Further Monetary Expansion ...How Much Longer?

The Monetary Policy Committee (MPC) held its last meeting for the year on the 23rd and 24th of November at the meeting, Committee assessed the prevailing policy of the central bank to leave the market awash with liquidity in a bid to foster credit expansion by Deposit Money Banks (DMBs) to the Real sector. However, the committee noted that the expected impact was yet to be met and it was against this backdrop that the MPC decided to reduce MPR from 13.0% to 11.0%, adjust the asymmetric corridor around the MPR  to +2.0% and -7.0% from +/-2.0%and slash Cash Reserve Ratio (CRR) further from 25.0% to 20.0%.

The 200bps cut in MPR and introduction of an asymmetric corridor around the MPR at +200bps and -700bps are the most significant of the policy decisions reached as this brings the Standing Lending Facility and Standing Deposit Facility rates to 13.0% and 4.0% from 15.0% and 11.0% respectively. The 5.0% cut in CRR is expected to add approximately N771.4bn to liquidity level based on October data from the CBN. A caveat was added, that the additional liquidity would be released on a condition that the funds will be channelled to the real sector. The more accommodative stance is expected to drive yields downwards in the secondary Bonds market as dealers are likely to bid-down on current rates in anticipation of lower yields at the primary market auction.

We expect NIBOR rates currently at 8.5% on average to adjust to the new SLF rate to an average of 7.1% (if the same spread is maintained) whilst average yields on T-bills and Bonds market have fallen to 3.1% and 9.5% respectively. Given the lower financial market rates, we expect slight reduction in prime lending rate.

In the short term, we do not expect the ease in monetary policy to immediately translate to increase lending to the real sector, especially given the high risk retail/SME loans segment. The various challenges would require more adjustments by the fiscal authorities to de-risk the sector. However, with the restriction on all cheap income lines, we expect a significant medium term expansion in credit to the private sector (currently at N19.1tn in October 2015 and up 6.8% Y-o-Y) by DMBs. This will necessitate banks to improve on their risk management framework to identify opportunities and earn a relatively higher margin (compared to the cheap rates in the fixed income market.

We anticipate Interest income earned by banks on investment securities and loans to reduce in the first quarter of the year as banks adjust to the lower primary auction rates in T-bills and bonds markets and reduced interbank rates. Cost of Funds will reduce but only marginally due to: 1) 25.0% of MPR minimum mandated interest rate on savings deposits and 2) the 80.0% maximum Loan to Deposits ratio regulation by the CBN that will continue to drive demand for deposits.

The CBN's action to buoy aggregate demand side of the economy by increasing liquidity levels and reducing market rates will have a feedback effect on price and exchange rate stability in the short to medium term. As the CBN has remained resolute in its resolve to keep administrative measures in place to reduce depletion in the FX reserves and create a contrived stability in interbank FX rates, the effects would be felt in the parallel market for FX where rates would further depreciate. We estimate a conservative FX rate of N255.00/US$1.00 at the parallel segment. The strong pass-through of lower exchange rate on consumer prices in Nigeria suggests high inflationary pressure is inevitable in the short to medium term.

Reactions from the Meeting
The relaxed monetary stance of the MPC after its last meeting for the year, though positive for stimulating short-term economic growth, may not come without negative implications for the economy in the medium term. With the reduction in interest rate, Nigeria is likely to face increased capital flight consequences in the medium to long term, more so if the Fed raises its benchmark interest rate at its next meeting in December.

Following the decision of the MPC, we noticed a re-pricing of stocks in the equities market during the week as investors sold down on Banks (down 4.2% W-o-W) relative to other sector (down 0.8 W-o-W). Equally, the spike in financial market liquidity resulting from the reduction in CRR to 20.0% as well as the expansionary 2016 fiscal year may further trigger inflationary pressure. While the decisions by the MPC ensued from a need to grow the real sector through increased lending by banks, we believe risk considerations in the overall economy may force Banks to remain conservative at expanding their loan books.