CBN Shocks the Market with CRR Increase of 25%
The monetary policy committee (MPC) met today in the midst of uncertainty and apprehension about the direction of interest rates, the value of the naira and the CBN Governor’s succession transition. The consensus amongst economists was that interest rates and the monetary policy stance would remain unchanged. However, the MPC in its communiqué did not fail to surprise the market with its decision to review its tightening of money supply.
What did the MPC Decide?
The MPC increased the controversial CRR on public sector deposits from 50 to 75%; a much- dreaded decision by the banking system. It left all other parameters including the MPR un- changed at 12% p.a, with an asymmetrical corridor of +/-200bps. The CRR on private sector deposit was retained at 12% and the liquidity ratio was unchanged at 30%.
Why did they take the Market by Surprise?
Governor Sanusi has never been one to shy away from contrarian moves or decisions to up- stage analysts. The concerns of the MPC were mainly:
Increasing divergence between the official and BDC exchange rates Creeping core inflation
Depletion of fiscal buffers and leakages
Declining foreign portfolio inflows
However, the global economic recovery and the likely impact of tapering in the US on invest- ment flows, shows some limited amount of vulnerability on the external sector of the Nigerian economy
The monetary policy committee (MPC) met today in the midst of uncertainty and apprehension about the direction of interest rates, the value of the naira and the CBN Governor’s succession transition. The consensus amongst economists was that interest rates and the monetary policy stance would remain unchanged. However, the MPC in its communiqué did not fail to surprise the market with its decision to review its tightening of money supply.
What did the MPC Decide?
The MPC increased the controversial CRR on public sector deposits from 50 to 75%; a much- dreaded decision by the banking system. It left all other parameters including the MPR un- changed at 12% p.a, with an asymmetrical corridor of +/-200bps. The CRR on private sector deposit was retained at 12% and the liquidity ratio was unchanged at 30%.
Why did they take the Market by Surprise?
Governor Sanusi has never been one to shy away from contrarian moves or decisions to up- stage analysts. The concerns of the MPC were mainly:
Increasing divergence between the official and BDC exchange rates Creeping core inflation
Depletion of fiscal buffers and leakages
Declining foreign portfolio inflows
However, the global economic recovery and the likely impact of tapering in the US on invest- ment flows, shows some limited amount of vulnerability on the external sector of the Nigerian economy
Impact of MPC Decision on Money Markets, Investors and Exchange
Rates
Money Markets
The impact of this decision on money markets will be a shock effect in the short run and a re- turn to equilibrium rates within six weeks. The first time the MPC increased the CRR on public sector deposits in August 2013, an estimate of N1trn or 6.84% of M2 was debited. At that time, the impact was a spike in interbank rates of approximately 800bps to an average of 21%p.a. Also, it coincided with the failure of two discount houses which exacerbated the situation. Even- tually, the rates declined to pre CRR levels. This set the stage for another round of excess li- quidity. This time, approximately N750bn will be debited on February 4. This amount is equiva- lent to 5.09% of M2. Therefore, we expect an initial spike of approximately 400bps before set- tling to a 1.5% increase in the effective cost of funds for the banking system.
Banking net interest margins and profitability will be affected whilst their liquidity will remain unimpaired. The Fed and State Governments will face some difficulty in extracting commissions from bankers.
Exchange Rate Management
The key variable that drove this decision remains the protection of the value of the naira in the foreign exchange markets. The CBN Governor expressed some concerns about the declining trend in foreign portfolio flows. This in addition to the leakages and falling fiscal buffers made the CBN take a more aggressive position to defend the naira.
The divergence between the official and parallel markets had widened to N20 or 12% of the offi- cial exchange rate. The CBN is of the opinion that the Nigerian economy is more exchange rate than interest rate sensitive. Therefore a depreciating currency will have a direct impact on infla- tion and could be counterproductive.
Is the Naira Really Overvalued?
Our crude analysis using the PPP /Mac Donald index suggests that the true value of the naira has not changed dramatically since August 2013. Therefore, an 11% depreciation in the cur- rency in the parallel market in the last 2 months, is more out of fear and speculation than fun- damentals. The other indicator less used, is the result of dividing the total money supply by
the aggregate foreign assets in the economy. This will give you a score of 340. If you then discount this with the annual dollar earnings, the outcome shows no difference between 2012 and 2013. All these suggest that the naira will most likely appreciate from N173 to N170 in the parallel market initially and diverge again if the external reserves deplete further in March. At the inter- bank and official markets, the naira will trade at current levels. The inverse relationship between interest rates and asset values may undermine the current stock market rally temporarily forc- ing a mini correction in the near term.
Money Markets
The impact of this decision on money markets will be a shock effect in the short run and a re- turn to equilibrium rates within six weeks. The first time the MPC increased the CRR on public sector deposits in August 2013, an estimate of N1trn or 6.84% of M2 was debited. At that time, the impact was a spike in interbank rates of approximately 800bps to an average of 21%p.a. Also, it coincided with the failure of two discount houses which exacerbated the situation. Even- tually, the rates declined to pre CRR levels. This set the stage for another round of excess li- quidity. This time, approximately N750bn will be debited on February 4. This amount is equiva- lent to 5.09% of M2. Therefore, we expect an initial spike of approximately 400bps before set- tling to a 1.5% increase in the effective cost of funds for the banking system.
Banking net interest margins and profitability will be affected whilst their liquidity will remain unimpaired. The Fed and State Governments will face some difficulty in extracting commissions from bankers.
Exchange Rate Management
The key variable that drove this decision remains the protection of the value of the naira in the foreign exchange markets. The CBN Governor expressed some concerns about the declining trend in foreign portfolio flows. This in addition to the leakages and falling fiscal buffers made the CBN take a more aggressive position to defend the naira.
The divergence between the official and parallel markets had widened to N20 or 12% of the offi- cial exchange rate. The CBN is of the opinion that the Nigerian economy is more exchange rate than interest rate sensitive. Therefore a depreciating currency will have a direct impact on infla- tion and could be counterproductive.
Is the Naira Really Overvalued?
Our crude analysis using the PPP /Mac Donald index suggests that the true value of the naira has not changed dramatically since August 2013. Therefore, an 11% depreciation in the cur- rency in the parallel market in the last 2 months, is more out of fear and speculation than fun- damentals. The other indicator less used, is the result of dividing the total money supply by
the aggregate foreign assets in the economy. This will give you a score of 340. If you then discount this with the annual dollar earnings, the outcome shows no difference between 2012 and 2013. All these suggest that the naira will most likely appreciate from N173 to N170 in the parallel market initially and diverge again if the external reserves deplete further in March. At the inter- bank and official markets, the naira will trade at current levels. The inverse relationship between interest rates and asset values may undermine the current stock market rally temporarily forc- ing a mini correction in the near term.
Source : FDC Research
Table 1: Is the Naira Really Over Valued
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Money Supply (M2)
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External Reserves
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M2/Ext. Res.
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2012
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N15.48trn
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$44.18bn
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350.49
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2013
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N14.74trn
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$43.26bn
|
340.65
|
Is this really good for the economy? Are we going to witness another sharp increase in interest rate.
ReplyDelete