Policy Bias Fueling Financial Repression to Outlast Economic Recession
The Central Bank of Nigeria’s (CBN) monetary policy dovish bias on interest rate fueling financial repression is expected to outlast economic recession.
Analysts are predicting reversal of negative growth in the first half of 2021, thus rates adjustment may not come before then.
The financial market has maintain low yields over a long period, this is not expected to ease following 2021 deficit budget plan.
Meanwhile, the repression has led to savers earnings below inflation rate as government continues to liquidate cheap local currency debt.
Yields on government instruments have plunged further in the fixed income market as non-bank local investors have finally rotated out of open market operation (OMO) bills.
Financial repression, a term that describes measures by which governments channel funds from the private sector to themselves as a form of debt reduction.
The overall policy actions result in the government being able to borrow at extremely low interest rates, obtaining low-cost funding for government expenditures.
In the fourth quarter of financial year 2019, the apex bank had placed ban on certain non-bank and individuals from participation in its OMO auction.
The decision has led to massive decline in yields on government instruments across board.
With these, it is not clear what would happen next.
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However, the fixed income market witnessed a regime change on Thursday 22nd October 2020, when non-bank local investors finally exhausted their OMO holdings.
Ordinarily, Chapel Hill Denham explained that this should have ignited an upward reversal in yields, but the firm expectation is that bonds will remain defensive in the near term due to two factors.
“The first consideration is that banks and foreign portfolio investors still have substantial OMO maturities between now and March 2021”, the firm explained.
In that case, analysts stated that yield direction henceforth will depend on CBN’s liquidity tolerance, or otherwise, in the next few months.
By implication, Chapel Hill Denham said investors will be watching the frequency and size of the Apex Bank’s OMO issuances.
“If the CBN ramps up OMO issuances to roll over the FPI-dominated OMO inflows in the coming weeks, it could start to force yield upwards.
“If the reverse occurs, then the liquidity backdrop will remain supportive of low yields in the fixed income market.
“We think the outlook is biased towards the later as the CBN appears convinced that its dovish monetary policy bias, which has led to financial repression, is neither fuelling inflationary pressures nor contributing to macroeconomic instability”, analysts explained.
Nevertheless, Chapel Hill Denham analysts believe that some anecdotal evidences also suggest that monetary, credit and exchange rate policies may have contributed to the macroeconomic instability in recent months.
Explaining further, analysts said the second factor to consider is fiscal policy, particularly the Local Currency (LCY) borrowing plan of the Debt Management Office (DMO).
DMO has taken advantage of the strong demand for securities to frontload its issuances for 2020, and already sold over 95% of its domestic issuance target as at October 2020.
As a result of this, analysts at Chapel Hill Denham said they think that the supply of government securities will remain thin in the short term, which is supportive for fixed income yields.
Particularly as market have substantial OMO maturities (N2.4tn), trickle of bond coupons (N23bn) and outstanding FAAC distributions left for the year.
Analysts traced the beginning of the bond rally to the CBN’s dovish tilt at the March 2019 MPC meeting, when the benchmark policy rate was cut for the first time in four years, by 50bps to 13.50%.
The rally gained momentum in October 2020 following the CBN’s decision to exclude non-bank local investors from its Open Market Operation (OMO) bills market.
That decision subsequently freed up over N3.5 trillion of liquidity from the OMO market, and into the sovereign bond market and other risk assets.
At the onset of the COVID-19 pandemic in March 2020, which triggered risk aversion, the bond market corrected.
But, the rally resumed in April as the CBN turned more dovish by substantially reducing issuances of OMO bills, which was followed by two 100bps policy rate cuts.
Analysts said what finally threw the market into a frenzy that resulted in the record low yields, was the indication by the DMO that the supply of bonds will reduce considerably in Q4-2020, starting with the October bond auction.
