The Monetary Policy Committee (MPC) continued its expansionary tone in rejigging the economy from a coronavirus-induced recession. The MPC reduced the Monetary Policy Rate (MPR) by 100bps to 11.5% and adjusted corridor rates to +100/-700bps around the MPR.
CBN roots for output recovery amid policy dilemma
Given the policy dilemma between supporting the receding economy and restoring price stability, the MPC decided to cut the MPR to hasten economic recovery as it noted that the upwards trend in inflation was non-monetary driven. By a split vote of six-to-four, members of the MPC voted to lower the MPR by 100bps to 11.50%. Amid inflationary pressures, weak capital and remittance flows and low oil receipts, the MPC has utilised the firepower (i.e. the gross international reserves) at its disposal to save the economy from a looming recession. This decision was taken to support a quicker recovery from the recession.
The economy recorded a 6.10% slump in Q2’20 as key sectors contracted including Trade, Manufacturing, Real Estate and Construction as economic activities were grounded to a halt during the 5-week lockdown. This was a far outcry from the -1.03% contraction expected by the CBN. We believe the downturn may persist despite CBN’s policy actions due to the small size of monetary stimuli and a sluggish transmission mechanism. Lockdown easing came with peculiar challenges due to double devaluation of the Naira, upward pressure on the exchange rate in the parallel market and reforms in the energy sector.
Inflation has also been on the uptrend due to energy and FX reforms. Capital importation numbers for Q2 showed both Foreign Direct Investment and Foreign Portfolio Investment fell significantly by 33.41% and 91.14% on a year-on-year basis as an overvalued Naira coupled with risk-off sentiments contributed to the depletion of reserves and adjustment of currency peg. The exchange rate has been devalued twice by a total of 24% year-to-date while parallel market rates rose due to exclusion of maize from the official FX window.
Reforms in the downstream sector have equally not been friendly as gains in crude prices for the past three months cascaded into higher monthly pump prices. This had a knock-on impact on inflation as higher transport costs infiltrated into commodity prices. Recently, the Federal Government announced full deregulation, hereby eliminating monthly price guides and allowing marketers fix pump prices. This would further upset prices as inflation maintains its upward sprint, given already pressured consumer wallets.
Nine members, out of ten, voted to adjust the asymmetric corridor to +100/- 700bps around the MPR to improve credit growth and economic recovery. The adjustment in the corridor rate effectively reduces the interest rate on commercial bank’s deposits with the Bank via the Standard Deposit Facility, which had been earlier capped at ₦2bn. This also reduces the interest payable to the Central Bank via the Standard Lending Facility. The Central Bank, believes this will corroborate the reduction in savings deposit rate, earlier implemented to moderate commercial banks’ interest expenses and induce lending to the real sector.
Monetary policy room limited, wait-and-see approach expected
Given a glaring pandemic-induced recession, price instability and weak capital flows, the Central Bank has limited capacity to curb inflation. Although recent policy parameter adjustments will boost credit to an extent due to the sustained Loan to Deposit policy rate checks, a rate cut may not translate into cheaper loans due to heightened risks in the business environment given energy reforms and ongoing exchange rate unification efforts that can crystallize forex risks. In addition, limited reserve supply and lean buffers could induce another currency adjustment, if oil prices deteriorate further due to rising cases of coronavirus. Adherence to OPEC+ production cuts and compensation for earlier oil production are further deterrents to reserve accretion.
With respect to growth objectives, the previous hike in the Cash Reserve Ratio (CRR) may need to be reversed to improve credit flow to the real sector, as the decision counters policy actions towards supporting economic growth. Low interest rate environment in the capital market may encourage capital raise for blue chip companies. However, SMEs are left to abysmally high bank lending rates. To cap it all, fiscal reforms are needed to fix infrastructure deficits and reduce cost of doing business. Thus, we believe the Monetary Policy Committee will HOLD rates in its future meeting while monitoring the transmission mechanism of its policies to the broad economy.