oil prices.

With oil prices remaining stuck at US$40 – 45/b range, Chapel Hill Denham said FX liquidity challenges will likely continue in the near term, with pressures likely to increase due to credit-fuelled demand.

Read Also: CBN to Borrow at 4.5% from SDF, Lend to Banks at 12.5%

It said the MPR is generally viewed as a blunt monetary tool, given market interest rates are largely delinked from the movement in MPR and yields are already depressed at single digits.

Yet, the CBN’s dovish policy signal is hard to ignore, and will likely catalyse further compression in fixed income yields in the secondary market and bond Primary Market Auction (PMA).

However, analysts said over the medium term, liquidity factors are expected to play a greater role in determining the direction of fixed income yields, with an inflection point likely to come in Q1-2021, once OMO maturities fuelling the fixed income rally begin to subside.

Contrary to consensus expectation of a status quo outcome, the MPC meeting of the CBN ended with a very dovish outcome.

For the second time this year, the MPC eased its benchmark Monetary Policy Rate (MPR) by 100bps, to a 4-year low of 11.50%.

Notably, six members of the MPC voted to reduce the MPR by 100bps, one by 50bps and three voted to hold.

Nine members voted for the change in asymmetric corridor while one voted to hold. However, the MPC voted unanimously to retain the Cash Reserve Requirement (CRR) at 27.5%, and liquidity ratio at 30.0%.

The key considerations of the MPC include the significant headwinds to economic growth.

However, unlike previous meetings, analysts said the Committee did not give a specific growth guidance, but projected a return to positive growth in Q4-2020, or latest by Q1-2021, based on knock-on impacts of monetary and fiscal expansion.

It however considered upward pressure on domestic prices attributed to structural rigidities and supply shocks, including the prevalence of security challenges, adverse weather conditions, increase in petroleum pump price, deregulation of electricity tariff and exchange rate adjustment.

The MPC noted the increase in aggregate credit and encouraged further expansion in credit to employment-generating sectors.

In addition, analysts said the CBN has disbursed N3.5 trillion worth of intervention funds in the wake of COVID-19 pandemic, and the Loan-to-Deposit Ratio (LDR) policy has resulted in N3.8 trillion increase in DMBs credit to various sectors to ₦19.33 trillion as at August 2020 from ₦15.57 trillion as at May 2019.

In its decision process, the Committee noted the rising public debt profile and urged fiscal authorities to strengthen debt management strategy, explore other sources of revenue, and enhance efficiency in public expenditure.

As well, MPC also considered the need to sustain regulatory surveillance over the banking system to ensure that non-performing loans (NPLs) remain low.

Banking sector’s NPL ratio was estimated 6.1% in August 2020, down from 6.4% in June 2020 and 9.4% in August 2019, due to recoveries, write-offs and disposals.

Monetary, Fiscal, Credit, FX Policies add to Macroeconomic Instability