Open Market Operations (OMO) bills sold by the Central Bank of Nigeria (CBN) were originally a tool for liquidity management by the apex bank, but along the line it somehow became an investment outlet for all comers including Pension Funds, Asset Managers, Insurers, Foreign investors and other institutional investors in the Nigerian fund management space.
The CBN Recently decided to return the tool to its original use when it banned all classes of investors (except banks and foreign investors) in both the primary and secondary markets from buying or trading OMO securities.
Naturally as these other class of investors could not participate in the purchase of OMO bills, they moved their considerable firepower into Nigerian Treasury Bills (NTB), leading to a flood of liquidity and resultant high demand (bid to cover ratios exceeding 4x in some instance), meant a crash in fixed income yields.
For instance 1 year FG Treasury Bills yielded 4.52 percent as at Thursday 0ctober 6, according to FMDQ data.
Not everyone is happy over this outcome however. For one some Pension Funds have grumbled over Financial Repression taking place.
Financial repression comprises “policies that result in savers earning returns below the rate of inflation” in order to allow banks to “provide cheap loans to companies and governments, reducing the burden of repayments”.
The yields on Treasury bills are now largely below inflation (which is in double digits) leading to negative real returns. Today 90 percent of the yield curve is below inflation, while a year ago all yields along the curve were above inflation (see chart).
There is also the valid argument about the fairness of seemingly favouring Foreign Investors (some of whom earn real returns in excess of 16% per annum in dollars) over domestic ones.
Feyi Fawehinmi, a U.K based accountant and social media influencer calls it the world’s first race based monetary policy. We wouldn’t go as far as that but would note that while the CBN has the legitimate mandate of price stability to pursue, there are also real world consequences they should be viewing carefully.
Then there is the huge cost of the policy itself. Estimates range between N1.7 trillion and N2trillion as the interest payments per annum on OMO bills issued between 2018 and 2019.
Fitch ratings in a note released in December revising Nigeria’s outlook to negative said:
“…risks stem from the central bank’s policy of attracting portfolio investments in its short-term Open Market Operations (OMO) bills through high yields and hedging instruments offered to non-resident investors at low cost, despite a wide spread between the naira and dollar interest rates. As a result, non-resident holdings of the CBN’s OMO bills soared to $17 billion by end-August, equivalent to 40% of foreign-currency (FX) reserves at the time.”
The CBN has not published its audited 2018 and 2019 annual reports so these are estimates but if the numbers are close to accurate then one can clearly see the problem.
Fitch notes that challenges to the durability of the current policy setting are underscored by increasingly complex regulatory measures taken by the CBN to reconcile its competing objectives of attracting foreign investments in OMO bills and spurring bank lending.
After the CBN barred non-bank residents from participating in the OMO market, it separately imposed a floor on bank loan-to-deposit (LDR) ratios to support credit growth.
The recent hike in LDR and introduction of weekly monitoring would help to cap the scope to which banks could create OMO assets, while the increase in the cash reserve ratio (CRR) to 27.5 percent at the last monetary policy committee (MPC) meeting, will help to sterilize the large maturity from OMO bills from non-bank investors which would have ultimately found its way to bank balance sheets.
Amidst all these the CBNs gross foreign exchange (FX) reserves are down $1.8 billion in 2 months (between Dec 2019 and February 2020)
Last year FX reserves fell by 12 percent between June and November as lower OMO market liquidity due to a narrower range of participants likely dampened net portfolio inflows, according to Fitch.
Nigeria’s current account (CA) balance has also shifted to deficit from a long-standing surplus, pointing to deteriorating macroeconomic imbalances and adding to external vulnerability.
Fitch expects the CA will record a deficit of 1.6 percent of GDP in 2019, its second-weakest level in 24 years, after a surplus of 2.6 percent in 2018.
Central Banks around the world are battling with tough choices over the impact of their chosen policy responses. In the U.S critics have said that the effect of the expansion of the Feds balance sheet and low interest rates is to punish savers and contribute to inequality. Central Banks in Europe and Japan are also battling with impact of negative interest rates on the financial system, especially on banks, insurers, Pension Funds and savers.
The Nigerian central bank is then not alone in navigating tough choices. The hope is that there is a plan for unwinding the CBNs balance sheet, that would not wreak havoc on the real economy!