50% CRR Removal to Squeeze Liquidity From System to Support Naira

The introduction of a 50% CRR on public sector funds at the 22/23 July MPC is an indication that the Central Bank of Nigeria (CBN) is keen to squeeze NGN liquidity to support the exchange rate. This is even as inflation in Nigeria reached 8.7% y/y in July, from 8.4% y/y in June and 9.0% y/y in May, and remained in single-digit territory for a seventh consecutive month. This outcome was broadly in line with our forecast of 8.8% y/y and market consensus. Interestingly, m/m inflation remained marginal, at 0.5% in July, from 0.6% in June and 0.7% in May, which is in line with the muted monthly price pressures recorded this year. In fact, m/m inflation volatility appears to have reduced to negligible levels lately.

All items less farm produce inflation rebounded to 6.6% y/y in July, from 5.5% y/y in June and 6.2% y/y in May, while food inflation rose modestly to 10.0% y/y , from 9.6% y/y and 9.3% y/y, respectively. Should the benign m/m inflation path persist in coming months, there is scope to believe that a sub-10% annual inflation environment will prevail in H2:13.

While this will be positively perceived by the CBN, a cut in the MPR or a shift to a more accommodative monetary stance will almost certainly not materialise. This is because the central bank is primarily concerned about exchange rate stability at this stage, an objective that would be compromised by a qualitative turn in monetary policy. The introduction of a 50% CRR on public sector funds at the 22/23 July MPC illustrates this stance; indeed, the CBN is keen to squeeze NGN liquidity to support the exchange rate, albeit not necessarily via the MPR or OMOs as in the past.

At first glance, bonds offer value given the high real rates on offer, even though this has now been the case for some time, and yet market yields have barely responded to this new paradigm in 2013. This certainly suggests that market rates are much more sensitive to the effective and even formal monetary stance, the portfolio flow position and the resilience of the exchange rate than the trajectory of inflation.

 The other issue is the sustainability of the current CPI trend post-2013, as base effects deteriorate and fiscal policy becomes more expansionary ahead of the 2015 elections. Besides, a structural multi-year drop in inflation to single digit levels would require more tangible progress in delivering adequate power supply and addressing infrastructure bottlenecks, two assumptions that will take time to materialise.

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