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Monetray Policy Committe (MPC) Meeting Outcomes - Liquidity Tightening

What did the MPC Decide? 

The MPC increased the CRR (cash reserve ratio) on public sector deposits from 50 to 75%; a much-dreaded decision and left all other parameters including the MPR (monetary policy rate) 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%. 

Liquidity tightening

CRR hike in line with expectations. We believe the CBN is moving towards a complete restriction of public deposits from lending and investing activities by banks. This should promote a sustainable banking model that is based on competition for private customer deposits.  Marginal downturn in share prices is expected. Although we expect a downward pressure on bank stocks over the next few days, we believe it will be marginal. Our view is consistent with the minimal downward pressure seen on the banks in August 2013 when the CRR on the public sector was increased to 50% from 12%. The banks in our coverage witnessed an average downward movement of 1.4% in share prices between 06 August 2013 and 13 August 2013, with prices stabilising afterwards.  UBA was the only stock that witnessed a material decline of 11% during the period. Currently, Skye Bank and FBN Holdings have the highest exposure to the public sector in our universe of banks with CRR on public deposits standing at 35% and 28% of total deposits respectively as at 9M-13. Nonetheless, we do not expect much of a downturn in their share prices as deliberate measures have been taken by the banks to reduce their public deposit exposure.   

NIBOR to rise marginally in the short term. We expect NIBOR to inch upwards on the back of the hike in the public sector CRR for a few days. The impact of the hike in CRR in August 2013 was a 907bps hike in NIBOR for 7 trading days, after which the rates normalised. We do not believe that banks were caught by surprise with this further hike, as strong liquidity currently exists in the market due to t-bill maturities and AMCON bond settlements. NIBOR should therefore be less affected this time in terms of rate spike and duration.


Impact of MPC Decision 

Money Markets SectorThe 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. Also, it coincided with the failure of two discount houses which exacerbated the situation. Eventually, the rates declined to pre CRR levels. This set the stage for another round of excess liquidity. This time, approximately N750bn will be debited on February 4. This amount is equivalent to 5.09% of M2. Therefore, we expect an initial spike of approximately 400bps before settling 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 12% of the official 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 inflation and could be counterproductive. 

Is the Naira 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 currency in the parallel market in the last 2 months, is more out of fear and speculation than fundamentals. 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 forcing a mini correction in the near term.

DISCLAIMER
While I check for accuracy and invest time in research, I am not liable for any misinformation. The details here should be construed as my investment view and any use of same is at owners risk. 

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