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Expansionary fiscal policy and risks’ outlook in 2013 pose greater challenges to Monetary Policy

The biggest challenge confronting the Nigeria’s Monetary Policy Committee (MPC) members at the upcoming Monetary Policy Committee (MPC) meeting due on Monday January 21, 2013 would not be the deluge of foreign portfolio investment (FPI) with the attendant destabilising effects should it reverse unexpectedly. Rather it is the contrasting and expansionary fiscal policy stance of the Federal Government, alongside a disturbing public revenue risk profile. The outcomes of both the expansionary fiscal outlook and the public revenue risk profile could become the triggers for the much feared sudden reversal of ‘hot monies’.

Budget 2013 may be too expansionary for monetary policy comfort

The budget 2013 as approved by the legislators appears substantially expansionary, not only at the federal government level but at the two other tiers of government in the face of potential oil market shock. The US$79 per barrel benchmark oil price and 2.53 million barrels per day (mbpd) production assumption would arguably put liquidity pressure on the economy as more funds are allocated to all levels of government while the allocation to the national buffer is reduced. Nationally, over 70% of government spending goes to recurrent expenditure.

Typically, these funds find their ways into the financial system in different manners- proper and otherwise, with the largest percentage arguably constituting a source of demand pressure on the Naira exchange rate. This happens as some of the proper portion funds government import consumption at all levels and the larger chunk of the improper portion becomes capital flights. The overall effects of this expansionary fiscal stance on systemic liquidity and foreign exchange stability could be destabilising to policy targets; and ultimately inflation rate.

United States of America may stop importing Nigeria’s oil

The second area of risk to fiscal policy in 2013 is the potential inertia (or decline) in oil price globally as America’s import declines sharply. Based on the recent forecast by US Energy Information Agency (EIA), analysts at Citigroup Global Markets predict that the US may stop importing sweet crude light from West African countries by the second quarter of 2013. US EIA forecasts the US oil import to decline to 6mbpd, roughly a third of what it uses, by 2014. Since July 2010, the U.S. has cut its Nigerian imports by half, from more than 1 million barrels a day, to 543,000 as of October 2012, the most recent data available through the EIA. Imports from Angola have dipped below 200,000 barrels a day from an average of 513,000 in 2008. Displacing West African oil from the US market will probably lower price overall due to greater competition. It is believed that US$90 per barrel might be the new cap for oil prices rather than the floor in the short to medium term.

In addition, the country’s budgeted oil production for 2013 may not be feasible

In 2012, the CBN statistics indicate that oil production fell short of the budget benchmark of 2.48mbpd by about 376,000 barrels per day on the average in the first three quarters of 2012. The shortfall in production, which is likely to remain in 2013, was caused by oil theft and vandalism. Yet the budgeted benchmark for 2013 is higher at 2.53mbpd. It is arguable that the challenges of oil theft and vandalism as well as insurgencies in the Nigeria oil production areas have not been substantially addressed; hence the probability of achieving this production target in 2013 is lower than assumed.

What happens when investors realise this risk?

The combined effect of sustained shortfall in actual production and oil price outlook as detailed above could impact on sentiments about fiscal sustainability in the course of the year with implications for exchange rate stability. A sudden realisation by investors of a potential structural deficit in government could scare them; leading to a flight to safety. No amount of interest rate hike would be helpful at that point. The liquidity challenge that the expanded fiscal policy outlook and attendant risks poses is a double hedge sword that could strike through the exchange rate channel or consumer demand and price channel. And the continued dominance of FPI in aggregate foreign capital inflows suggests the need to put in place measures against capital reversal. Balancing these odds is the biggest huddle for the Committee members at the next MPC meeting.

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Why the MPC should consider a downward review of Monetary Policy Rate (MPR) this January

General sentiments support the need to commence the reversal of the two and a half year’s old monetary policy tightening programme in 2013. The tightening mode was initiated and has been sustained as a result of the high inflation in Nigeria which the monetary authority believed was largely a monetary phenomenon. However key indicators relevant to monetary policy actions supports a reduction in the MPR at the monetary policy committee meeting scheduled for Monday 21, 2013. And that a little reflation of the economy now would show the readiness of the monetary authority to use the monetary policy in an appropriate manner- short term, quick response and sharp on focus.

