Pre-MPC Note: Monetary Policy Committee at a Crossroads

The Monetary Policy Committee (MPC) is scheduled to meet for its 250th meeting next week (23rd & 24th May 2016) to review global and economic developments within the last 2 months in the Nigerian economy. This is coming against the backdrop of sustained pressure on domestic output and elevated headwinds in the economy. Key indicators in the economy continue to worsen on the back of prolonged FX supply bottlenecks, delayed budget implementation, petrol market crisis, dragging consumer spending and weaker corporate earnings. Nevertheless, the recent policy pronouncement by the Minster of State for Petroleum Resources on guided deregulation of the petrol market is expected to take the centre stage given the impact on key monetary policy variables going forward.

Latest GDP numbers submitted by the National Bureau of Statistics (NBS) today indicated that Q1:2016 GDP contracted to 0.36% Y-o-Y (as against 3.94% growth in Q1:2015) as structural challenges in the system bites harder. Meanwhile, Consumer Price Index (CPI) for April released earlier in the week indicated that inflation rate galloped to 13.7% in April, 2.3% point higher than 11.4 % in February- just before the last MPC meeting. Persistent rise in prices remained driven by lingering structural constraints in the economy, as electricity rates, kerosene prices, vehicle spare parts, other import products and prolonged petrol crisis drove core inflation to 13.4% while food inflation settled at 13.2%. As a result, real interest rate worsened to -1.7% in April from -0.8% in March.

Although fiscal impulse from recently signed appropriation bill is anticipated to stimulate performance in H2:2016, the recent move by NNPC to deregulate the downstream petrol market comes with serious monetary policy implications. Oil marketers are now allowed to freely import fuel and to approach autonomous sources rather than the CBN for their FX needs. This has been broadly speculated to prompt the Apex bank to bite the bullet and allow the naira find its true value in the official market. Expectedly, the local bourse especially the oil & gas space has experienced a resurgence, rallying 4.9% in the last 6 days following the announcement by NNPC. However, failure on the part of the MPC to fix the currency market crisis will; 1) Widen the spread between interbank and parallel FX markets 2) Create more opportunities for arbitrage 3) Increase the pump price of petrol in the PPPRA price modulation template and 4) further pressure the general price levels, ultimately defeating the objective of price stability.

In the light of the above, we advocate the need for the MPC to adopt a complementary policy in its next meeting to forestall negative impact of a weaker exchange rate in the parallel market. As highlighted in our Flash Note (“Price Modulation “of the Downstream Sector… taking the Bull by the Legs) published earlier in the week, we restate our expectations as follows;

1. MPC should adopt a more flexible exchange rate policy that will close the spread between the official/interbank market rate and the N285.00/US$1.00 rate assumed by PPPRA in its pricing template. This is to reduce the pressure on the parallel market rate which has already been endorsed by the pronouncement of NNPC.

2. Remove the restrictions earlier imposed on 41 items that were excluded from accessing FX at the official/interbank market and allow the fiscal authorities to impose an appropriate trade policy in line with the agenda of the government. This will instil confidence in the system and ensure the influx FPIs and FDIs that will help increase FX supply. The CBN does not have to compel itself to meet any demand but can choose to intervene when it needs or wants to at market competitive prices. The arrangement will again reinstate the interbank market as the main market for pricing foreign exchange thereby creating the required liquidity for the market to work. If this is not done, a currency adjustment would aggravate the situation as the demand pressure from oil marketers and the banned 41 items could cause parallel FX market rate to skyrocket.

3. The Committee in the last meeting guided that it will maintain a positive real interest rate for which MPR was hiked to 12.0% when February inflation touched 11.4%. Inflation rate has accelerated to 12.8% and 13.7% in March and April 2016 with higher projections for coming months (14.6%); hence, for consistency, it would be proactive, if the Committee frontloads inflation expectation into MPR in anticipation of higher prices. Thus, we assume that MPC could set MPR at 15.0% to ensure positive real return in the interim.

4. Given that inflation in Nigeria, most especially the recent episode, has been studied to be majorly cost-push, we believe if the Committee leaves MPR unchanged, allowing the market to find its true yield, but concentrating on its OMO mop-up strategy of controlling liquidity, the result may be more absorptive for the economy. Therefore, the dilemma for the Committee would then be to either increase MPR to 14.0% or 15.0% in addressing negative real return problems and risk higher cost of credits to both government and businesses or allow the market set interest rate and risk inconsistency in policy.

Although, predicting the actual line of action of the MPC appears dicey, we imagine the Committee to choose amongst the following;

Option 1: Adjust the peg on FX rate close to the N285.00/US$1.00 rate as guided by PPPRA, remove the restrictions earlier imposed on 41 items allowing for flexibility of interbank market and choosing when to intervene if need be. (50.0% probability)

Option 2: Adjust the peg on FX rate close to the N285.00/US$1.00 rate as guided by PPPRA, remove the restrictions earlier imposed on 41 items allowing for flexibility of interbank market while also hiking MPR by 200bps to ensure a positive real interest rate. (30.0% Probability)

Option 3: Hold all rates constant, with a leeway for the Central bank to continue to adopt administrative measures in managing FX in line with recent trend and continue to harp on structural reforms and fiscal impulse in anticipation of improvement in the economy going forward. (20.0% probability).