Nigeria Central Bank’s decision on CRR to have ‘shock effect’ on money market

The MPC increased the already controversial Cash Reserve Ratio on public sector deposits from 50 to 75 per cent
The decision by Nigeria’s Monetary Policy Committee, MPC, to increase the already controversial Cash Reserve Ratio, CRR, on public sector deposits from 50 to 75 per cent would in the short term, have a shocking effect on the nation’s money markets, Bismarck Rewane, a finance analyst and Managing Director, Financial Derivatives Company, has said.

“The 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”, Mr Rewane said in a report analysing the MPC’s decision.

He said the first time the MPC increased the CRR (the percentage of funds banks have to keep with the Central Bank) on public sector deposits in August 2013, an estimate of N1trn or 6.84 per cent of Money Supply (M2) was debited.

“At that time, the impact was a spike in interbank rates of approximately 800 basis points (bps) to an average of 21 per cent per annum. Also, it coincided with the failure of two discount houses which exacerbated the situation. Eventually, the rates declined to pre CRR levels,” said Mr, Rewane.

“This set the stage for another round of excess liquidity. This time, approximately N750 billion will be debited on February 4. This amount is equivalent to 5.09 per cent of M2. Therefore, we expect an initial spike of approximately 400bps before settling to a 1.5 per cent increase in the effective cost of funds for the banking system,” he added.

The MPC met on Tuesday in the midst of uncertainty and apprehension about the direction of interest rates, the value of the naira, and the succession of Lamido Sanusi as Governor of Central Bank. The expectation amongst economists was that interest rates and the monetary policy stance would remain unchanged. However, the MPC in its communiqué surprised the market with its decision to review its tightening of money supply.

The nation’s MPC increased the already controversial Cash Reserve Ratio, CRR, on public sector deposits from 50 to 75 per cent; a much-dreaded decision by the banking system. It left all other parameters including the Monetary Policy rate, MPR, unchanged at 12 per cent per annum, with an asymmetrical corridor of +/-200 basis points. The CRR on private sector deposit was retained at 12 per cent and the liquidity ratio was unchanged at 30 per cent.

Mr. Rewane said the decision took the market by surprise.

“Governor Sanusi has never been one to shy away from contrarian moves or decisions to up-stage analysts. The concerns of the MPC were mainly: Increasing divergence between the official and BDC exchange rates, Creeping core inflation Depletion of fiscal buffers and leakages Declining foreign portfolio inflows” he said.

Mr. Rewane, however, highlighted that the global economic recovery and the likely impact of tapering in the U.S. on investment flows, showed some limited amount of vulnerability on the external sector of the Nigerian economy.

He said banking net interest margins and profitability will be affected whilst their liquidity will remain unimpaired. He also said that the Federal and State Governments will face some difficulty in extracting commissions from bankers.

According to Mr. Rewane, the key variable that drove this decision remains the protection of the value of the naira in the foreign exchange markets. He said the Central Bank Governor expressed some concerns about the declining trend in foreign portfolio flows and that this, in addition to the leakages and falling fiscal buffers, made the Central Bank take a more aggressive position to defend the naira.

“The divergence between the official and parallel markets had widened to N20 or 12 per cent of the official exchange rate. The Central Bank is of the opinion that the Nigerian economy is more exchange rate than interest rate sensitive. Therefore depreciating currency will have a direct impact on inflation and could be counterproductive,” he said.

Addressing concerns as regards the Naira being really overvalued, Mr. Rewane said “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, 11 per cent depreciation in the currency in the parallel market in the last two months is more out of fear and speculation than fundamentals”.

“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” he said.

Also, Yvonne Mhango, Sub-Saharan Africa Economist, Renaissance Capital, an investment bank, said MPC’s tightening of the monetary policy by the raise of public sector CRR would further tighten liquidity, and is positive for the Naira.

“The MPC believes firm action is needed to stabilise the Naira. Absence of fiscal savings implies that stability of naira depends on inflows. (The MPC) Believes cost of weaker Naira (large capital outflows, in our view), outweighs benefits,” she said.