Economic expectations as CBN cuts interest rate by 2%- Tribune
SIX years after steady increase in lending rates, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN), last Tuesday, November 24, 2015 resolved, among other issues, to reduce the benchmark interest rate otherwise called Monetary Policy Rate (MPR) from 13.0 per cent to 11.0 per cent. It also reduced the cash reserve ratio (CRR) from 25.0 per cent to 20.0 per cent. Chima Nwokoji examines the implication of this decision which took most analysts by surprise, expectations of Nigerians, how the decision will touch key sectors of the economy and cost of items in the market place.
The Governor of CBN, Mr Godwin Emefiele, on Thursday, June 5, 2014unveiled his blueprint for the Nigerian economy. One of the cardinal promises which brightened the faces of manufacturers and entrepreneurs was that, "we shall pursue a gradual reduction in interest rates ... as well as provide complimentary developmental functions by creating an environment for Nigerians to live better and more fulfilled lives."
Perhaps still in pursuit of what will make "Nigerians to live better and more fulfilled lives," the CBN governor barely a year and five months after, has fulfilled his promise. Against all odds in the economy, Emefiele and his team at the apex bank reduced benchmark interest rate by 2 per cent.Interestingly, that was a bigger reduction than forecast by seven of the 20 economists surveyed by Bloomberg, while the rest predicted the rate would stay unchanged.
As it stands, market women and artisans are eagerly waiting and expecting to feel the impact of lower interest rate, foreign investors, fund managers and captains of industry have returned to the drawing board. The banks are not left out as they are adjusting for the transmission effect.
However, most discerning investors, financial experts and economists are pessimistic that it will not have desired effects soon. They argue that the decision, like the refusal to devalue the naira, has political undertone and does not follow proper, conventional economic principles. This argument raises the question as to what is the real reason for the CBN's decision.
Why CBN decided on interest rate cut
The MPC said the decision was taken after considering the difficulties in the domestic macroeconomic environment and the concern that the previous liquidity injections embarked upon through the lowering of the cash reserve ratio in the last MPC has not translated into improved credit delivery to sensitive sectors of the economy.
"What we've decided to do at this meeting is that we must stimulate growth," Emefiele told reporters after the decision. "We don't have a choice."
In a communiqué issued at the end of the meeting, the committee also said there was the need for the deposit money banks to ensure that "measures taken by the CBN to inject liquidity and stimulate the economy adequately translate into increased lending to the sectors with sufficient employment capabilities and the potential to generate growth."
Based on the above, stakeholders deduced that a slowdown in inflation and a weak economy is the major reason for the CBNto ease policy. The inflation rate fell for the first time in almost a year in October to 9.3 per cent, staying above the bank's target band of 6 per cent to 9 per cent. The economy expanded 2.8 per cent in the third quarter from a year earlier, slightly higher than the 2.4 per centrecorded in the previous month.
Regional Head of Economics, Africa, Standard Chartered Bank, Razia Khan, believed that CBN might likely take more measures that would release more money into the system following the confirmation of sub-3 per cent real Gross Domestic Product (GDP) growth in the third quarter (Q3) 2015.
Impact of interest rate cut on banks
Ayodeji Ebo, Head of Research and investment at Afrinvest Securities saidthat cost of fund will reduce but only a little, due to 25 per cent minimum mandated interest rate on savings deposits and the 80 per cent Loan to Deposit ratio regulation by the CBN that will continue to drive demand for deposits.
He led other analysts from the company in concluding that Tier-1 banks, which are net placers of funds in the Interbank Market and with higher deposit liability to fund, will be impacted more in terms of net interest margin. Tier-2 banks which, are net borrowers, would have their cost of fund reduced, though the lower interest income would still taper off Net Interest Margin.
"We anticipate interest income earned by banks on investment securities and loans to reduce in the first quarter of next year as banks adjust to the lower primary auction rates in the bonds market and reduced interbank rates.
"Overall, we expect Net Interest Margin to decline in Q1:2016 (from 6.4 per cent in Q3:2015). We expect a re-pricing of stocks in the stock market in the trading sessions ahead as investors are likely to go short on financial services and long on other value-sector equities," an Afrinvest analyst stated.
