Analysts Disagree Over Acceptable Level Monetary Tightening

While financial analysts agree that monetary tightening remains the way to go, there are diverse views on what level of tightening will safeguard the economy against electioneering spending and possible imported food inflation amid growing fears that there might be shortfall in food production this year.
Samir Gadio, analyst with Standard Bank of London believe that since the excess liquidity in the system is about N490 billion, the 300 basis point cap on private sector Cash Reserve Ratio (CRR) is sufficient to deal with the problem of over-flowing liquidity.
But Razia Khan, another analyst with Standard chartered Bank of London sees the hike in private sector CRR as a mere compromise.
The Monetary Policy Committee (MPC) of the Central Bank of Nigeria, meeting with nine members, sent a clear message on its commitment to price stability – tightening policy further. “There appears to have been some debate on the nature of the tightening, with a 300 bps rate hike in the private sector CRR almost appearing to be the compromise solution. The MPR is retained at 12 percent. The public sector CRR is kept at 75 percent”, said Khan.
She said, while this will provide some near-term stabilisation to markets – it is a tightening of policy and signals the withdrawal of additional liquidity after all – it falls short of dealing with the much bigger issues currently facing Nigeria. Given current conditions – QE tapering, concerns about bigger policy changes ahead, a shortfall in oil earnings, a secular narrowing of the current account surplus and the election cycle – each successive round of tightening is likely to be even less effective in attracting new inflows into Nigeria.
The spread between the interbank and Retail Dutch Auction System (RDAS) foreign exchange (FX) rates is likely to remain in place.
“In all likelihood, pressure on FX reserves – now less than $38bn – will persist. This is the consequence of structural factors. With continued depletion of FX reserves, speculation that the CBN’s official band will have to give eventually, is only likely to increase. The CBN might have dealt with this from a position of strength, at a time of relative calm in the markets. Or it might choose to make the adjustment at a time of increased stress, with the likelihood in that case that we see considerable FX overshooting”, she queried.
She further explained that the nature of the tightening also matters. “It isn’t a matter of equivalence between the magnitude of liquidity withdrawn in the case of a sizeable public sector CRR hike vs. a more modest private sector CRR hike. The degree of asymmetry matters. A public sector CRR hike has a disproportionate impact on some institutions – those that typically have more surplus liquidity to place in the markets, making for a much more effective – some might say dramatic – form of tightening. The growth in domiciliary – or foreign currency accounts – recently will also have an influence on how much tightening a private sector CRR hike is able to effect.
“Few believe that tightening alone will close the spread between the interbank and RDAS markets, or that near-term conditions will allow for a naira appreciation on the interbank market with USD-NGN retracing below 160. In order to avert more pressure on FX reserves, we expect perhaps a gradual creep up in the USD-NGN rate at official auctions, with the CBN ideally remaining in control of the process the whole way through, but the spread between the official rate and interbank FX rates gradually narrowing. This remains necessary if Nigeria is to stabilise its FX reserves, which in turn is key to Nigeria’s ability to commit to price stability”.
But Gadio said the increase in CRR on private sector deposits to 15 percent (seven votes to two), from 12 percent, which should result in an additional liquidity withdrawal of around N350 billion based on private sector deposit estimates of N11.7 trillion.
“Given that excess liquidity in the system stood today at around NGN490bn, the impact of this measure is likely to be moderate”, he said.
He however said, “we had recommended a more aggressive package, including a 200bps hike in the MPR as well as an increase in the CRR on public and private sector deposits to 100 percent and 15 percent in order to send a strong signal to the market, improve the external competitiveness of Nigerian fixed income assets and contain the pressure on the naira and FX reserves. With the FED tapering related pressure on EM FX and rates having subsided and even moderately reversed since February 14, it would have been easier for the CBN to bridge the value gap of Nigerian tradable instruments versus peers. While the tone of the MPC statement was certainly hawkish and stressed the need to maintain a restrictive monetary stance, the market is unlikely to see the private sector deposit CRR decision as sufficient to restore dwindling NGN confidence.
Increasing the private sector deposit CRR ratio clearly also pushes the cost of liquidity management onto the banks rather than the CBN, which is coming under political pressure regarding Open Market Operation (OMO) costs. Indeed, the CBN overshot its 2013 budgeted expenditure by NGN326.3bn (to NGN739.6bn) because of liquidity management operations (NGN536.6bn). The CBN’s expenditure is budgeted at a reduced NGN377.9 billion in 2014 which may force it to keep OMOs under control. Ironically, the cost of OMO sterilisation is presently being reduced by draining NGN liquidity via FX interventions.
CBN still committed to exchange rate stability… The MPC suggested that a devaluation of the currency and/or a move in the mid-point of the RDAS FX band (N155) were not on the agenda and that the CBN would continue to defend the naira. The MPC still feels that a weaker exchange rate will weigh negatively on price stability and macroeconomic aggregates, while resulting in limited gains in terms of export competitiveness and import substitution. Besides, adjusting the RDAS FX mid-point – or widening the +/-3 percent band around it – is unlikely to narrow the spread with the interbank $/N rate (currently in the N164-N165 area). It is probable that the upward pressure on $/N would merely re-exert itself at a higher exchange rate level if not accompanied by significantly tighter monetary policy and less expansionary fiscal policy capable of restoring longer-term confidence in the currency.

Leave a Reply

Your email address will not be published. Required fields are marked *