Contrary to the expectation of many for an interest rate cut, the Central Bank of Nigeria may actually raise rates by the fourth quarter of 2018, says the latest report from Coronation Merchant Bank.
In a report titled: “Interest rate outlook, 2018”, released on Tuesday, the investment bank noted that while countries such as Kenya and Egypt, that offer one-year risk-free local currency yields in excess of 5.00 percentage points (pp) above inflation, Nigeria offers a one-year risk-free rate of 0.72 pp over its inflation rate.
It explained that in spite of CBN wishes to keep interest rates down, it may have to jack up market interest rates by Q4 2018.
“A significant part of Nigeria’s Naira-denominated risk-free securities are held by foreign investors and logic suggests that CBN must increase interest rates dramatically to keep the investors. However, we believe the CBN will keep interest rate rises to the minimum, while allowing a degree of foreign exchange reserve deterioration if foreign investors either sell or do not renew their Naira fixed income positions ahead of elections in February 2019. We think that the CBN would tolerate a degree of parallel exchange rate deterioration, if this results,” asserted Guy Czartoryski, Head of Research, Coronation Merchant Bank.
The report indicated that the CBN is aware of the risk of outflows of foreign investment in Naira money market instruments and the threat of pre-election spending that will most likely feed through to inflation in H2 2018.
“For these two reasons we think that the CBN will raise its open market operation (OMO) rates to achieve an annual yield of 14.00 per cent-15.00 per cent by Q4 2018, from 13.20 per cent per annum (pa) recently. However, we doubt that it will make an overt signal by raising its Monetary Policy Rate (MPR) above 14.00 per cent pa this year,” it added.
According to a report recently released by the industry-leading Coronation Research – a part of Coronation Merchant Bank Group – on interest rate outlook for the year, conditions for emerging market currencies have deteriorated in the last two months. While the crisis in the Argentinian Peso is an extreme example, few emerging markets can take their exchange rate for granted and in some cases market interest rates have risen. US dollar strength is taking a toll
The report examined the current yield on government-issued or central bank-issued one-year bills of three groups of emerging market/developing countries: Brazil, Russia, India and China (BRIC) countries; selected emerging markets with double-digit inflation; and selected sub-Saharan African countries.
It compared the current yield on the government securities with domestic inflation rate as an indicator of how much currency depreciation, against the US dollar, an international investor might expect.
“Brazil, Russia and India have inflation below 5.0 per cent per annum (pa) and also offer one-year risk-free yields above 6.0 per cent pa. Countries with double digit inflation (i.e. Ukraine and Egypt) have one-year risk-free local currency yields that are 5.00 percentage points (pp), or more, higher than the headline inflation and are defending their currencies effectively. Policy rates in these countries are also high, with the Ukrainian policy rate at 17.00 per cent pa and the Egyptian policy rate at 16.75 per cent pa. Compared with other sub-Saharan African countries, Nigeria is an outlier; the average one-year risk-free rate of 13.20 per cent is 0.72pp above the headline inflation rate of 12.48 per cent pa (for April).
Coronation Research claimed Nigeria will have to offer a higher interest rates more than what the market currently offers to attract international investors looking for a return, and lock in domestic funds that might otherwise go to the foreign exchange market.
“Rather than have market interest rates trend down with inflation, we believe that in H2 2018 the CBN will seek to increase the spread between inflation and the one-year risk-free rate, which it effectively sets with its OMO rate.”