Also commenting on how banks might be impacted by the new regime of lending rates, a team of economists at Renaissance Capital (RenCap) stated that interest rates would clearly remain low for longer period which implied that Q4 2015 margin pressure on banks continues into 2016.
"This, coupled with extant asset quality pressure, makes for a gloomy earnings outlook for 2016," said the analysts.
They, agreeing with Afrinvest, pointed out that some banks would have significantly more funding cost benefits than others, while some are better shielded from asset yield pressure given their loan/asset penetration levels.
For the leading tier 1 banks like First Bank Holdings, Zenith, GTBank and UBA, that typically operate with significant excess liquidity on their balance sheets, RenCap said they could face considerable margin pressure given the low yield environment, while some banks such as Access and Stanbic IBTC could benefit more from lower funding costs compared with peers while dealing with systemic asset yield pressures.
Kunle Ezun, an analyst at Ecobank Transnational Inc., remains hopeful that "The banks will be encouraged to lend to agriculture, solid minerals and real sectors that create jobs," just in line with his colleagues.
With the restriction on all cheap income lines, analysts at Afrinvest expect a significant medium term expansion in credit to the private sector (currently at N19.1tn in October 2015 and up 6.8 per cent Y-o-Y) by Deposit Money Banks (DMBs).
This, they believed, would necessitate banks to improve on their risk management framework to identify opportunities and earn a relatively higher margin (compared to the cheap rates in the fixed income market) and buoy assets turnover and shareholders' return.
CBN and Keynesian economics
Most stakeholders are convinced that CBN effort trying to inject liquidity and stimulate the economy is a way of applying Keynesian economics which may not apply to the Nigerian environment.
This is an opposing view to those who criticized Emefiele for not applying conventional economic principles. They had argued thatmonetary policy in Nigeria was becoming harder to predict as the CBN turns to unconventional tools to protect its currency and boost economic growth.
Recent developments in the Nigerian economy and how almost everyone advances economic analysis may have explained why Peter Temin, a professor emeritus of economics at Massachusetts Institute of Technology, said about modern day economists:"When things collapse, everybody becomes a Keynesian."
Yet, CBN's aim of stimulating the economy, which had remained standstill due to dwindling revenue of the government and other tightening measures, falls in line with John Maynard Keynes' argument on interest rate. He had said that cutting interest rates is fine for raising growth in ordinary times, because "lower rates induce consumers to spend rather than save while stimulating businesses to invest."
Keynes was the economist who demonstrated that monetary policy ceases to be effective once interest rates hit zero. Herecommended thatthe best policy in a period of unemployment, rising food prices, debate about devaluation, no money in people's pockets, was tax cuts and more spending by the government to put money in the hands of people who will now demand products which companies produce.
True, he's been dead since 1946, but a herd of analysts still believe the British economist, investor, and civil servant Keynes has more to teach policy makers today about how to save the global economy and Nigerian economy in particular,than an army of modern Ph.D holders equipped with models of dynamic stochastic general equilibrium. Most economists said the symptoms of the Great Depression that Keynes correctly diagnosed are back, though fortunately on a smaller scale: chronic unemployment, deflation, currency wars, and beggar-thy-neighbor economic policies (a country that cheapens its currency, allowing it to export more (and create jobs) while importing less (hurting employment abroad).
For instance, Emefiele has been preaching that Nigeria should do what Germany is doing. Germany is keeping its workers busy by producing goods and services for export, while not buying the goods and services produced by other countries. That explains why the surplus on its current account, the broad measure of trade and investment income, equals 7 per cent of its gross domestic product, the highest among major economies.
Most Nigerians are eager to know what happens to the naira now that interest rate has been reduced. The answer was provided by formerManaging Director, Asset Management Corporation of Nigeria (AMCON), Mustapha Chike-Obi. In an earlier interview with the Nigerian Tribune,Chike-Obi explained that interest rate and exchange rate should fall at the same time.
"If you lower interest rate, the naira will fall. They move together. What is strange is that the naira is falling and interest rates are rising. That is not usual. What you don't want as a system is interest rates rising and your currency falling. That is what is called double whammy. That means you are losing on both sides," the financial expert and assets manager explained.
