Nigeria: Policy Normalization

The Central Bank of Nigeria has raised its policy rate by 50bp. In the Monetary Policy Committee (MPC) communiqué published late last night, the Committee noted with satisfaction the sustained single-digit inflation readings throughout this year, the eventual attainment of the US$50 billion mark in foreign exchange reserves last month (equivalent to some 23 months of import cover), and the much-publicized appreciation of the naira; it also resolved to remain committed to the pursuance of price stability going forward. The Committee also noted the sharp rise in M2 money supply and credit, which are now up 25.3% and 72.2%, respectively this year, but was careful to point out that these have not translated into higher inflation during the year – at least, not yet!

Why the rate hike, when fundamentals are still healthy?

Despite the positive macroeconomic assessment, the MPC nevertheless opted to raise interest rates by 50bp. This was based on its contention that “the Federal Budget for 2008 has projected significant increases in expenditure on account of a build-up of infrastructure, environmental protection and social safety nets” and, as a corollary, its concerns about the impact that these expenditure increases would have on aggregate demand and inflation. We find this rather surprising, because total federal government spending as published in the 2008 budget last month is only expected to rise by 8.3% from the 2007 Budget levels – hardly a rate of increase that would call for pre-emptive policy tightening. What is even more confusing is the fact that the capital spending budget for 2008 has actually been cut by 19%, pending a comprehensive strategic and technical reassessment of projects that were initiated by the previous regime (see Nigeria: No Surprises in 2008 Budget, November 9, 2007). Morgan Stanley therefore believes that there could be other reasons for the rate hike beyond those specifically advanced in the MPC statement. We discuss two plausible ones:

First, is the pressure from state governors to release funds housed in the excess crude account: In order to maintain a more stable fiscal cycle, the government decided in 2000 to introduce a strict oil-price-based fiscal rule that sought to save excess oil revenues during boom years in an ‘Excess Crude’ account, with the view to running down on such savings when the need arose in lean years. The excess crude account now holds about US$12 billion, and the CBN has had a torrid time warding off state governors who, keen to spend the oil savings, have often argued that, legally, the federal government has no right to retain its share of the excess crude account at the CBN. Last month, a presidential committee set up to resolve the issue recommended that some US$8.3 billion be kept as a base deposit, and the rest distributed to all tiers of government. It also recommended that, after 2008, only 20% of the oil savings would be banked, while 80% is disbursed to all tiers of government in the following year. As things stands now, if the committee’s recommendations are implemented, we estimate that, theoretically, some US$3.7 billion of the existing US$12 billion oil savings could be injected into the Nigerian economy in coming months. Such a huge liquidity injection risks stoking inflationary pressures in 2008. We suspect that this is where the central bank’s concern resides, and are not surprised that the MPC also decided to issue new instruments “to mop up a significant portion of the anticipated liquidity in the system”. Also, data from the CBN show that Reserve Money was above target at end-September (see Nigeria: Letting the Naira Go, October 19, 2007) and, unless a significant liquidity mop-up is conducted (such as the one envisaged by the MPC), the CBN will likely close the year above its December target too, in our view.

Second, we believe that yesterday’s rate hike could be part of an attempt to normalize monetary conditions, following the rather confusing policy decision in October (see EM Economist, October 5, 2007). As we noted then, by merging the policy and CBN lending rates, what was meant to be monetary tightening was actually a de facto loosening in the monetary policy stance, as the effective lending rate was cut from 10.5% to 9%. Therefore, in order to restore monetary conditions, we believe that the MPC may have to hike rates by a further 50-100bp in early 2008, ceteris paribus.

By Michael Kafe Johannesburg
Morgan Stanley
December 6, 2007