In contrast to our expectation, the benchmark interest rate was reduced by 100bps to 12.50% (Second rate cut since November 2015) while other monetary parameters were held unchanged as follows:
ü Cash Reserve Ratio at 27.50%
ü Liquidity ratio at 30%
ü Asymmetric corridor of +200/-500 basis points around the MPR.
· In our view, we believe the decision of the committee to reduce the MPR was guided by the expectation of a negative impact of the novel COVID-19 on growth. Although, the nation’s economy has been weak prior to COVID-19 pandemic, we believe the current pandemic may exacerbate the weakness in the nation’s economy. While a cut in MPR may discourage foreign portfolio inflow, we think the dovish stance of Central Banks in major economies in the face of weak global outlook may limit the extent of capital flight out of the country due to lower interest rate. We are of the view that the Committee’s decision implies a trade-off of higher inflation for growth as the Committee forgoes its long term inflation target of 6-9% in order to save the nation from a looming recession. Although, theoretically, a continuous increase in inflation (12.34% in April 2020) requires a tightening monetary policy, we believe the current inflationary pressure is caused by cost-push factors that will require more fiscal and other policy measures to limit general cost of production and improve ease of doing business. While we expect the CBN to use the CRR to manage excess liquidity, we think a lower borrowing rate could still encourage more borrowing and by extension put pressure on inflation rate in the near term. As such we expect inflation to remain well above CBN target in the short to medium term. Nonetheless, we believe the recent Consumption Expenditure survey by the NBS, which showed that Nigerians spent about 57% on food and 43% on non-food items in 2019 compared to 60% on food and 40% on non-food in 2009/10, suggests a potential rebasing of the (Composite) Consumer Price Index. This could reduce the headline inflation rate if a rebasing is implemented.
· Furthermore, while this rate cut may create more liquidity which could increase the rate of speculation on Naira, we think CBN has enough reserves (currently US$36.40billion) to discourage further speculation on Naira against USD and maintain a stable exchange rate in the near term. Nonetheless, the long term FX environment remains a concern as the nation’s dollar inflows are constrained. We expect the major sources of FX inflows, Oil proceeds, FPI inflows/foreign borrowings (excluding intervention funds) as well as Diaspora remittances, to shrink due to the impact of COVID-19. This must have been priced into the current 3-year and 5-year Naira FX futures which currently trade around N499.88/USD and N584.88/USD respectively.
· In terms of growth, while this rate cut may provide little impetus for economic recovery by improving consumer spending and business investment, we think it may not be sufficient to save the country from a looming recession given the damage the pandemic has caused on economic activities. We expect Oil output to contract in Q2 2020 due to the nation’s compliance with the OPEC+ output cut agreement as well as high base effect (Oil output was around 2.02mbpd, including condensates, in Q2 2019). In the same vein, we believe that Non-Oil output is likely to contract due to the challenging business environment, supply chain disruptions and FX scarcity on the back of measures taken to combat the spread of the virus. Looking at the CBN’s PMI report for the month of May which showed contraction for both Manufacturing and Non-Manufacturing PMI at 42.4points and 25.3points respectively (50: Constant, <50: Contraction, >50: Expansion), we expect growth on the Non-oil sector to be negative in the next quarter. Overall, we believe Nigerian economy may enter a technical recession by Q3 2020 with recovery likely to be seen further into 2021.
· Despite the rate cut, we do not expect a massive increase in banks’ loan books as most of the Deposit Money Banks will be concerned about asset quality in the face of a pandemic like this. While non-performing loans ratios seem to have improved on the back of significant increase in loan book, they remain above the regulatory threshold of 5.00% at 6.03% (industry wide average as at December 2019) according to the National Bureau of Statistics’ Banking Sector Credit Report. Although, we expect a lot of loan restructuring which may help to manage NPL ratios of banks, we think banks may still have to report a significant increase in loan impairments as they reprice their loan books taken into consideration the impact of the pandemic on assets. In the same vein, banks will still have to make provision for CRR rate of 27.5% which is even lower than effective CRR for most banks while they try to meet the LDR target of 65%, though not feasible for most banks in 2020. While this rate cut may reduce cost of funds for banks especially those with higher proportion of deposit from Savings account (Interest rate on Savings Deposit is usually around 30% of MPR), asset yields may also contract as returns on OMO bills and other short term instruments fall.
· While CBN’s loosening suggests a potential for further decline in yields in the fixed income space, we believe the impact on fixed income market would be minimal as yields are already below inflation rate (negative real return) at low single digits especially at the short end of the curve. Thus, the rate reduction may have a limited impact on the overall market dynamics with little reaction from market participants in the short term. We may see some buy-interests in the bond space in the near term.
· Overall, we expect to see more interests in the equities market as investors try to earn a return above inflation rate. Despite the recent recovery in the equities market, we expect investors who have shied away from the market to start buying quality names with decent dividend yields above the yields in the fixed income space. Similarly, a lower interest rate makes equity valuation more attractive. Nonetheless, we believe the weak macroeconomic condition on the back of the impacts of the current pandemic may limit investors’ interest in the equities. We expect investors to be sceptical about the impact of the pandemic on companies on the exchange which may start to reflect in their Q2 results as well as the nation’s GDP in the near term. However, we advise investors to buy quality names with a medium to long term investment horizon.
· OUR TOP PICKS: ZENITHBANK, GUARANTY, MTN, NESTLE, DANGCEM & OKOMU.