Chapel Hill: Liquidity in OMO market likely to reduce on OMO guideline

The Central Bank of Nigeria's recent directive to limit individuals and local corporates from participating in Open Market Operations (OMO) Auctions is a clear indication that the Apex Bank is gearing up to reduce its balance sheet expansion. This move is designed to flatten or reduce the pace of growth, as highlighted by Macro and Fixed Income Analyst at Chapel Hill Denham, Omotola Abimbola, in a recent interview with CNBC Africa. Abimbola pointed out that the CBN has been using open market operations to shore up its currency reserves and stem inflationary pressures by tightening liquidity in the domestic markets. The aggressive monetary policy measures implemented by the CBN in recent years have come at a significant cost, with the central bank spending approximately 1.4 trillion naira in the first half of the year to support its obligations. This represents a significant increase of over 50% compared to the same period in 2018. The rising costs have also had a ripple effect on borrowing costs for the federal government and corporate entities, as the CBN's activities have crowded out private sector participants in the short-term markets. Abimbola emphasized that the primary objective of the CBN's latest directive is to curtail the pace of balance sheet expansion while simultaneously reducing borrowing costs for the government and private sector. The exclusion of domestic corporates and individuals from participating in OMO auctions is expected to trigger a substantial reallocation of liquidity in the market, as these entities seek alternative investment channels. The immediate impact of the CBN's move is likely to manifest in three key ways. Firstly, the federal government is expected to increase its issuance of Nigerian Treasury Bills to accommodate the excess liquidity in the system. With NTB issuances at an eight-year low in 2019, there is room for the government to ramp up its obligations to absorb the surplus funds. Secondly, the corporate debt markets are poised to witness a surge in activity, with more companies turning to commercial paper and bond issuances to leverage the liquidity influx. Furthermore, the remaining liquidity is anticipated to find its way into domestic commercial banks through money market instruments and fixed-term deposits. This influx of funds is expected to alleviate funding costs for banks and bolster their balance sheets going forward. Abimbola underscored the necessity for the CBN to continue its efforts to reduce its balance sheet size, as the current levels are unsustainable in the long run. While the exclusion of domestic participants from OMO auctions is a step in the right direction, Abimbola suggested that the CBN should also consider curtailing foreign portfolio investors' access to the market. Foreign investors currently hold a significant portion of OMO bills and external reserves, posing potential risks to the FX market stability. Despite the challenges associated with excluding foreign investors, Abimbola stressed that it is a crucial step in achieving the desired liquidity management objectives. In conclusion, the CBN's decision to limit participation in OMO auctions marks a strategic shift towards balance sheet contraction and liquidity management. While the short-term repercussions may necessitate adjustments in the market dynamics, the long-term benefits are expected to promote a more sustainable and stable financial environment in Nigeria.