The Monetary Policy Committee (MPC) will hold its second set of meetings of the year on the 22nd and 23rd of March 2021. We expect the Committee to review the domestic and external macroeconomic conditions and financial markets developments since its last meeting in January and provide forward guidance on how it intends to balance the competing goals of price and exchange rate stability.
As in its prior meetings, we expect the Committee to reiterate that supply-side factors remain the main drivers behind domestic inflationary pressures.
Thus, there is still the need to maintain an accommodative monetary stance to recover from the pandemic-induced slump in the prior year.
Against this backdrop, we expect the majority of the members to vote to retain key monetary policy parameters but expect a soft dovish tone given the growing need to address external sector imbalances and ultimately attain macroeconomic stability.
Optimism on Sustained Economic Recovery
Surprisingly, the domestic economy exited the COVID-19 induced recession in Q4-20, with real GDP growth growing marginally by 0.11% y/y (Q3-20: -3.62% y/y). The increase was primarily driven by the (1) agricultural sector (+3.42% y/y vs Q3-20: +1.39% y/y), which had its highest growth since Q4-17 (+4.23% y/y), (2) robust growth in the telecoms sector (+17.64% y/y vs Q3-20: +17.36% y/y) and (3) growth in the real estate sector (+2.81% y/y vs Q3-20: -13.40% y/y) after six quarters of recession. We believe the positive GDP outturn in Q4-20 will bring some comfort to the Committee that the knock-on effects of monetary and fiscal responses to the pandemic are gradually beginning to yield results.
Nonetheless, we think the growth’s fragility will remain a significant concern for the Committee. The oil sector is also recovering progressively with the Agbami field’s classification as condensates even as the country continues to take additional cuts for overproduction in Q2-20 and Q3-20. Indeed, data from the OPEC Monthly Oil Market Report (MOMR) showed that Nigeria’s crude oil production (excluding condensates) increased by 161kb/d to 1.49mb/d in February (January: 1.33mb/d).
With the arrival of an estimated 3.94 million doses of COVID-19 vaccines, we are now more confident about the sustainability of the economy’s full re-opening. The preceding should support improved informal sector activities (which contributes over 60% to GDP) as supply chain networks gravitate towards pre-pandemic levels. Consequently, we think the preceding lays the ground for sustained economic recovery over the rest of the year. We have revised our 2021FY GDP growth forecast to 2.75% y/y from 1.98% y/y. Overall, we expect the Committee to express their confidence about continued expansion in economic activities, maintaining the positive growth trajectory over Q1-21 and beyond.
Mounting Inflationary Pressures
Despite the partial re-opening of the land borders in December 2020, domestic inflationary pressures show no signs of respite. In our view, the persistent increase is price level has been primarily due to the combined effects of (1) ongoing security challenges in the country, (2) FX liquidity challenges, and (3) poor distributional networks. The headline inflation has risen from 15.75% in December 2020 to 17.33% as of February 2021 – the highest in four years. Given the prior year low base effect alongside the persistent increase in food prices, we think the headline inflation is on track to exceed the 18.72% recorded in January 2017, the highest inflation rate since the NBS started the current data series.
Although a dovish monetary policy contradicts rising inflationary pressures, we expect the Committee to reiterate that a hike in interest rate will oppose its current growth mandate, given the adverse impact on the rising cost of borrowing for households, businesses and the government. To a considerable extent, we think the Committee’s views may be justified because the persistent rise in inflation is primarily driven by supply-side factors outside monetary policy’s confines.
Accordingly, we expect the Committee to call on the fiscal authority to address the country’s security and distribution challenges to compliment the CBN’s direct interventions in the economy. Our baseline expectation over the medium term is for the headline inflation to reach a peak of c. 19.25% y/y in June before a high base effect gradually sets in over the rest of the year.
Global Growth Prospects have brightened on Vaccination Efforts and Stimulus Package
On the external front, the general administration of vaccines in advanced economies has raised prospects of a cyclical upswing in global economic activities. We also expect the recent USD1.9trillion COVID-19 relief bill signed by the U.S President to drive consumption expenditure in the U.S with a spillover effect on commodity prices due to increased activities in the manufacturing sector.
Since the last meeting in January, conditions in the oil markets have also tightened further, with Brent price rising by 23.4% to USD67.57/bbl. as of 17th March 2021 (January average: USD54.77/bbl.). The increase is due to the confluence of (1) the decision of OPEC+ to maintain production cuts of 7.2 mb/d through April at its meeting in March, (2) Saudi Arabia’s decision to maintain its voluntary cut output of 1.0 mb/d, (3) gradual decline in global crude inventories, and (4) optimism surrounding the efficacy of COVID-19 vaccines.
Despite the myriad of positives in the external economy, we do not think the Committee will be overly worried about the rising yields in the U.S. It is driven mainly by growth expectations instead of a hike in interest rate by the U.S Fed. That said, we believe the seemingly bright outlook on the external economy will bring some comfort to the Committee that the days of grim oil prices may be behind us.
Indeed, this will enhance oil earnings and help shape the FX reserves to enable the apex bank to address the liquidity challenges in the FX market. We note that the FX reserves have decreased by USD1.92 billion (-5.3%) since the last policy meeting to USD34.48 billion as of 16th March 2021. Overall, we believe the crude oil market developments bode well for accretion to the FX reserves in the near term.
Odds are in Favour of a HOLD Decision
Like the January meeting where all Committee members voted for a HOLD decision, we anticipate a similar outcome this time around, albeit the underlying tone from the Committee will be less dovish. We think most Committee members believe that the MPC still needs to maintain its accommodative monetary stance, despite rising inflationary pressures, to enable economic growth and gain more foothold.
Moreover, we think a hike in interest rates will trigger another wave of selloffs in the bond market, amplifying deficit financing pressures for the federal government. Additionally, it will also push borrowing rates upwards, constraining credit flow to the private sector.
Lastly, we expect the Committee to highlight its recent initiatives on diaspora remittances as a policy action that will help ease the local currency pressures in the short term until the CBN can step up its intervention across the official windows. On a balance of factors, we believe the Committee will keep the monetary policy parameters unchanged and affirm the continued adoption of its secondary “toolbox” in addressing the imbalance in the external account and restoring macroeconomic stability.
