During the past year of declining real output, cost-push inflationary pressure and lacklustre foreign appetite for Naira assets, the Monetary Policy Committee (MPC) adjusted three of its four key parameters in its quest to boost lending and reflate the economy.
After considering several real, monetary, and external factors, the MPC decided to maintain status-quo by holding all parameters constant in its first meeting of the year.
Current Monetary Policy Variables
Trudging a sticky recovery path
Citing vaccine developments and its impact on oil price recovery and external reserve accretion, the MPC noted that the virus remained a threat to economic recovery given the spike in fatalities and rapid spread of a newer strain of the virus.
Against this backdrop, the Bank cautioned against a second wave of lockdown due to the downside risks it poses to the anticipated recovery.
Making reference to recent GDP numbers, the Committee noted the milder economic contraction recorded in Q3’20 (-3.62%) compared to Q2’20 (-6.10%) due to the reopening of the economy. However, the lag effects of the lockdown, security challenges and FX challenges are contributory factors to dampened recovery prospects.
While the END SARS protests extended the contraction in manufacturing activity into the month of October, the brief recovery in November could not be sustained into December due to the stifling impact of the FX situation.
With two bearish readings out of three, the manufacturing PMI predicts another quarter of declining industrial output in Q4’20 while the consistently underwhelming services PMI reading portends another bearish outturn for the services sector.
Amid shaky recovery expectations, consumer prices have been surfing the inflationary tide for 5 years, unable to meet the threshold set by the Central Bank. With the recent reforms adopted by fiscal authorities, inflation may continually soar beyond current levels.
Further increases in the pump price of PMS and electricity tariffs are expected to propel inflation further during the year. However, the Central Bank projects moderation in growth headwinds, as continuous fiscal and monetary intervention measures permeate the economy.
MPC to sustain a dovish stance
The CBN’s decision to hike the Cash Reserve Ratio (CRR) in H1’20 amid enforcement of loan-to-deposit ratio (LDR) floors raised several concerns over liquidity in the banking system.
Despite the hostile business climate, huge deductions were made from banks’ reserves for not meeting LDR benchmarks, limiting room for credit expansion. According to Q3’20 GDP numbers, growth in the financial services sector slowed to single-digit levels, partly because of the high base effect.
At the meeting, the Committee commended the CBN on the industry’s low non-performing loans ratio, which is slightly above the prudential benchmark despite its aggressive credit expansion programme. However, we note the subsisting headwinds in the business environment could have contributed to the slowdown in loan expansion amid restrictive CRR debits.
Given the dismal PMI readings, the CBN may sustain its accommodative stance by keeping rates low and ramping up development finance activities. In addition, further rate cuts could be meted out in future meetings should real output continue its recessionary trend in Q4’20 and Q1’21.
While further rate cuts could support economic recovery, the Bank’s dovish stance could support fiscal policy given the CBN’s role in financing 2020 fiscal deficit, already high debt servicing-to-revenue ratio and the recent passage of the 2021 budget.
With the recent recovery in oil prices, elevated energy costs could drive inflation further from the Central Bank’s target for the sixth consecutive year. While the reopening of the borders should serve as a disinflationary trigger, the continued bans on rice & poultry imports through the land borders would keep inflationary pressures high.
Thus, we expect the CBN to continue its supply-side interventions, accelerate credit access to medium and small-scale enterprises and devise targeted funding strategies to propel economic recovery.