He said what happens in the above situation is that as foreign goods are getting more expensive, so are local goods because interest rates are higher, meaning manufacturers do not have cheap fund to invest in production of local goods.
"Local goods have to be cheaper or remain at the same price level, as foreign goods get costlier. That is the only way you can get people to produce local goods profitably. So, you have to clearly state what the problem is. The problem in my own perspective is that our economy is not growing fast enough and we are not productive enough. If we can address those two issues, then the naira will eventually start getting stronger," said Chike-Obi.
He believes there is need for even more interest rate reduction because itis difficult to see a local manufacturing business surviving at the current level of interest rate.
To Chike-Obi, "If we do not increase our productivity, which requires a lot of infrastructure investment, if we do not make our capital and interest rate affordable for our businesses, in conjunction with the level of the naira, I think we will continue to see the level of the naira get weaker, weaker and weaker.
"The only long term cure for the naira is increased productivity in Nigeria, and how we get there, is a whole macro-economic question."
Razia Khan did not, like Chike-Obi, talk about the fact that in economics, interest rate falls together with exchange rate, instead she believes that CBN might not allow the naira to fall further.
"The inference from MPC's policy choice is that there are no plans for imminent change to the fixed foreign exchange (FX) regime currently in place," Khan stated.
The naira has remained virtually fixed at N198 to N199 per dollar since Emefiele imposed the foreign-exchange restrictions in February, while policy makers in other major oil-selling nations, including Russia, Colombia and Kazakhstan, have let their currencies fall.
Government and interest rate cut
For the fact that certain economic policies are influenced by political considerations, a number ofanalysts said while African central banks from Ghana to South Africa are tightening monetary policy to protect their economies from plunging currencies, the CBN has reduced the benchmark rate, the first in six years. They maintain that lower interest rates will only help support PresidentBuhari-led administration as it ramps up borrowing to fund the budget and compensate for drops in oil earnings, but may not reduce the pressure on the local currency.
Chief Executive Officer of the Financial Derivatives Limited, Bismarck Rewane, said: "People are divided because they are starting to believe that decisions are being made devoid of any economic rationale. Some of the decisions being made now are made with political rationale."
President Muhammadu Buhari had asked lawmakers last week to approve a supplementary budget for this year that seeks to raise spending by 10 per cent and boost borrowing by an additional N1.6 trillion ($8 billion). Most Nigerians are worried that this type of budget will require larger deficit.
In a flash note to investors made available to Nigerian Tribune, the investment research company Afrinvest wrote that about N771.4 billion will be released to the economy.
"Prior to the MPC decision, there has been a regulatory maximum on the remunerable Standing Deposit Facility (SDF) placement by each bank at N7.5billion. The MPC's decision to complement this by a further 5.0 per cent cut in CRR will add approximately N771.4 billion to liquidity level based on October data from the CBN.
"Given the lower financial market rates anticipated, we expect slight reduction in prime lending rate," stated Afrinvest.
In the short term, industry players do not expect the ease in monetary policy to immediately translate to increase lending to the real sector, especially given the high risk retail/Small and Medium Scale Enterprises (SME) loans segment. Structural bottlenecks, weak quality of infrastructure and the current slowdown in economic activities constitute high risk to real sector lending, which would require more adjustments by the fiscal authorities to de-risk the sector, they argued.
According to the investment research company, the CBN's action to buoy aggregate demand side of the economy by increasing liquidity levels and reducing market rates would have a feedback effect on price and exchange stability in the short to medium term. As the CBN has remained resolute in its resolve to keep administrative measures in place to reduce depletion in the foreign exchange (FX) reserves and create a contrived stability in interbank FX rates; the effects would be felt in the parallel market for FX where rates would further depreciate, they said.
The decision is seen by most analysts as a move that may not come without negative implications for the economy in the medium term. With the reduction in interest rate, Nigeria is likely to face increased capital flight consequences in the medium to long term, more so if the United States Fed raises its benchmark interest rate at its next meeting in December they argued.
