Back and forth on ‘ways and means’: Over the weekend, the former Central Bank of Nigeria (CBN) governor, Emir Muhammad Sanusi II stated that the apex bank was violating certain portions of the CBN Act 2007 which cap monetary financing of fiscal deficits at 5% of prior year’s revenues. Given the implications of unrestrained monetary financing of fiscal deficits, we examine the issue to ascertain the true picture and focus on likely implications on fixed income markets. Using data available from the apex bank, CBN claims on FG have risen steeply over the last two years to N4.2 trillion at the end of October 2016. The increases reflect sharp expansion in overdrafts and converted bonds facilities, which cumulatively account for 95% of the outstanding balance, to N2.1 trillion and N1.9 trillion, respectively.
In our H1 2016 Nigeria Strategy Report, we had highlighted that CBN financing came in handy in 2015 with Budget Office data showing that the apex bank’s advances (N616 billion) helped fund 40% of the fiscal deficit that year. Going by 2014 FGN retained revenues of N3.2 trillion, we can safely say that, in 2015, the apex bank overshot the ceiling of ‘5% of prior year revenue’ imposed in the CBN Act 2007.
Voice of Jacob but hand of Esau: Clearly, the key insight from parsing through the data is that faced with a gory revenue picture, the FGN has been reliant on the apex bank thus far in 2016. For evidence, the stated overdraft of N2.1 trillion is two-times of total net borrowings (bonds & bills) thus far in 2016 (N1.06 trillion). Importantly, where it had seemed more pristine motives of discipline and focus on long-term inflation were behind FG’s reticence to borrow at high rates, the CBN’s backhand funding clearly lessened the need for haste in fiscal borrowings, including the foreign leg, with the planned Eurobond issuance postponed at least three times in 2016.
Spotlight on CBN ‘back-door’ funding to drive policy normalisation? Going forward, with the spotlight now firmly on the ways and means funding, we think the FGN and CBN are less likely going to continue to rely on the avenue for deficit financing. Given lack of progress on foreign borrowings and the urgency regarding spending, the expected cap in CBN temporary financing should result in FG relying more heavily on domestic borrowings with limited room for cost sensitivity. All of this points to higher debt supply in 2017, further deterioration in debt service to revenue ratio, and upside to interest rates.
Monetary policy at cross purposes: In itself, the extent of the ways and means financing puts CBN’s tightening stance under scrutiny. The reduction of banking sector liquidity and raising of short-term rates (via OMO interventions & high T-bill rates) while expanding liquidity into the economy at negotiated rates via its backdoor FGN financing, also ‘short-term’ by definition puts monetary policy at cross purposes, in our view. That dissonance also reconfirms to us that, despite the inflation alibi, the raising of short-term rates is so at odd with everything else on the domestic front that the motivation could only be for attracting FPI. The question is then when the apex bank wakes up to the realities that the latter is not wooed, especially not with the whack-a-mole actions on the currency, and start to focus on what it indeed can influence.
Given that 2016 has borne out our long-held views about the inefficacy of interest rate hikes on taming cost push inflation even as FPI remains reticent to naira assets, we think a more coherent and consistent approach would be for the apex bank to adjust its policy stance in line with its intentions to support growth especially considering it’s already indirectly seeking to combat the recessionary conditions via deficit financing to the fiscal side anyway. It is that potential for a twist to an easing regime that makes higher rates from the replacement of CBN’s support to financing FGN deficit less of a foregone conclusion with full-blown stimulus mode possibly leading to contraction in yields with extent however limited by sizable fiscal paper supply.