How CBN’s tight monetary policies hit stock market

The stock market plays an important role in mobilising domestic resources for productive investments.

The stock market is regarded as an integral component of most economies since it signals the reallocation of assets among different economic units within an economy.

The performance of the market is tied to the overall performance of an economy. The correlation between the two variables was demonstrated last week, when the stock market lost over N1 trillion within eight trading days after the Central Bank of Nigeria’s (CBN)’s decision to tighten monetary policy by increasing the Monetary Policy Rate (MPR) by 100 basis points to 14 per cent, the second increase this year, to curtail rising inflation.

Specifically, the market capitalisation of listed equities on the Nigerian Exchange Limited (NGX), which stood at N28.208 trillion as at July 19, 2022, the day the rate hike was pronounced, slumped by N1.046 trillion within eight trading days, to close at N27.162 trillion on Friday.

The all-share index (ASI), which measures the performance of listed firms, also dipped by 3.8 per cent from 52, 308.88 to 50,370.25.

Consequently, most of the blue-chip stocks pushing market capitalisation in the equities sector have been on a downtrend since the pronouncement.

The banking sector was mostly hit. Other sectors equally affected by the rate hike include, insurance, consumer goods and oil & gas.

In the banking sector, GTCO, United Bank for Africa and Access Bank were the most affected stocks, while Mansard and NEM were impacted in the insurance stocks.

Nigerian Breweries, Cadbury and Nestle stocks declined in the consumer goods sector. Oando also depreciated in the oil and gas sector.

The industrial goods were defensive, as only Lafarge WAPCO was down during the period.

On the percentage decline, the insurance stocks shed 2.75 per cent while, -the banking sector depreciated by 4.43 per cent. Consumer goods declined by 5.92 per cent.

NGX oil/gas lost 1.16 per cent and the industrial sector dropped by 0.71 per cent one week after.

The equity market sustained a bullish trend from the beginning of the year, amid rising inflationary pressure and other exogenous factors, appreciating by N5.64 trillion in the first half (H1).

Precisely, market capitalisation appreciated by N5.64 trillion or 25.3 per cent in H1, 2022 to close the half year at N27.935 trillion, from the N22.297 trillion it opened for trading activities on January 4, 2021.

Also, the ASI rose by 21.31 per cent or 9,101.15 basis points to close at 51,817.59 basis points in H1 2022, the highest performance in 14 years, from 42,716.44 basis points it opened for trading. The index had risen by 9.95 per cent to close at 46,965.48 basis points in the first quarter (Q1 2022).

Chief Research Officer of Investdata Consulting Limited, Ambrose Omordion, said CBN’s tightening and fear of recession have ripped the market off over N1 trillion within eight trading days from the N5 trillion achieved in six months.

He cited the effect of the macro-economic headwinds on business operations in Nigeria, stressing the need for an active collaboration of fiscal and monetary authorities to reverse the trend.

Specifically, he pointed out that given the increasing level of insecurity, kidnapping, unemployment, weak naira, rising inflation and dwindling revenue, the government has to evolve new strategies to tackle factors impeding the nation’s economic growth.

“We know that the factors pushing cost and inflation are more of insecurity and cost of diesel. Now that they have increased pump prices, one will expect a higher, galloping inflation, which informed the CBN’s decision to increase the rate.

“This is not the only way to check inflation, there is also a need for the economic managers to influence some fiscal moves.

“Rising insecurity in the country has affected the price of goods; the government must address the issue of insecurity so that farmers can go back to their farm,” he said.

Vice President of Highcap Securities, David Adonri, noted that the hike in interest rate in June 2022, caused equities to lose 3.4 per cent in that month.

He maintained that a further hike in rate in July 2022 may cause equities to lose more even as the impact of a rate hike on debt is not yet pronounced.

Adonri argued that figures from the capital market showed that the policy slowed down equities with minimal impact on debt.

According to him, when this slowdown in the entire market is juxtaposed with the rising cost of production, coupled with the disruptions caused by insecurity, the fear of recession may become justified.

He insisted that it is only fiscal policy intervention, which is a long-term solution to the structural imbalance underpinning the economic dislocation can avert the slide to recession beyond monetary initiatives.

Professor of Finance and Capital market at Nasarawa State University, Keffi, Uche Uwaleke, said the stock market would most likely be bearish with the tightening monetary policy.

He pointed out that most sectoral indexes will decline except for the oil and gas index which will continue to respond to favourable International crude oil prices.

According to him, monetary tightening due to rising inflation will increase yields in the fixed income market, compelling fund managers to rebalance their portfolios away from equities to fixed income securities.

He argued that the scenario that would play out in most developed and emerging markets especially with U.S. currently in a technical recession and many economies witnessing high inflation is that investors will sell stocks to invest in safer asset classes.

Operators have argued that when it comes to monetary policy tightening and rate hikes, the stock market suffers most because at that time, every other investment window becomes more attractive with less risk.

For those that are risk averse, they want to look at those money market instruments because once the rate is high, the yield will be higher in money market instruments and it becomes more attractive.

Although, there is always opportunity in the market in an inflationary period when one understands how to play the market because there are still some stocks that can offer better returns above the inflation level despite the rate hike but the fear of recession is always apparent.

This is because, in any economy, there are five stages of the economic cycle: early expansion, mid expansion, late expansion, early contraction and late contraction.

More so, three factors determine the direction of the economy: the national output production, rising inflation and interest rate. When the interest rate of any particular country is on the high side, and inflation also follows, industrial output will decline and this will impact heavily on the economy and plunge such economies into recession and that is exactly what is happening in Nigeria presently.

The United States’ economy is technically in recession because the rate hike has increased the cost of funds.

Already, the CBN has signalled that the nation’s economy is in the early contraction stage, which may lead to recession if necessary steps are not taken to reverse the trend.

Recall that money supply expanded astronomically following the expansionary monetary and fiscal policies deployed by the government to move the economy out of recession in 2020.

The excess liquidity, which was targeted at output growth, strayed more into the equities market due to the low absorptive capacity of the production sector.

As a result, equities appreciated by 50 per cent in 2020, unexpectedly. The low-interest rate environment in 2020 depressed the debt market and caused yields to plummet which simultaneously caused financial assets to migrate to equities.

However, in 2021, the debt market started recovering, causing financial assets to emigrate to debt as yields started rising.

Consequently, equities declined to 6.07 per cent in 2021. The recession in 2020 was accompanied by high inflation. However, the global and domestic economies started to reopen in 2021 and supply chains were restored.

Hence, the high rate, of inflation started declining as the economy exited recession. The inflation rate which peaked at 18.17 per cent in March 2021, declined steadily to 15.4 per cent in November 2021, but started rising again up to about 18.6 per cent in June 2022. At the same time, the inflation rate also started surging in major economies of the world due to the sudden war in Ukraine and the resurgence of COVID-19 in China that disrupted supply chains, causing commodity prices to rise sharply.

Since the beginning of the year, advanced economies like the United States and the United Kingdom embarked on tight monetary policies to rein in inflation and hence normalise their economies by raising the interest rate.

Being in a similar, if not worse situation compounded by FX distress and debt crisis, Nigeria embarked on tightening monetary policy by first raising MPR by 150 bps to 13 per cent in June 2022 and recently by 100 bps to 14 per cent in July 2022.