The MPC took drastic actions to curb systemic liquidity and exchange rate volatility In our Pre-MPC meeting report, we argued that an increased in the MPR would support the foreign exchange rate supply side by improving the attraction of Nigerian assets to foreign investors due to the consequent higher risk adjusted real return on Nigerian assets. The existence of a tactical removal of the lower MPR corridor with the N7.5 billion deposit limits aligns with our expectation of an asymmetric corridor as part of the outcomes.
Our submission
The Committee believes that the cause of the volatile foreign exchange scenario in the wake of the oil related external shock included speculative attack on the Naira; driven by the high liquidity in banking system. This belief necessitated the increased sterilization of the banking system liquidity with the 500 basis points increase in the CRR on private sector deposits. It is estimated that about N400 billion would be withdrawn from the system through this action which could translate to a reduction of about N40-42 billion in industry profits over the next 12 months considering the opportunity cost of 10-12% rates on treasury bill and money market instruments.
In our opinion, while this is a very bold and necessary action, it might have been too drastic and a bit too harsh on the banking system as it appears that the Committee largely discounted the impact of the foreign portfolio investment (FPI) content of the economy.
Sell down of assets expected immediately
The outcomes of the meeting as highlighted above portend downward pressure on equities and fixed income assets immediately as banks mobilise funds to comply with the CRR decision since the decision takes immediate effect. Without prejudice to the expectation that most FPIs have left the market prior to this pronouncements, the reprising of risks by most institutional investors in the equities space could push the market lower.
Market correction in the near term
High yields and interest rates implications of the decision portend reduction in valuation of many equities assets. However, since the mark et is expected to correct in the near term, discerning investors would take the opportunities of the bargain prices to re-enter the market and benefit from potentially significant returns.
Bold action on the exchange rate
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Although we did not expect these actions to be mutually deployed, the movement of the midpoint to N168/US$1 is more drastic to our expectation of N160/US$. In our opinion, this was an emphatic way of telling the market that the Committee would take bold decisions where necessary. And considering that the interbank foreign exchange market is already trading at N173.7/US$ at the time of the meeting, a lower midpoint would have been short of target as the +5% upper limit of the new band of N176.4/US$1 is only slightly above the interbank market rate. We expect rates across all market segments to move to the extreme of the band immediately but will moderate soon afterward.
Improved fiscal spending may temper liquidity pull
The fiscal financial implications of the new exchange rate level however could moderate the liquidity effect of the CRR on banking system liquidity by the next FAAC allocation. This is because, the application of the new exchange rate level to government revenue proceeds implies higher Naira FAAC distributable values and hence more Naira inflow to the banking system. Respite for the Naira exchange rate is also expected from the expected increase in bond yields as outcomes of these decisions. This is however conditioned on the sentiment on the political risks facing the economy at this time of a possible permanent lower price of oil price.
