MPC to deploy some, not all its weapons

The monetary policy committee (MPC) meets today and tomorrow in Abuja in particularly difficult circumstances. The US Federal Open Market Committee (FOMC) met last week and announced a further US$10bn tapering of monthly asset purchases by the Federal Reserve, which takes the total down to US$55bn. The most recent data releases out of the US (industrial production, retail sales and non-farm payrolls) suggest that the bad weather phenomenon has passed. The authorities are therefore likely to feel comfortable with the underlying economy and labour market, and to maintain tapering at the current pace. Additionally the Fed’s forecasts now see the policy rate at 1.0% at end-2015, compared with 0.75% previously.

This adjustment may be modest (or “very limited” in the words of Janet Yellen) but it still fuels the fears of those who anticipate a rout in emerging and frontier markets as the end of the era of cheap money in the US approaches. In Nigeria there has been an exit by some portfolio investors: indeed official reserves have now fallen close to the level at end-July 2012 (ie before the JP Morgan announcement that FGN debt instruments would be included in its government bond indices) although the decline is attributable in part to drawings from the excess crude account (ECA).

The fall in the reserves has gathered pace since last month. Statements by policymakers including the CME and the acting governor, Sarah Alade, that the CBN’s remit of price and exchange-rate stability is unaffected by the suspension of Lamido Sanusi have failed to soothe the market. Ordinarily, fx demand eases after the imports for the end-year holiday season. This has not been the case in 2014: the most obvious explanation is the incidence of fx demand at auction which the CBN terms “speculative” (ie not import-related). The CBN sold US$3.1bn in its retail Dutch auction system (RDAS) in February, and a further US$2.4bn in March to date.

The MPC would not find itself in this predicament this week if the FGN had maintained fiscal discipline and built up a solid buffer against external shocks in the ECA. The same would apply if Nigeria was not suffering the current oil production losses and if oil revenues were flowing into the federation account as stipulated in law. However, it is in this predicament and is unlikely to be supported on the fiscal side in the near term. Its challenge therefore becomes to stem the exit of the portfolio investor and, ideally, the said speculative domestic fx demand with new policy measures.

Clearly, if the depletion of reserves continues much longer, then the current exchange rate becomes unsustainable. There is no question of waiting for the new governor to assume office on 01 June, particularly when we remember that only about 80 per cent of the reserves are the “CBN’s” for the defence of the rate.

The MPC has a number of tools which it can deploy this week including: an increase in the cash reserve requirement (CRR) for banks’ public-sector deposits from 75% to 100%; a rise in the CRR for their private-sector deposits from the current 12%; an increase in the monetary policy rate of 12%: and an adjustment to the midpoint and/or the corridor for the exchange rate. Additionally the CBN could impose administrative measures by circular such as restrictions on access to the RDAS.

The committee could use most of its ammunition simultaneously this week and come up with a very powerful statement to match the increase of 275bps in the policy rate at its extraordinary session in October 2011. Alternatively, and more likely in our view, it will deploy some of its firepower in the hope of reversing the depletion of reserves.

We expect a 100% CRR for public-sector deposits. It would have favourable liquidity implications, support the development of the Treasury single account and follow naturally from the increase to 75% in January. We would be surprised by a higher CRR for private-sector deposits. Only three of the eight members present in January voted for a rise from 12% to 15%, and they included Sanusi.  Under his governorship, the committee and the CBN had an uncompromising, sometimes punitive, stance towards the banks. We see a softening ahead, whether or not the new governor comes from the industry.

We also see a rise of 100bps in the policy rate to 13.00% on the basis of the CBN’s stance in its open market operations since late February. Since monetary policy, as we noted, has little support from the fiscal side, the MPC needs to keep the offshore community onside if it is to stem the depletion of reserves. In the ideal world, of course, the policy would have a domestic agenda. In this world, however, and given the CBN’s mandate, it has to cater to the offshore investor. Incidentally, the connect between the policy rate and lending rates for the real economy is weak for well-documented reasons such as low financial intermediation.

We think therefore that the committee will take these two steps and wait for the market impact. Thereafter it could adjust the midpoint and/or the corridor for the exchange rate if the depletion of reserves continues unchecked. An all-guns-blazing approach this week would be a surprise under the interim governorship. It would also leave no ammunition in reserve.

Gregory Kronsten