Tuesday, March 24, 2020   /12:50PM / by CardinalStone Research / Header Image Credit: BCL

CBN pushes the FX button; activates monetary stimulus packages

Inaddition to its six initial policy response to the COVID-19 menace churned outon 16 March 2020, the CBN announced a N1.1 trillion stimulus to support localmanufacturing & boost import substitution (90.9%) as well as ensure thatlaboratories, researchers, and innovators work with global scientists to patentand produce vaccines (9.1%). The CBN also quietly devalued the naira byadjusting its FX intervention rates at the I&E (-5.6%% to c.N380/$) and BDC(-5.0% to c.N378/$) markets, amongst others, in response to Nigeria's weakeningexternal position and buffers. At the official window, the naira was alsorepriced lower to c.N360/$ from N307/$, resulting in a narrower spread betweenthe official rate and the rates in other FX market strata. Elsewhere, the apexbank revealed plans to activate the N1.5 trillion Infraco project and redirectoil & gas dollar sales to itself instead of the NNPC. The former isexpected to boost infrastructure while the latter is aimed at ensuringcontinued funding for petroleum imports and supporting the new policy on fuelprice modulation.

Policy responses are likely to provide a calming effect.

Webelieve the soothing measures could help manufacturers cover importantobligations and keep plants running to meet domestic demand withoutinordinately raising prices to account for the rising cost of raw materials.The measures to support pharmaceutical and healthcare companies are alsopositive, given the shutdown of countries across the globe, ongoing spread ofthe COVID-19 virus in Nigeria, and sustained panic buying of pharmaceuticalproducts domestically. However, measures to boost liquidity and economicactivities may cascade to some pressures on the naira, which has been well soldin the last two months (CBN intervention: February - $2.1 billion; March - $1.8billion). These pressures, and continued moderation in oil prices, are likelyto offset gains from the mild naira devaluation implemented by the CBN. Inaddition, even though the FX rates across the I&E and BDC markets are nowpriced closer to the long-run real effective exchange rate of N382/$, webelieve our fair value estimate of c.N437.20/$ better captures the realities ofsustained double-digit inflation and twin deficits across fiscal and currentaccounts. That said, the recent narrowing of FX spreads across the currencymarkets could imply CBN's growing acceptance of the need to reprice thecurrency to reflect the state of fundamental variables in challenging periods.

MPC may highlight CBN's growth resolve with a 50bps rate cut.

Althoughthe monetary policy rate (MPR) scarcely dictates yield movements in Nigeria,the Monetary Policy Committee (MPC) is likely to use it as a signaling tool forthe second time in less than twelve months, at its ongoing policy meeting.Precisely, we expect the MPC to reduce the MPR by 50bps to 13.0% and, possibly,expand its differentiated CRR net to encourage bank lending. For clarity, whilewe do not expect another CRR adjustment, the CBN may become more accommodativein its discretionary implementation of the CRR to motivate banks to key intoits growth campaign. Our prognosis is largely in line with CBN's responses tothe 2008/2009 global economic crisis and the extended oil price crash thatresulted in Nigeria's 2016 recession. Importantly, CBN's increasing dovishnessis likely to cap scope for significant interest rate increases in the domesticmarket but could fail to stall FPI outflow in isolation. Among other things,FPIs may feel that the mild currency repricing does not sufficiently compensatefor the increasing risk of credit rating downgrades amidst weaker oil price andproduction outlook. On this wise, the CBN may likely leave carry tradeopportunities attractive enough at the OMO market.

Fiscal intervention may be needed to stimulate demand

Aspart of measures to prevent a meltdown of the Nigerian economy, we anticipatemore fiscal responses from the Federal Government. These measures are likely tocomplement already announced monetary policy initiatives and fiscal drives. Inour view, CBN's stimulus (c.2.1% of GDP) may not be weighty enough to offsetpotential shocks from the current crisis. We hold the view that a significantstimulation of consumption and direct intervention in healthcare from thefiscal authorities may be more impactful on households. For instance, webelieve the direct reduction of PMS price to N125/litre from N145/litre, toreflect the fall in oil prices, could lead to cost savings and higherconsumption for consumers in coming months. Other than this, we see otherplausible fiscal initiatives likely to be rolled out:

Budget review could mean record fiscal deficit in 2020

TheFederal Executive Council (FEC) recently approved a N1.5 trillion cut toNigeria's 2020 budget amid the recent crash in oil prices to $20/barrel levels.Notably, FG revised its oil price benchmark to $30.00/bbl (from $57.00/bbl),while leaving its oil production target unchaged at 2.18 mbpd. The resultant reductionin oil revenue and projected non-oil revenue cut1 may result to a 45.0% declinein budgeted revenue for 2020. Similarly, government expenditure was reduced byN1.5 trillion after capital expenditure projection was cut by 20.0% andrecurrent expenditure was surprisingly slashed by 25.0%. For us, the budgetreview was a necessity given recent oil price shocks. However, we believe thatthe government is still likely to underperform its revenue target for tworeasons. Firstly, we see significant risks to oil production forecast of 2.18mbpd as deep offshore production (c.40.0% of Nigeria's oil production) may bedisincentivized if prices remain around current levels of $20/barrel (vs.average upstream production cost of $30/barrel). Secondly, we believe that theinitial budget overestimated potential revenue from other non-oil sources suchas FGN balances in special levies account, FGN share of actual balance inspecial accounts, and Signature bonus/Renewals revenue. 

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