Central Bank of Nigeria (CBN)'s Monetary Policy Committee (MPC)kept its Monetary Policy Rate (MPR) unchanged at 12 per cent and maintained the symmetric corridor around the policy rate (standing deposit facility (SDF) at MPR-200 bps (10 per cent);standing lending facility (SLF) at MPR+200 bps (14 per cent). Additionally, the CBN alsoheld the cash reserve requirement (CRR) ratiosteady at 8 per cent. We had advocated a 100 bps hike to consolidate the recent gains in the forex market and the positive real rate regime in the economy. Yet the CBN pointed to several factors to justify its position, including some stabilisation in the FX market, early signs of fiscal restraint and restrictive liquidity conditions. Meanwhile, we expect the central bank to consistently utilise open market operations (OMO) to offset monthly Federation Account Allocation Committee disbursements to the three tiers of government and address other liquidity-related risks.' Midpoint of FX band moved to 155. CBN Governor Lamido Sanusi announced that the midpoint of the +/-3 per cent FX band will shift up to 155 from 150 (the Wholesale Dutch Auction System (WDAS) rate was already 155.2 on 21 Nov). Furthermore, the CBN said it would continue to seek convergence between WDAS and interbank rates, which it has partially achieved lately by proactively intervening and selling dollars in the interbank market. Although the spread between the WDAS and interbank rates initially widened up to cNGN10 in Oct, it has compressed in recent weeks. But the MPC also admitted yesterday that pressures on the exchange rate have persisted. In this regard, we think the risk associated with a neutral policy stance at this stage is that it has the potential to undermine NGN market confidence. We do however believe the CBN will most likely be able to preserve the current FX framework as long as oil prices remain high.' Removal of fuel subsidies, an upside risk to the CPI outlook. The MPC stressed the mild rebound in inflation in recent months (10.5 per cent y/y in Oct, from 10.3 per cent y/y in Sep), but suggested that the immediate outlook for the CPI was relatively mixed and would benefit from the lagged effect of the sharp tightening in monetary policy this year. In a related matter, we suspect the main risk to the inflation trajectory stems not so much from depreciation, which will be offset by increasingly positive base effects in global food and oil prices in coming months, but from the likely removal of fuel subsidiesin 2012.' Fiscalimbalances pose a threat to macroeconomic stability. The MPCpointed tothe reduction in the oil price benchmark to USD70 pbl in the 2012 budget, from USD75 pbl in 2011, which in its view indicates that the government may have initiated some form of modest fiscal consolidation. Also, the MPC appeared to suggest that a solution to the imbroglio over the Sovereign Wealth Fund could emerge in the short-to-medium term. It added that theauthorities were likely to cut non-necessary expenditure in case of an oil price shock instead of increasing public borrowing. Yet, we still think the expansionary fiscal stance remains a threat to the exchange rate outlook and macroeconomic stability. Other symptomatic issues include the proposal put forth by the States to change the revenue sharing formula in their favour. Meanwhile, the relevance of the nominal deficit set in the Federal Government budget (c3 per centof GDP) is limited, as it is the consolidated net Federal fiscal position (including government savings) that matters. In contrast with most African oil producing economies, the country's inability to rebuild FX reserves (USD33.0bn on 17 Nov) and oil-related savings despite the relatively positive external environment will continue to weigh negatively on NGN confidence. In such a context, the macroeconomic dilemma in Nigeria is that monetary policy will have to remain exceptionally tight going forward to prevent a macroeconomic systemic shock, as a quasi-fixed exchange rate andloose fiscal policy are not compatible in the long-run. Even so, the CBN will not be able to indefinitely raise policy rates to address these distortions.
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