Tight policy by CBN & SARB to continue

By Rafiq Raji, PhD

Central banks at Africa’s two largest economies, Nigeria and South Africa, are meeting this week to decide on interest rates. Foreign exchange scarcity and the consequent weakening of the naira is principally what is stoking Nigerian inflation, which has been on an upward trend since the beginning of the year. From a 2016-low of 9.6 percent in January, annual consumer inflation accelerated to an 11-year high of 18.3 percent in October. Still, the Central Bank of Nigeria (CBN) is widely expected to hold its benchmark lending rate at 14 percent, when it announces its decision on 22 November. Its South African counterpart, the South African Reserve Bank (SARB) may raise rates, however, by 25 basis points to 7.25 percent is my reckoning. At 6.1 percent in September, headline inflation remains outside the central bank’s target inflation band (3-6 percent). My forecasts (6.1 percent for October) put the headline outside of the band for the remainder of 2016 and first month of 2017. Even so, external factors like the imminent policy tightening by the American central bank and uncertainties about what a Trump-led America means for the world at large may be what tilt the SARB’s decision towards a hike. Not that there are not ample domestic worries that weigh on the inflation outlook: the continued negative political dynamic that sends the rand on a tailspin every other two weeks or so for instance. There is some relief though: surplus maize (the staple food) output is predicted for 2017, after drought-induced shortfalls in the last season. The SARB announces its decision on 24 November.

FX scarcity and politics limit CBN’s choices
The CBN’s monetary policy committee (MPC) would be making its decision this week amid an ongoing economic recession and tricky political environment: there is limited political space for it to raise rates; that is, if it desired to make the policy rate positive in real terms. In any case, there is probably no need for it to do so, as inflation likely reached its zenith in October, and could begin to slow from December onward; albeit all too slightly at first, at about 18 percent then. Even so, the CBN governor, Godwin Emefiele, in recent comments, has ruled out a rate cut anytime soon. At least, not at current inflation levels. More importantly for the CBN would be how to tackle the continued foreign exchange scarcity. It was confirmed last week that the CBN may seek extraordinary powers from the legislature to prosecute those who keep foreign currencies for more than a predetermined legal holding period, 30 days, say. Although the CBN says in news reports, by Bloomberg at least, that the proposed legislation did not emanate from it, it did not seem to object. The proposal comes against the backdrop of recent raids by security operatives on black market foreign exchange operators, mandating them to sell FX at a price directed by the central bank. In a nutshell, what has turned out to be a disappointing turn of events, after initial excitement that the naira would trade freely since its supposed float in June 2016, has worsened further. Much needed foreign portfolio flows would probably slow even more consequently, as fund managers hold back their funds for fear of getting burnt a second time. Prior to the float, the CBN frustrated the repatriation of capital abroad, with investors and businesses having their funds stuck in the country for much longer than even their most extreme risk model scenarios ever envisaged. Most lost money.

It is tempting to think that the reason there is FX scarcity is because crude oil prices have more than halved, with similar consequences for the revenue of government. An examination of the typical structure of FX flows into the country, in 2014 say, reveals that the dominant source of foreign exchange inflows is not the CBN or crude oil. Instead, it is the so-called autonomous sources that supply about 70 percent of needed foreign exchange, at least in 2014. These are those kept in domiciliary accounts, sold over the counter, and non-oil receipts by banks. In the current anti-corruption environment, the OTC sources have diminished significantly. And those in domiciliary accounts, which have risen as speculation is rife, remain just there. The CBN now wants to tap into that source. With the CBN’s foreign exchange reserves fast depleting on its stubborn but futile support for the naira, the central bank is clearly desperate. A suggestion to the CBN on how to tap domestic dollar deposits without resorting to coercion might be to issue a domestic dollar bond, like Ghana did. But even after that, it cannot run away for too long from the inevitable measure it must take: allowing the naira to find its level. Any solution that avoids that is never going to be sustainable.

Toxic politics and imminent Fed tightening may force SARB’s hand
The SARB’s MPC meeting this week comes against the backdrop of an almost certain rate hike by the US Fed in December and consequent strengthening of the US dollar in anticipation of it. President-elect Donald Trump’s expected fiscal expansionism adds to market sentiments buoying the dollar. Never mind that South Africa has upheavals of its own. The political environment remains toxic, spewing at every other occasion, some irritation or the other to rile market participants. Incidentally, at least one rating agency, Moody’s no less, is expected to reveal its rating assessment this week (25 November). Although it has South Africa two notches above sub-investment grade, its decision may lead the mood ahead of the much more anticipated decision by SPGlobalRatings in early December. Besides that, the inflation outlook suggests annual consumer inflation would remain outside the upper bound of the SARB’s 3-6 percent target range for the remainder of 2016 to January next year. Rand volatility weighs certainly. After showing some resilience to the now expected negative political event every other week, it almost lost its bearing, so to speak, once it became clear the US Fed was going to hike rates almost for sure in December – bets of a hike are about 100 percent in some cases. The dollar exchange rate of the rand has weakened by almost 10 percent over the past two weeks to 14.4 (18 November), a 2-month low. The SARB, although it would be loth to acknowledge this, might also want to pre-empt potential market volatility should SPGlobalRatings go ahead to downgrade the rating of South Africa to junk status in December. Short of a pre-emptory strike by the SARB, all these may be a little too much to bear for South African assets. These considerations underpin my reckoning that the SARB may raise its repo rate by at least 25 basis points to 7.25 percent this week.

Also published in my BusinessDay Nigeria newspaper back-page column (Tuesdays). See link viz. http://www.businessdayonline.com/tight-policy-by-cbn-sarb-to-continue/

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