Immediate market reactions
Dealers said the capital market is already reacting tothe decision of the MPC. "We noticed a re-pricing of stocks in the equities market during the week as investors sold down on Banks (down 4.2 per cent) week on week (W-o-) relative to other sector (down 0.8 W-o-W).
"Equally, the spike in financial market liquidity resulting from the reduction in CRR to 20.0 per cent as well as the expansionary 2016 fiscal year may further trigger inflationary pressure. While the decisions by the MPC ensued from a need to grow the real sector through increased lending by banks, we believe risk considerations in the overall economy may force Banks to remain conservative at expanding their loan books, "dealers from Afrinvest said.
Also, there are fears that Nigeria is likely to face increased capital flight consequences in the medium to long term, more so if the US Fed raises its benchmark interest rate at its next meeting in December.
Welcoming the development, the President of Lagos Chamber of Commerce and Industry (LCCI), Remi Bello, stated that the current monetary policy stance is needed to stimulate the economy through increased lending to productive sectors at this time.
According to him, the MPC decision leverages on the global monetary policy stance which appears to be focused on reviving/sustaining growth and employment generation.
He, however, warned that "To maximise the benefit presented by MPC decision, issues such as access to foreign exchange for raw materials need to be addressed by CBN.
"Bank fees and charges on credit facility (i.e, management, drawdown, insurance fees) which accounts for about 5 per cent of credit costs need to be reviewed by CBN as well."
Will prices begin downward trend?
With the reduction in cost of borrowing funds from commercial banks, it will be expected that prices of goods and services will trend lower in the months and years coming.
But this may not be possible so soon considering the fact that there are fiscal issues which the economy will still have to contend with.
Umoh, who is the Managing Director and Chief Executive Officer of Stellarchem Industry Limited, ruled out the possibility of prices coming down soon, pointing out that there were fiscal factors which the government would have to address before prices of goods and services begin to trend consistently lower over a period of time.
"Manufacturers still will have to spend about 40 per cent of their earnings generating electricity. And spend additional 40 per cent paying for security and access to passage on the roads.
"Do not forget that corruption still takes its own toll. And we still have most of our raw materials coming from abroad, and 24 hours clearing of goods is not possible yet. The corruption level in the ports is still very high.
"Previously, your documents will pass through about seven tables but now you have to pass through 126 signatures. Given the corruption level in the country, you know what each table entails.
"In the light of the foregoing, we are not going to see prices crashing except if the government puts other things right. Corruption has to be tamed. Power generation and distribution have to be stabilised. And the billing from power distribution companies does not have to be erratic and outrageous as it is right now.
"If all these fiscal policy issues are addressed by the government, prices of goods and services will continue to go down progressively until they get to the right levels that can make local manufacturers competitive with their foreign counterparts," Umoh concluded.
Former Executive Director of Diamond Bank Plc, Abdulrahman Yinusa, had previously explained that there were fiscal issues to tackle in the economy which were beyond the purview of CBN.
"The CBN can only address the monetary aspect, but we still have fiscal issues to tackle," Yinusa had stated.
Preemptive of the commercial banks' reluctance to key into the new lending rates regime, the CBN has taken a position that the liquidity arising from the reduction in the CRR to 20 per cent, will only be released to the banks that are willing to channel its liquidity flush to employment generating activities in the economy such as agriculture, infrastructure and solid minerals.
With this caveat, the apex bank leaves no doubt that it is out to walk the talk by the ruling party regarding reviving the economy and improving the living conditions of the people through production growth and every other legitimate means.
It should be recalled that CBN also changed the symmetric corridor of 200 basis points around the MPR to an asymmetric corridor of +200 basis points and -700 basis points, around the MPR.
The new corridor, together with the lower MPR, resets the rate on the CBN's standing lending facility at 13 per cent (15 per cent previously) and on the standing deposit facility to 4 per cent (11 per cent previously).
In simple language, it implies that commercial banks will have to borrow from CBN at 13 per cent as against 15 per cent previously and deposit with CBN at 4 per cent as against 11 per cent previously.
Written by: Chima Nwokoji -Lagos
Monday, November 30, 2015
