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Cardoso faces naira, inflation, interest rate hurdles

Former banker endorses CBN Governor’s FX reforms amid naira volatility

When Olayemi Cardoso, the newly appointed governor of the Central Bank of Nigeria (CBN), assumes office, he will meet an in-tray filled with the hurdles facing the country’s economy.

The hurdles, which have lowered the standard of living in Africa’s most populous nation, include rising rates of inflation, increasing interest rates, and constant fall in the value of the naira against the US dollar.

When the Monetary Policy Committee (MPC) meets on September 25 and 26, these and other issues around the global and domestic economy and the outlook for the rest of the year will shape their decisions.

Nigeria’s August headline inflation increased to 25.8 percent year-on-year, largely attributed to a spike in the petrol price and naira depreciation.

Month-on-month headline inflation increased to 3.18 percent from 2.89 percent recorded in July. At its meeting in July, the CBN MPC raised the Monetary Policy Rate, also known as the benchmark interest rate, by 25 basis points to 18.75 percent.

It was the first decision of the monetary committee since President Bola Tinubu took the helm of Africa’s biggest economy on May 29, 2023.

Read also: Stocks rise by 0.71% as investors price-in Cardoso appointment, others

Hold stance expected at next week MPC

“The food inflation (29.34 percent) recorded an increase of 235 basis points when compared with the previous month. The highest increases were recorded in the prices of vegetables, milk, cheese, eggs, bread, cereals, potatoes, tubers, fish and oil. Food inflation has remained stubbornly high largely due to insecurity in food production areas, high logistics costs, and storage issues,” the Chinwe Egwim-led team of economists at Lagos-based Coronation Research said.

They expect a hold stance or a 25bps rate hike next week, given that headline inflation has continued to record upticks.

Developments at both the global and domestic levels will continue to pose significant challenges to Nigeria’s policy environment, even as the country’s output growth continues at a moderate pace amid the elevated general price level.

Reserves disclosures offset more positive recent developments

Fitch Ratings, in a September 6 note, said Nigeria’s weaker net international reserve position, as indicated in new data, emphasised the sovereign’s external vulnerabilities.

“Exchange-rate liberalisation and improvements in the overall monetary policy framework could strengthen the sovereign’s credit profile by easing foreign-currency supply constraints, but a recent loss of reform momentum and the constrained reserve position highlight the significant challenges such policy adjustments face,” Fitch Ratings said.

The rating agency said Nigeria’s exchange-rate liberalisation should make it easier to attract capital inflows, “supporting the country’s external position, on which lacklustre domestic oil production, which was 1.3 million barrels a day (including condensates) in July, remains a drag”.

“However, official and parallel exchange rates diverged again in August, undoing some of the narrowing seen after June’s depreciation of the official rate and highlighting the challenges to sustaining exchange-rate liberalisation. The divergence may partly reflect the CBN’s reluctance to allow further official rate depreciation due to high consumer price inflation,” Fitch Ratings said.

It said the CBN had made only partial progress in clearing its backlog of unsettled foreign-exchange forwards, highlighting ongoing foreign-currency shortages, and a weaker net reserve position could hamper the pace of exchange-rate liberalisation through more constrained FX supply and the potential to weigh on investor sentiment.

Gross foreign reserves fell by $3 billion in January-August 2023, reaching $34 billion in August, equivalent to around 4.1 months of current external payments, it said.

The agency said: “The recent publication of consolidated financial statements to end-2022 by the Central Bank of Nigeria (CBN), the first for many years, suggest the net reserve position may be weaker than we had anticipated. The statements, which confirm sizeable liabilities, increase transparency around Nigeria’s reserves, but important gaps remain, preventing a reliable assessment of the net reserve position.

“When we affirmed Nigeria’s rating at ‘B-’ with a stable outlook in May, we stated that external finances were a key rating sensitivity. We estimated that around 30 percent of Nigeria’s gross reserves (which were $37 billion at end-2022) comprised swaps with domestic banks, although we considered that some other reserves could well be encumbered.

Read also:Cardoso takes helm of CBN as FX backlog lingers

“The CBN financial statements indicate that liabilities at end-2022 include $7.5 billion of securities lending ($5.5 billion of which is short term), though it is unclear whether the pledged assets are reserve-eligible and are included in the CBN’s gross reserve figure. In addition, there is a $6.8 billion short-term liability from foreign-currency forward payables. Particular uncertainty surrounds nearly $32 billion of ‘FX forwards, OTC futures, and currency swaps’, which are recorded as an off-balance-sheet ‘commitment’ but are not broken down.”

It noted that the reserve disclosures offset more positive recent developments for Nigeria’s credit profile. Policy reform, notably fuel subsidy withdrawal and greater exchange rate flexibility, has proceeded more quickly than Fitch had assumed in its May assessment.

CBN should pursue low interest rate environment – Analysts

“On interest rate, I believe the CBN governor needs to take a heterodox approach to managing interest rate policy. With the liberalisation of the FX, I believe there is a need for monetary policy accommodation notwithstanding the elevated inflationary environment. Notably, the uptick in inflation is not money-induced, and as a matter of fact, money supply growth has been modest, with perhaps subtle outlook as economies like China and a few developed economies face risk of recession,” said Abiola Rasaq, former economist and head of investor relations at United Bank for Africa Plc.

According to him, it is apposite to note that monetary policy tightening cannot and should not be used as a tool for taming inflation at this time, given the very weak transmission mechanism, especially as inflation is currently driven mainly by structural factors which are outside of the control of monetary policies.

He said: “Indeed, a high-interest rate at this time would only serve to constrain supply of basic and intermediate goods, and by extension it would undermine overall productivity in the economy. So, using an orthodox policy of hiking interest rates at this time would be misguided and would only continue to undermine output growth and exacerbate the already poor unemployment rate in the country.

“Rather, monetary policy authority should pursue a low-interest rate environment to stimulate money supply and productivity, albeit this should be coordinated with relevant FX policies to prevent undue outflows of FX.”

Rasaq stressed the need to ensure that banks direct credit to the real sector of the economy in a reasonable manner, “while mitigating moral hazards and adverse selection that may lead to inadvertent weakness in the quality of banks’ credit portfolio”.

He said: “I do believe that a lower interest rate environment, which helps to improve supplies and productivity, may help in stemming the rise in some components of the consumer price index basket, thus easing the inflationary pressure.

“On the FX market, I believe the CBN should continue to monitor transactions in the market and ensure transparency of the system, with relevant penalties on erring market participants. It is important to follow through with the liberalisation, while providing requisite monitoring to prevent and check any market abuse. As the pent-up demand is gradually being cleared and the seasonal demand eases, we should begin to see positive offshoots of the liberalisation.”

Agric sector funding vital to check food crisis

In the first quarter of 2023, the agricultural sector contracted by 0.90 percent, compared with a growth of 2.05 percent in the preceding quarter, on account of the large decline in livestock production, the CBN said in its economic report.

This was occasioned by the persisting security challenges affecting cattle husbandry, and the limited access to cash that dominated the quarter, thereby constraining economic activities, since most of the activities within the sector are cash-driven, particularly in the livestock subsector.

Thus, livestock and fishery subsectors contracted by 30.57 and 2.92 percent, compared with a contraction of 1.59 percent and 3.02 percent in the Q4 of 2022, respectively. However, crop production and forestry subsectors grew at a slower pace by 1.93 percent and 1.24 percent, compared with 2.41 percent and 1.63 percent in Q4 2022 respectively.