Impact of reduction in MPR from 8% to 6% on the NSE
July 14th, 2009 Manasseh Egedegbe || manasseh.egedegbe@stockmarketnigeria.com
The CBN made an aggressive move by slashing the Monetary Policy Rate (MPR) by 200 basis points from 8% to 6% last week. This is the second time the MPR would be reduced within six months and the reason behind this decision was the tightening liquidity in the general economy despite the first reduction that took place less than three months ago. This latest action was also coupled with guaranteeing of inter-bank transactions by the CBN for the next nine months and a complete switch of foreign exchange transactions from the Retail Dutch Auction System to Wholesale Auction Dutch System.
The question currently bogging the mind of analysts at the moment is how this move will play out in the economy in the short to medium term. There has been differing views about how soon it will impact the currently prohibitive lending rates; some believe that banks are going to open up their vaults because of the guaranteeing of inter-bank transactions and therefore crash lending rates while others believe that it will not happen any time soon because of the uniform year end for banks as they all make moves to beef up asset base. There are many other factors that are going to affect how it will all play out and a future forecast is at best a guesstimation. I belong to the second school of thought that believes that interest rates are likely to remain high for the rest of the year and illiquidity is likely to persist because banks are likely to soak up any available form of liquidity. The cap on lending and borrowing rates are still in place and it is well known that these rates are not reflective of current economic reality as the rates are far below what they should be in a free market.
Core inflation has been going down according the National Bureau of Statistics; this can be partially attributed to the systemic illiquidity but yet food inflation has virtually gotten out of control. This is even worsened by the fact that the Met has issued a report that rains are going to stop early this year; this has the potential of worsening food inflation further as the year draws to a close. Therefore the fear that core inflation may reverse and continue on another upward march is not likely to happen with this reduction in MPR. I expect inflation to continue its descent towards a single digit before the year runs out.
The equity investor is particularly interested in the lending and borrowing rates that are theoretically positively correlated with the MPR. The lower the MPR, the lower these rates should go and the lower these rates, the higher the disposable income available for stock investment. And the higher the disposable income the higher the expected returns on equity investments.
Lower borrowing rates means that fixed deposit rates are likely to fall and the lower they fall the less interested investors would be in the return generated from such investments. This will therefore push them to invest in high risk high return media such as the equity market.
Lower lending rates means that there will be lower cost of capital and companies will be able to finance their businesses with short term loans; the lower the rates the higher the spread between the returns generated by the businesses and cost required to maintain the loans. This will boost profitability both in the short and long run and as profitability increases the higher the dividends they pay out the more interested investors become in the stock market. Lower lending rates also means that consumers will be able to consume more now and pay later and have more money to spend now; because they consume more, companies are able to generate more revenues and pay more dividends and because consumers have more money to spend now and companies are paying great dividends, they will be more interested in investing these monies in the stock market in order to have higher returns.
However, given the current trend in the macroeconomic indices, I expect the interest rates to remain high for the remaining half of the year and therefore investment in the NSE from the retail end to also reduce towards the end of the year. This might just be the best time to cut losses or take profits and wait for bargains when they eventually return to the market.
 |