September 25, 2018/Vetiva Research
The fourth Monetary Policy Committee (MPC) meeting of 2018 will conclude later today. In a year when prior expectations of monetary stimulus to boost growth have made way for a more hawkish outlook amid rising inflation and an unwelcome external backdrop, the MPC has voted to hold all policy levers up to this point, even with the shadow of elections looming.
There was a seven/three (hold/hike) split at the July meeting, and although we anticipate an even closer vote, we do not expect the committee to tighten monetary policy as the key variables (inflation and exchange rate market) have mostly evolved in line with expectations formed in prior months. Therefore, we predict another HOLD decision.
Nigeria to ride out emerging market storm without a rate hike Emerging & Frontier Market currencies have come under significant pressure in 2018. The Turkish Lira and Angolan Kwancha have depreciated as much as 40% so far this year while the Russian Rouble (-13%), South African (-12%), and Ghanaian Cedi (-9%) have also suffered. Indeed, only Egypt (-1%) and Nigeria (-1%) have been relatively stable, and the former is still under an International Monetary Fund programme that forced a large prior devaluation.
The reason for this is two-fold. The first is the accelerating trade war between the United States (U.S.) and China. The U.S. placed a new round of tariffs on $200 billion worth of Chinese goods (China imports roughly $130 billion worth of goods from the U.S.) and this could weigh on the Chinese economy which remains a key trading partner for many Emerging Markets.
The second is that U.S. monetary policy is getting much tighter and much quicker than anticipated. The Federal Reserve (Fed) has hiked interest rates twice already this year and raised their year-end upper bound forecast from 2.25% to 2.50%, which would probably lift the Fed rate above core inflation for the first time in a decade. Moreover, the 2019 outlook looks similarly hawkish, with the Fed projecting three hikes for the year. In summary, the Fed is likely to deliver on its seven promised hikes through to 2020 (three in 2019, and two in 2020) which would put the Fed fund rate around 3.50%-3.75%.
Amid all of this, Emerging Markets have experienced substantial capital outflows in the last six months, but the response of central banks has been mixed. Non-African central banks have moved swiftly to hike interest rates, with India and Indonesia raising rates by 25bps each in August to 6.5% and 5.5% respectively while Russia did likewise in September to 7.5%.
Turkey has also increased its base interest rates from 8% at the start of the year to 24% in September, albeit in an effort to assuage a severe currency crisis. In contrast, South Africa, Ghana and Angola all held interest rates at their September meetings. We anticipate a similar response from the Central Bank of Nigeria (CBN) as it is arguably better equipped to weather the capital reversals than many of its African peers.
Despite notable pressure on Eurobond yields in recent months, Nigeria’s external position is decent; current account balance is modest at 8% of GDP and external reserves— though declining—are still strong at $49 billion. In addition, oil earnings are resilient as oil exports have recovered and global oil prices remain at favourable levels.
The only additional sour spot is the onset of election season which comes with risk-off sentiment among foreign investors, but it is likely that the capital markets (the most vulnerable to transient foreign flows) have already felt the brunt of this as the market has lost 23% since its January peak.
In summary, although we acknowledge the impact of U.S. monetary tightening and the trade war on capital flows and the exchange rate, we expect the CBN and markets to weather the storm in the medium-term.
Inflation will tempt voters
The dominant factor in the monetary policy equation is inflation and, on this note, there is arguable case to hike. Nigeria’s annual inflation rose from 11.1% in July to 11.2% in August as the effect of a weaker base was felt- though month-on-month inflation cooled from 1.1% to 1.0%.
Food price pressure remains the primary concern as many farmers have been displaced by conflict and flooding in the Middle Belt. In addition, the coming election season is likely to introduce sizable liquidity injections as candidates ramp up spending. Even with a forecast of little change to m/m inflation in the coming months, annual inflation would still rise as a result of the weak base from last year.
Our forecast for December inflation is 12.8% y/y, and we project further rises going into 2019. Despite this bearish inflation outlook, we do not anticipate any change in monetary policy as the committee anticipated these trends. Nevertheless, we note that earlier onset of the reversal in inflation trend may sway a swing voter.
Key variables trend as expected, MPC to hold rates The evolution of the external environment and domestic inflation present a fair case to hike interest rates, but we anticipate a hold decision because the key variables have evolved as expected. To clarify, we argue that the MPC has largely anticipated the observed trends and the fruition of expectations ought not to alter policy path.
Notably, the reversal in inflation was expected with the CBN Governor Godwin Emefiele saying, “My immediate predisposition is for further tightening of domestic policy stance to rein in expected inflation and ensure FX market stability,” in his May statement. In addition, those that voted to hike rates at the July meeting did so in order to anchor inflation expectations.
In his July statement, Joseph Nnanna explained that he voted to raise the monetary policy rate (MPR) by 50bps to “signal the need to anchor inflation expectations”. Finally, it is clear that inflation and external conditions would drive a shift in committee consensus. The statement made by Isa-Dutse Mahmoud in his debt MPC meeting read, “If the liquidity situation and external conditions worsen in the coming months, we should raise rates and use other instruments as well to reduce the negative impact on inflation and exchange rates.”
In our view, neither external conditions nor domestic inflation has changed sufficiently to warrant a shift in consensus vote, which would require a swing of three voters (or two voters and the CBN Godwin Emefiele). Thus, we expect the vote to be closer but for the result to be the same: a HOLD decision.