Global growth prospect expected to improve later in the year but not earlier

The Economic Intelligence Unit (EIU) sees improving fundamentals in many economies, supported in part by a heavy dose of stimulus, mainly from central banks. In this regard, it is worthy of note that the Nigerian monetary authority have pursued the opposite path consistently to fight inflation. Coupled with rising demand in many economies and the slow but steady resolution of banking and debt overhangs from the recession, the outlook for global growth is improving. These gains will, however, take some months to fully materialise, and in any case, will come against the backdrop of several risks early in the year. To sustain this trend in 2013, the combination of monetary easing and buffer building has been advocated by the Word Bank. More importantly, emerging and developing countries must avoid policies that are pro-cyclical at this time.

Nigeria’s monetary policy has been pro-cyclical, arguably compounding growth challenges

Amidst sustained impacts of economic downturn and domestic structural challenges on economic growth in the last two years, the monetary policy stance has been rather pro-cyclical. It may have added to the challenges of the productive sectors’ recovery from the economic downturn by promoting sustained deleveraging, pushing corporate hurdle rates higher and making it less attractive for banks to lend to the private sector, especially reducing the small amount of lending that erstwhile goes to the small and medium scale enterprises (SMEs) and consumers. The implication on the employment of human and material is depressing with unemployment rate for 2012 estimated at 25.6% from 23.9% in 2011. In this regard, the monetary authority agreed there is the need to support the economy with appropriate monetary policy actions as soon as possible.

Inflationary outcomes and threat are expected to be lower in 2013

Although inflation resurged in November 2012 when the year on year headline inflation surged to 12.3% from 11.7% in October, the slowdown to 12% in December 2012 however highlights the argument that the surge was significantly caused by base effect. This is shown by the dynamics of the monthly change in the CPI during the period, in addition to the unpredictably volatile dynamics of the year on year core and food inflation in recent times.

Despite the underlying inflationary tendencies that the dynamics of core inflation rates presents, we agree with the CBN research team, that inflation rate would slow down significantly in the first quarter of 2013 starting from January. This is expected to be caused largely by base effect as the base for 2013 monthly inflation rate estimation shifts to 2012, a year with high CPIs. In this regard, among other factors, the outlook for inflationary pressure in the short term is downward; thus providing substantial reason for the commencement of the reversal of monetary tightening.

Stronger and perhaps sustainable exchange rate has been achieved

The interbank and BDC rates moderated between the last MPC meeting in November and currently from N157.96/US$ and N159.00/US$ to N157.29/US$ and N159.00/US$. The official rate was largely flat at N155.75/US$ on the average during the period. Sales at the weekly wDAS market did not exceed US$300m and averaged only US$142m per sale. The stability of the foreign exchange market is also reflected in the growth of the nation’s foreign exchange reserve to US$44.6 billion on January 10, 2013 compared to US$36.8 billion at the end of June 2012. The outlook for the Naira exchange rate in 2013 is stable, on the back of the institutionalised market actions, import prohibition measures and perhaps positive outlook for FPI.

Systemic liquidity was well managed barring the surge in hot monies inflow

Money market liquidity, which provides a reasonable gauge of the dynamics of the systemic liquidity in lieu of the delayed monetary aggregate data, ended the month of December with a total net outflow of N211.23 billion. Characteristically, the liquidity squeeze was largely driven largely higher outflows through the CBN treasury operation and bond issues than the inflow from maturing bills and bonds. However, the mild moderation in short term interest rate during the month suggests that foreign portfolio inflows (FPI) perhaps sustained systemic liquidity higher than captured by the money market liquidity gauge above. The CBN utilised the OMO tool appreciably well to manage liquidity during the year.

The spate of hot monies is however worrisome

The FPI is ‘hot monies’ whose likely sudden reversal could derail any form of economic stability it may have helped to achieve. According to the CBN External Sector Development report for the third quarter of 2012, FPI inflow accounted for 76.21% of the total US$6.07 billion foreign capital inflow during the quarter; growing by 75.9% in that quarter alone.

Truly, the continued dominance of FPI in aggregate foreign capital inflows suggests the need to put in place measures against capital reversal. Yet, at this point on the Nigerian growth and unemployment scale, reflation will be countercyclical and in favour of the economy in the short to medium term.  On a decision scale, the argument for a mild reflation tilts the balance in favour of, at least, 25 basis points cut in MPR.

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