Pre-MPC: Competing Objectives Call for a Balancing Act

The Monetary Policy Committee (MPC) will be holding its fifth meeting for the year on the 19th and 20th of September 2016 to review developments in both the global and domestic economy. In the periods following the last MPC meeting held in July, the global economic and policy environment has experienced a mixed bag of fortunes. Whilst concerns surrounding a global contagion from presupposed hard-landing for Britain following the BREXIT vote have dissipated, global growth outlook has remained subdued with the IMF revising its 2016 forecast downwards from 3.2% to 3.1%.

Monetary policy environment has however stayed broadly accommodative, with the Bank of England cutting interest rate from 0.5% to 0.25% in August to mitigate the potential damning impact of the Brexit vote, whilst the ECB and BoJ have maintained easy policy outlook. This, in addition to policy and polity improvements has continued to fuel the 4-month long rally in emerging markets assets. Yet, mixed policy guidance from the US Fed regarding speculations of a further hike in Fed Fund rate remains a risk on the horizon and investors will be looking towards the FOMC meeting scheduled to hold next week.

On the contrary, domestic economic headwinds have remained elevated within the period after the last MPC meeting. On the 31st of August, the National Bureau of Statistics released various reports on macroeconomic indicators which were all indicative of weaker macroeconomic fundamentals. The Q2:2016 GDP figures confirmed the widely expected recession in the Nigerian economy following two consecutive quarters of contraction; -0.4% Y-o-Y in Q1:2016 and -2.1% Y-o-Y in Q2:2016. Labour market condition also slackened further as unemployment rate rose to 13.3% in Q2:2016 from 12.1% in Q1:2016 while capital importation fell 9.0% Q-o-Q and 75.7% Y-o-Y in Q2:2016.

Foreign trade data was the only macroeconomic indicator that improved within the period, as merchandise trade value grew 49.0% Q-o-Q in Q2:2016 while trade deficit trimmed 78.9% Q-o-Q. However, we note that the merchandise trade surge was majorly driven by the devaluation of the domestic currency in Q2:2016 and not necessarily an increase in trade volumes. Nonetheless, the significant improvement in trade deficit (despite below-trend oil export) is positive in restoring external sector balance.

Inflation rate has also continued on a steady rise, and this was further confirmed by the recently released August Inflation report which signalled a rise in Headline Inflation to 17.6% from 17.1% in July, driven by both the food (+1.2% M-o-M) and core (+0.9% M-o-M) sub-indices. However, CPI growth has trended lower on a month-on-month basis, paring to 1.0% in August from year-high of 2.8% in May. Despite positive steps taken to harmonize rates at various segments of the FX market, the spread between interbank and parallel market rates continues to widen, reflecting shortages at the official market. The aforementioned macroeconomic challenges have implications for asset quality and capital adequacy for banks and consequently financial stability. Non-Performing Loans ratio rose to 10.7% in June 2016 from 4.9% in December 2015 and above the 5.0% regulatory threshold.

Thus, with economic growth faltering, inflation spiking, FX rates diverging and increasing downside risk to financial stability, the challenge before monetary policy continues to be how to achieve a balancing act amongst competing policy objectives. The CBN’s justification for policy tightening in July was that policy instruments could do little to buoy a structural-induced growth slowdown, hence more prudent to focus on anchoring inflation expectation lower and repricing fixed income assets yields upward to compensate investors for higher inflation, attract foreign capital and buoy liquidity in the FX market. Recently released personal statements of MPC members at the last sitting suggest this strategy was a hard sell with votes evenly split between hiking MPR and maintaining Status Quo. Ex-post, deciding on the next policy course of action requires an assessment of the impact of decisions taken in July, particularly policy members’ views of the questions below:

  • If the MPC presumes policy easing will do little to support growth, does that also imply tightening will have no negative feedback on consumption and private investment spending, especially given the marked downturn in economic activities?
  • Has the hike in interest rates (policy and markets) significantly anchored inflation expectation lower?
  • How responsive has portfolio capital been to the aggressive policy tightening which has resulted in a humped yield curve ostensibly guided to achieve positive short term real return?
  • Have FX market liquidity dynamics improved and long-term foreign capital (a measure of economic confidence) responded to policy-tightening?

Afrinvest research believes the committee members face a choice to:

  • ease monetary policy in response to growth slowdown and widening output gap;
  • maintain status quo whilst reinstating the need to fully implement the currency market reforms to regain credibility and push for fiscal-monetary policy coordination to implement structural reforms;
  • hike rate further to conform with recently guided inflation-targeting thrust and further attract portfolio capital inflows.

Whilst we believe the current recessionary shock conventionally calls for a more accommodative fiscal and monetary policy alongside structural reforms to jumpstart growth, we think the MPC will likely not take this path given that fiscal, FX liquidity and terms of trade realities are constraining policy options. Also, by tightening at the last meeting, the MPC Crossed a Rubicon and to backtrack yet again will jeopardize efforts at ensuring policy consistency and restoring credibility. Thus, we expect the MPC to maintain status quo on policy rates and wait on impacts of fiscal stimulus, talks on reaching a détente with Niger-Delta militants and full implementation of recent FX reforms.