Saving Interest rates?
Last week the Central Bank of Nigeria (CBN) decided that it would substantially adjust its Cash Reserve Ratio (CRR) regime.
Under the CRR commercial banks must leave 27.5% (but in practice, much more) of their customer deposits with the CBN with zero interest: but last week they were informed that the CBN would issue them with ‘Special Bills’ in respect of some or all of their CRR positions. The interest rates on these bills are yet to be announced.
At one level this is pure banking supervision. Sums debited for the CRR do not count towards liquidity calculations, with the result that a high level of CRR means that some banks struggle with the CBN’s 30.0% liquidity requirement. So, the change in the CRR regime is designed to help them from a regulatory perspective.
The CRR regime also causes practical issues. Take the example of a bank which receives a large sum of cash from a pension fund in respect of redeemed securities. Part of that cash is now removed for the CRR, but if the pension fund now asks for all its money back (e.g.to fund new purchases), the bank may be short of cash.
Banks have become adept at creating liquidity when it is lacking. They may now use the new Special Bills as collateral to raise cash.
However, the effects of last week’s move probably go, beyond managing bank liquidity. For over a year the CBN has overseen a dramatic fall in market interest rates so that Treasury bills now yield 0.15% pa, versus inflation at 14.23% pa (see last week’s Nigeria Weekly Update: Where is the money going?).
Nigeria’s inflation-adjusted risk-free one-year rates are among the lowest in the world. There is a danger that, with a high level of the CBN’s open market operation (OMO) bills to be redeemed this month, T-bill rates could move into negative territory.
In our view, the CBN, having allowed the flow of OMO redemptions to crash T-bill and bond rates this year, may want to stop short of negative rates. Setting a rate on these new Special Bills gives it a tool for adjusting market interest rates. We must wait to find out what rates it wants to see.
Last week there were some upwards moves in FGN bond yields, suggesting that some market participants expect the CBN to set a floor under short-term rates.
The CBN also allowed, last week, unrestricted access to US dollars in domiciliary (i.e. onshore) accounts where these have been paid in electronically. The result was that customers could remove their US dollars and buy Naira. The Naira duly strengthened in the parallel market.
Nobody knows how large or liquid the parallel market is, but it probably comforted the CBN that it could influence the rate so effectively. Nevertheless, we do not think that this is the end of the parallel market.
Last week the equity market continued its advance, with large gains by Airtel Africa, up 19.63% on the week, among the largest weights in the Nigerian Stock Exchange All-Share Index (NSE-ASI). By contrast, Nigerian Breweries fell by 7.05% and it accounts for 2.40% of the NSE-ASI.
We hold a notional neutral weight in Airtel Africa and no notional position in Nigerian Breweries. Therefore, we could reasonably hope for some outperformance, so long as the profit-taking in the banking sector was not too big. The sub-index of 10 bank stocks was down 3.22% on the week.
Last week the Model Equity Portfolio rose by 1.11% compared with a rise in the Nigerian Stock Exchange All-Share Index (NSE-ASI) of 0.72%, therefore outperforming it by 72 basis points. Year-to-date it has gained 36.46% against a gain of 30.91% in the NSE-ASI, outperforming it by 556bps.
Model Equity Portfolio for the week ending 04 December 2020
We have written recently about Flour Mills of Nigeria and about Dangote Sugar, and whether we should take notional positions in them. Both these stocks fell last week, and we sense that there is no hurry to make up our minds. We plan no changes in the Model Equity Portfolio this week.