A seemingly simple move by the CBN is achieving outcomes that have previously been deemed difficult in Nigeria’s financial sector.
The CBN, deciding not to worry any longer about excess liquidity in the banking system, and letting short term money market instruments mature without rolling them over, has caused a flush in the amount of liquidity in the system, thereby potentially causing lending rates to fall.
Previously, the CBN used Open Market Operation instruments to suck away ‘excess liquidity’ from the banking system, thereby keeping interest rates high in order to maintain Nigeria’s attractiveness to Foreign Portfolio Investors (FPI) who seek higher returns.
The CBN had to maintain Nigeria’s interest rate attractiveness to FPI investors to boost forex inflow and support the Naira.
But with the sharp slow down of the economy (Q3 GDP growth rate is estimated to come in at 1%), the CBN has had to take measures to reinvigorate the economy. It is doing this by easing liquidity in the economy.
Along with the monetary policy side (the CBN), the fiscal policy side (federal government) is also planning to spend as much as is possible to prevent the economy from sliding into a recession.
Reports say that the government is planning an N8 trillion budget for 2016, 78 percent greater than the 2015 budget.
But the tricky part of the mulled 2016 budget is the revenue side. For the current 2015 budget, the performance of the government’s revenue sources is put at less than 45 percent, as lower oil prices continue to bite the government.
Revenues will most likely become tougher to come by in the near term, because Nigeria’s oil cargoes are becoming a hard sell in the global oil markets. It is becoming economically uncompetitive for major buyers to purchase Nigeria’s oil partly because freight costs have soared.
According to Reuters, up to 15 November-cargoes are still in the markets awaiting buyers, while nearly 50 million Nigerian oil barrels have hit the market additionally.
With the revenue outlook appearing murky, the government will most likely resort to borrowing.
If the CBN decidedly stays out of OMOs for an extended period, it will basically prepare the ground for a new era of cheap borrowing for the government, which is exactly what it needs at this time when revenue is flailing.
Since the CBN decided to stand out of Open market operations, the demand for fixed income securities have shot up as banks became awash with liquidity (boosted also by the drop in CRR). The surge in demand, though starting with the short-dated tenures has spread across to longer-dated maturities.
As a result, yields have fallen by about 27 percent on average across 11 maturities since the beginning of October.
If the CBN continues this easing trend, banks could struggle to find uses for their funds. They could enter a scramble to snap up government bonds during the auction, which will further lower the interest rate that the government will have to pay for borrowing from them. Otherwise, the banks could have to increase their lending to the real economy.
Things could get much worse if the CBN takes its easing drive up a notch by further reducing CRR.
The effects of this trend might as well spread out to other paper securities such as equities, as banks seek to deploy their cash hoard productively. (Is a stock market bubble imminent?)
As the government gets set to issue bonds, the stage for lower-cost borrowing could already be in motion, paving the way for government to go on borrowing spree at lower rates if it wanted.
Many have wondered how the government plans to finance its budget within the context of lower oil prices, especially with the lofty plans of the social-capitalist APC party.
With this development in the financial system, the answer is not out of the reach of imagination.