On Wednesday, October 23rd, 2019, the Central Bank issued a new circular that once again spooked the financial markets to its core. In one of several circulars released during the week, the Apex bank restricted purchase for its much-coveted Open Market Operations (OMO) to only foreign investors and local Nigerian Banks.
Thus, freezing out corporate Nigeria and individuals from being able to purchase OMO from both the primary and secondary markets. The CBN under the leadership of Godwin Emefiele will probably go down in history for its unorthodox monetary policies but this latest move is stuff made of gimmickry.
The Open Market Operation is basically designed to be a short-term market instrument that the CBN uses to control the supply of money in the economy. Whenever the CBN believes the inflation rate is high due to increased money supply it sells OMO bills at high-interest rates mopping up liquidity from the economy. On the flip side, if it believes there is a liquidity squeeze due to high-interest rates it buys back OMO bills flooding the financial market with cash so that. As you’d expect these are short term bills that typically should not be more than 90 days, except that these days OMO Bills are now sold with maturity as long as 365 days competing toe to toe with Treasury Bills.
Why OMO: Data from the CBN indicate it has a total OMO Bills of about N13.8trillion out of which local banks held N3.95 trillion, corporates N3.7 trillion and foreign investors N6.1 trillion. In fact, OMO Bills were as high as N17 trillion in August as the CBN sold more bills in a bid to “control the supply of money”.
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OMO bills also attract a juicy interest rate of about 15% per annum making them one of the most sought-after securities in Nigeria and indeed emerging markets explaining why foreign investors hold nearly half the size.
Exchange Rate Stability: The CBN under Godwin Emefiele is understood to have one major mandate; keep the exchange rate stable at all costs and avoid devaluation. This is the cornerstone of his monetary policy and underlines every action the CBN has taken since the Buhari administration came into power in 2015.
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To keep his mandate of keeping the exchange rate stable at N360, the CBN has had no choice but to keep interest rates high, mopping up naira from the economy relying on OMO sales. However, the major incentive for offering such high-interest rates is foreign investor dollars. The CBN’s FX reserve of $40 billion can only be sustained if foreign investors hold back on repatriating their money. Some reports seen by Nairametrics indicate foreign investor holdings of OMO Bills is a staggering $17 billion explaining why OMO is such an important monetary tool for the CBN.
To keep their appetite strong, the CBN offers them high-interest rates and will continue to do this so long as its objective remains to keep the exchange rate stable and avoid devaluation. Unfortunately, this decision to sell OMO bills at a 15% interest rate is taking a toll on the CBN’s balance sheet. Analysts opine it is costing the CBN has high as N2 trillion in 2018 from over N1 trillion in 2017 and expected to hit a whopping N2.7 trillion in 2019 in interest rates.
Yanking off Corporate Nigeria: Party planners typically do one thing when they are on a shoe-string budget but still want to have a stupendous party with lots of freebies. They cut down the guest list and ensure the party is strictly by invitation. This is basically what the CBN did when it decided to cut out corporates including pension funds, mutual funds, insurance companies, treasury departments of multinationals and large companies from participating in the OMO market.
Sensing that what it wants is dollars, corporate Nigerian (except banks) became casualties of the great interest rate party. The CBN is giving out high-interest rates to maintain its dollar reserves and attract more forex inflows as such it probably sees no reason why it should allow non-banks into the party. Foreign investors will continue to provide dollars while banks will provide some liquidity.
Others are just in for the freebies so why not just cut them off. So, by stopping non-banks from buying OMO bills from the primary and secondary market, these investors will have to now divert their attention towards treasury bills and other fixed-income security which as you’d expect have lower interest rates. This has several implications for the Nigerian Economy.
Yields could fall: Pension Funds, Insurance Companies, and other institutional investors will now have to rely on treasury bills and bonds to invest their money. Unfortunately, this market lacks the sort of volume and availability OMO bills are characterized by and does not offer the same interest rates. Ironically, some analysts believe interest rates could crash for bonds and treasury bills, with the ensuing increase in demand. Deposit rates could also fall as banks now have the upper hand against their big depositors who no longer have the option of going the OMO route.
Ricochet on foreign investors: Whilst the CBN may have reassured foreign investors that they are always invited to its part, this move could hold some inherent risk for those it seeks to protect. By restricting local participation in the market to banks, the CBN has effectively squeezed out liquidity in the secondary market. A research report sighted by Nairametrics indicates about circa 25% of the market liquidity has now been extinguished.
This means foreign investors who decide they want to sell OMO bills and repatriate their dollars may have to rely on banks to buy giving them fewer options, a move that can significantly play on price. Indeed, if nothing this latest move suggests desperation on the part of the CBN arousing concern from more risk-averse foreign portfolio investors.
What next: The last couple of weeks have seen the CBN pull off several policies aimed at keeping the exchange rate stable often in the guise of increasing lending to the real sector rather than to risk-free government securities. However, this gimmickry is overplayed and at some time will crystallize on the CBN. When it does, we hope we will still have an economy to savour.