Nigeria’s external reserves fell to $39.9 billion last week, the lowest in 22 months. This development compounds the policy dilemma that will confront members of Monetary Policy Committee, MPC, of Central Bank of Nigeria, CBN, as they tackle the challenges of inflationary pressures in their meeting holding in Abuja today and tomorrow.

Data from CBN shows that the latest figure is the lowest since December 2017.

The reserves had been on the downward trend since July 5, 2019 due to a combination of three factors, namely, low crude oil price, foreign portfolio investors (FPIs) exiting the nation’s fixed income market, and increased dollar sales by CBN in order to meet dollar demand by exiting FPIs while maintaining exchange rate stability.

As a result, the reserves fell by $5.1 billion or 11 percent, to $39.969 on Thursday November 21, from $45.069 billion on Friday, July 5.

This is in sharp contrast to the performance in the first half of the year (H1’19), when external reserves rose by 4.5 percent to $45.069 billion as at June 30 from $43.116 billion as at December 31, 2019.

Analysts, however, opined that the downward trend in external reserves will persist through the first half of 2020 (H1’2020), though at a moderate  rate.

“We do not yet see an end to the declining trend in external reserves”, said, Mr Victor Ofili, an analyst with Cowry Asset Management Limited.

“In fact, we could see sustained decline in external reserves if we consider factors which influence inflows and outflows of dollars to and from the economy. This is also compounded by decline in interest rates which so far yields negative real returns on investments. This could be reversed if interest rates rise in order to boost supply of foreign portfolio inflows (supply side). So we believe this trend could continue up until H1 2020 unless we see more external revenue sources.”

On his part, Mr Wale Olusi, Head of Research at United Capital Limited, also projected that the decline in external reserves will persist. He, however, noted that recent policy measures by CBN will help moderate the pace of decline and keep the reserves above $35 billion in 2020, which can support over eight months of imports.

He stated: “We think pressure on the external reserves will persist so long as CBN maintains its resolve to keep the naira relatively stable via periodic intervention in the currency market. Notably, the sharp drop in the size of the dollar reserves observed since July 2019 is linked to downward pressure on oil prices and slower inflow of foreign portfolio investment. Looking forward, the argument for a reversal of this trend is weak. Hence, pressure on the external reserves may persist.

“Give or take, we expect the stock of Nigeria’s external reserves to stay buoyant in 2020 given CBN’s unorthodox monetary policy stance which creates a window for Open Market Operations, OMO, sales to FPIs at a more attractive rate compared to local debt market. While the trajectory of the dollar reserves may continue southwards, net impact of CBN’s stance as well as oil proceed should keep the reserves well above $35 billion, which can support over eight months of import, by year end.”

Also projecting a moderation in further decline in the external reserves, Mr Saheed Bashir, Head of Research at Meristem Securities Limited, said, “The development in the OMO market, now exclusive to foreign investors, should sustain forex liquidity. The decision by CBN to participate in the secondary OMO market should create liquidity and assuage concerns by foreign portfolio investors in that segment of the money market.

“There are also maturing OMO instruments due to mature before the end of the year and rates are attractive enough to prevent capital flow reversals and maintain liquidity. Hence, further drops in the external reserves should be modest.”

Analysts, however, stressed that a surge in crude oil prices and in crude oil output by Nigeria, coupled with sudden influx of foreign investors, as well as less intervention by CBN can reverse the downward trend of the external reserves.

MPC dilemma

However, the outlook for the external reserves vis-a-vis the 11 percent decline so far in H2’19, adds to the list of the macroeconomic challenges to be considered by members of MPC as their last meeting of the year kick-starts this morning .

But for the third quarter 2019 bounce back, economic growth has been weak since the nation’s recovery from recession in 2017. This was compounded by two consecutive quarterly decline in GDP growth from 2.38 percent in Q4’18, to 2.1 percent in Q1’19 and down again to 1.94 percent in Q2’19, until the 2;3 percent record was turned out for Q3’19.

On the other hand, inflation rate, which moderated by 42 percentage points to 11.02 percent in August from 11.44 percent in January, rose for the second consecutive months in October to 11.6 percent, the highest level in 17 months, since May 2018, driven by increases in food prices occasioned by the ongoing closure of the nation’s land borders.

At the last meeting in September, the 13 members of MPC unanimously voted to retain the Monetary Policy Rate, MPR, at 14 percent. The Committee ignored the imperative to raise the MPR, compelled by the double digit inflation rate and decline in external reserves, saying, “the Committee was of the view that doing so in the midst of a fragile growth outlook would increase the cost of credit, and further contract investment and constrain output growth.”

MPC also decided against lowering the MPR saying this could lead to increased system liquidity and interest rate moderation resulting to exchange rate pressures.

But analysts at Financial Derivatives Company, FDC, and Olusi of United Capital opined that the worsening condition of the external reserves and inflation rate will make it difficult for the MPC to arrive at a decision on the MPR at the end of today’s meeting.

According to Olusi, “We think MPC is going to be a difficult one. Members will have to choose between tightening policy stance in the face of new pressure on general price level amid border closure and massive OMO maturities in the weeks ahead; or hold on to status quo in favor the apex bank’s determination to stimulate private sector credit growth as well accelerate output growth.”

Continuing he said, “Clearly, MPC will be concerned about the pass through effect of the recent decision of CBN to stop OMO bills sales to Non Bank/ local investors. Certainly, this will mount upward pressure on inflation rate and demand for forex, with a negative impact on reserves. As such, MPC will be caught between two stools! Maintain status quo or tighten to check creeping inflation which is fuelled by border closure.”

Making a similar projection, analysts at FDC said: “The spike in the headline inflation at a time of falling external reserves puts MPC on the spot at the upcoming meeting, especially with the imminent wage-induced inflation.”

Status quo may prevail   — Analysts

But, in spite of the policy dilemma, most analysts opined that MPC will still maintain the status quo at the end of its meeting tomorrow.

According to Chinwe Egwim, a Macroeconomic and Fixed Income analyst with FBNQuest Merchant Bank, “The latest personal statements of MPC are thinner in substance than usual. They also broadly adopt the same mindset since the verdict of the committee was unanimous. Put very succinctly by one member: ‘he may have wanted to ease due to the trend in inflation and the wish to encourage growth and employment but decided otherwise to underpin reserves, profit from ‘normalization’ by the Fed and others, and hedge against vulnerable oil prices.’ The statements tell us to expect no change from the MPC again next week.”

Explaining why MPC may choose to retain its policy rate, Mr Saheed Bashir of Meristem Securities Limited, said: “We expect the decline in reserves and two month climb in inflation rate to dominate MPC meeting holding next (this) week. The Committee will consider the $40 billion as healthy and will not be bothered so much. However, the recent uptick in inflation rate should be worrisome. At 11.60 percent, it is the highest since May 2018. However, this type of inflation is cost-push, reflecting the impact of the border closure on food supply and monetary policy is ill-equipped to address this.

“So given the pro-growth outlook of the Committee, we expect MPC to encourage an increase in local supply and hold MPR.”

Also citing the pro growth posture of MPC, Mr Victor Ofili projected that MPC will not adjust the MPR. He said: “We do not see a material change in policy rates for as long as the monetary authority remains aligned with the fiscal authority’s objectives of increasing economic growth even if it comes at the expense of investors getting negative real returns which speak to the rising inflation rate.”

 

Vanguard