Time to crash interest rates in Nigeria

Just where is macroeconomic policy headed in Nigeria today? Do we have stakeholders’ consensus on earth breaking policy initiatives to take us out of the woods? Indeed, have we carried out correct diagnosis of the economic malaise afflicting the nation?

Each of these posers leads us to even more probing but pertinent questions whose answers, space may not permit us to broach in this intervention. We will therefore limit ourselves to an interrogation of the role of interest rate in Nigerian economy, save for tangential treatment of cross-cutting issues. To the man in the street, interest rate is simply the price of borrowing and/or lending money. But to the financial expert, the economist, the policy maker and the sophisticated economic agent, interest rate is a veritable policy instrument of resource, nay, income allocation and re-allocation.

This is why Nigerians must take more than a passing interest in the bi-monthly CBN ritual of “tinkering” with this monetary policy tool, among others, under the auspices of the Monetary Policy Committee (MPC). Thus in raising the benchmark (policy) interest rate, the Monetary Policy Rate (MPR) during its July 2016 MPC deliberations, was the CBN guided by a correct diagnosis of the short term and long term challenges of the economy? To be fair, the Bank faced two classical cases of policy dilemmas. On one hand, there was the need to bring external balance in sync with internal balance; on the other hand, promoting growth (and employment) would leave the rampaging inflation uncontained.

These, in a nutshell, were the short term policy challenges that occupied the minds of monetary authorities, but short term economic problems are better appreciated with a sound understanding of the long term---especially, structural and institutional---problems. It goes without saying that short term solutions can only be efficacious and sustainable in the context of a long term outlook, informed by rigorous analyses of different baseline and policy scenarios. In addition, the prioritised macroeconomic objectives (stable prices, full employment, external balance etc) must be borne in mind.

The decision of the last MPC meeting to increase MPR in order to contain inflation at the expense of growth should be interrogated and overlooked only if the MPC faced a Hobson’s choice. True, increasing the rate to achieve real positive interest rate would not only attract capital inflow and make public debt instruments (bonds and bills)attractive, it would engender exchange rate stability, given the dynamic and symbiotic relationship among the three prices in the three markets of an economy (products, money and foreign exchange markets). If the ensuing exchange rate stability were to engender net accretion to, against net depletion of, foreign reserves, the monetary authorities would have achieved, or at least, approach external balance.

But an external balance achieved at the expense of huge under capacity in the real sector, with concomitant high rate of unemployment and unpleasant inflationary outcome, all pointing towards stagflation, easily turns out to be a pyrrhic victory. What a price to pay to please a jealous mistress! At this juncture, we attempt to sketch out the likely outcome of the alternative policy postulation of lowering the rates to promote growth. For one, the real sector would have accessed credit facilities at more competitive (favourable) interest rates, leading to increased productivity, reduced unemployment and increased aggregate demand with the potential to unleash a virtuous circle that may see the economy out of the then incipient recession faster than under the alternative policy scenario the MPC voted for, the theoretical trade-off between unemployment and inflation notwithstanding. Secondly, the anticipated growth would have complemented the prevailing exchange rate in having a salutary impact on export-oriented (tradable goods) production thereby improving the foreign reserve position.

As pointed out above, the relative efficacy and suitability of either of these policy stances must be predicated on the country’s long term macroeconomic fundamentals and objectives. On this score, the CBN is severely constrained by the apparent absence of an economic vision jointly owned or shared by the monetary and fiscal authorities talk less of its framework to guide the Bank’s monetary policy. This calls for an urgent consensus on the broad outlines of the long term economic goals that encapsulate the vision of the government, with clearly specified milestones, not only on improved macroeconomic aggregates, but also on fiscal sustainability, structural shifts and institutional reforms. Although this is a matter for another day, it suffices to point out that whatever monetary policy tools the central bank deploys in response to emerging challenges will come to nought in the absence of a clearly defined fiscal policy direction. The one must complement the other for completeness, a macroeconomic affirmation of an African aphorism popularised by the late M.K.O. Abiola, averring that “one hand cannot clap alone”.At the moment the fiscal hand has left the macroeconomic policy space to the monetary hand to strut on, largely alone.

This extenuating circumstance notwithstanding, the point must be made ahead of subsequent MPC meetings that an economy in recession requires reflationary, nay, countercyclical measures and not procyclical ones that elicit a vicious cycle. Correspondingly, the complementary fiscal action required is increased public expenditure and/or reduced taxation. Yes, easy monetary and fiscal measures, and not tight ones, are required to reflate the economy. In any case, the decision under scrutiny was undoubtedly based on the havoc being caused by inflation: a partially correct diagnosis in the sense that it apparently ignored the variant of the inflation in question. It was inflation quite alright, but a cost-push, and not a demand-pull inflation. A rise in interest rate is the correct prescription in the case of the later, but even at that, only if there is no compelling reason to do otherwise. But in the case of the former causality, which is selfevident in Nigeria, interest rate reduction is called for. The CBN’s latest rate hike of July 2016,was therefore not a Hobson’s choice but a policy slip. Oops!

Beyond the short term nature of MPC decisions, our present circumstances present Nigeria with an opportunity to examine the possibility of achieving the much trumpeted but elusive single digit interest rate. The justifications for single digit interest rates are legion, including but not limited to the following: availability of affordable credit to spur productivity and growth; enhancing disposable income to raise aggregate demand as the economy approaches full employment; mitigating the phenomenon of crowding-out the private sector; reining-in cost push inflation, to achieve price stability; reducing interest cost element of public expenditure, which improves overall balance of fiscal operations; mitigating the phenomenon of financial repression by reducing the wide spread between the deposit and lending rates and minimising the incidence of non-performing loans.

If these objectives are substantially achievable through lowering the interest rate, the financial, fiscal and real sectors of the economy will be vibrant. But how does all this rub off on the external sector which, in any case, should not be treated as a residual? As the economy approaches full employment of factors, export -oriented production will pick up, aided in part, by the already depreciated local currency and the proceeds therefrom will improve the reserve position, and indeed the Balance of Payment (BOP) position. Hopefully, if the rate of export expansion outpaces whatever marginal increase in imports that results from increased aggregate demand, the country witnesses an improved trade balance.All this will obviate the need for continuous and/or increased foreign borrowing,giving the CBN more flexibility in exchange rate management, and greater cushion for the government in the form of enhanced fiscal and reserve buffers.

But achieving a single digit interest rate for an economy like ours can never be a walk in the park, and certainly not through an abiding faith in orthodox policies. Consequently, we posit a two- dimensional condition to arrive at this desirable goal. In the first place, we return to the issue of structural shifts in the economy, a necessary condition to guarantee long-term perspectives in economic management. The structural shifts required are too numerous for an in-depth treatment in this piece. It however suffices to raise two issues here. First, monetary authorities must encourage the financial system to prioritise sectors by “picking winners” who possess linkages that will pull up other sectors (spin-offs) on sustainable bases.The collaboration of the government, especially the Ministry of Budget &Planning, cannot be overemphasised. While one notes the outcome of the last retreat of the National Economic Council and the roadmaps released by two or three MDAs thereafter, we must admonish against sprouting of siloes, an unflattering testimony to a palpable lack of coordination.

our present circumstances present Nigeria with an opportunity to examine the possibility of achieving the much trumpeted but elusive single digit interest rate. The justifications for single digit interest rates are legion, including but not limited to the following: availability of affordable credit to spur productivity and growth; enhancing disposable income to raise aggregate demand as the economy approaches full employment