Two weeks ago, we asked whether the Central Bank of Nigeria (CBN) wanted to put a floor under market interest rates (Nigeria Weekly Update, Saving Interest Rates?, 7 December).
Now we have an answer, namely that the effect of the CBN’s Special Bills issue (bills granted to banks in respect of their excess cash reserve ratio held by the CBN), with a yield of 0.5%, has been to support interest rates. T-bill rates have been rising for two weeks.
This is a change in the way the market sees interest rates rather than a guarantee that the CBN is in favour of raising them. The market has seen market interest rates crash this year and was wondering whether negative market interest rates would emerge.
The CBN’s response was to address the liquidity issues caused by its cash reserve ratio (officially 27.5% but effectively much higher, hence the excess CRR) by issuing N4.1 trillion (US$10.5bn) of Special Bills to banks. But its 0.5% rate was, presumably, a signal to the market.
Nigerian Inter-bank Treasury Bills’ True Yield Fixings (NITTY 12M)
What options are now open to the CBN? 2021 will be another year of significant deficit financing for the Federal Government of Nigeria (FGN), with the result that, according to the draft budget, N5.2 trillion (US$13.3bn) needs to be raised.
From the point of view of the government’s Debt Management Office (DMO), it is preferable to raise this at low-interest rates. But, before the question of what rate is going to be achieved, it is probably advisable to ask where the money is going to come from.
In 2020 the CBN achieved effects of quantitative easing (QE) without announcing a bond-buying program.
It did this (starting in October 2019) by preventing Nigerian institutions from buying new issues of its open market operation (OMO) bills, effectively reducing the size of the OMO market over time (e.g., from N9.8 trillion in January to N5.5 trillion in mid-December) and causing these funds to be diverted into the Treasury Bill and FGN Bond markets.
At the same time, the CRR took liquidity from the banking sector into the public sector.
This can only be done once, in our view. The OMO market cannot be run down indefinitely (part of it is foreign-owned, in any case) and the CRR cannot be raised indefinitely (the CBN has acknowledged that it causes banks liquidity problems).
So, the options for financing the budget deficit in 2021 include raising interest rates to attract institutional money and, possibly, expanding the CBN’s balance sheet (as would happen in a conventional QE program).
Meanwhile, while the aim of increasing bank lending has been achieved, inflation is rising, with headline inflation at 14.89% y/y and food inflation at 18.30% y/y (November). We doubt that the CBN wants to address inflation with interest rates, but it may tolerate a rise in interest rates over the coming months as a way of stabilizing public finances.