Liquidity

The Nigerian financial system has been suffering a liquidity squeeze for some months. The stock market has felt the full force of the squeeze as Naira value of trading has been on the decline since early March. The All Share Index (ASI) has also lost 22% since its all time high achieved on 5th March this year.

One common explanation offered for the decline in liquidity is the proposed common year end for all banks. This is as a result of desperation of some banks to attract deposits to boost their balance sheets. Previously some of the banks have used inter bank borrowings to boost their balance sheets at year end. However, these funds will no longer be available if the common year end is implemented.

The Central Bank of Nigeria (CBN) concerned with the outrageous deposit rates some banks have been offering out of desperation to attract deposits decided on July 23rd to postpone the policy implementation to December 2009 instead of December 2008. The postponement only lasted 13 days as the CBN announced on August 5th that the policy has been completely cancelled. Banks can now do as they wish.

Will the policy reversal improve the liquidity situation? Yes it will. But in my view not to the level that will push the Index back to record territory.

Liquidity will take some time to improve significantly. This is because another major cause of the liquidity squeeze will take time to disappear. This is the effect of the capital raising of banks and other companies on the liquidity of individuals and institutional investors. More than N1.5 trillion was raised through IPO’s and PO’s in the last two years. This is a significant amount representing more than 14% of the current market capitalization. To put it in context Guaranty Trust Bank had N365 billion deposit liabilities as at 29th February 2008. So taking out N1.5 billion (this does not include funds raised through private placements) from the banking deposit system is bound to create a strain on the system.

Therefore unless something happens to accelerate the replenishment of funds in the pockets of Nigerians and Institutional investors, the liquidity squeeze will continue for another couple of months. Perhaps even till the implementation of the 2009 budget.

The banks off course can help accelerate the replenishment by offering cheap credits to consumers using the capital they have raised. This might take some time as some of the banks have expensive deposit liabilities raised during the “desperation” period.

My outlook for August and September remain the same. I don’t expect any significant upward movement in the ASI.

As is the usual trend, October might offer some respite buoyed by the policy reversal, gradual improvement of liquidity and year end positioning.

I hope so.