The Monetary Policy Conundrum

Perhaps, the major headache facing the Central Bank of Nigeria (CBN) Governor, Mr. Godwin Emefiele and other members of the Monetary Policy Committee (MPC) today, is to loosen monetary policy or not at this time.

The situation became more nerve-wracking with the slowdown in the first quarter Gross Domestic Product (GDP) that was announced by the National Bureau of Statistics (NBS), last week.

The MPC last week, rose from its second meeting for the year, expressing apprehension that the late passage and implementation of the 2018 budget, as well as election spending, could trigger inflationary trends and reverse the economic gains made so far, if pre-emptive measures were not adopted.

Therefore, the committee, which for the 11th consecutive time, retained the Monetary Policy Rate (MPR) at 14 per cent, Cash Reserve Ratio (CRR) at 22.5 per cent, Liquidity Ratio (LR) at 30 per cent, and the asymmetric corridor at +200-500 basis points around the MPR, explained that it retained them in consideration of the forecast of high liquidity injection in the second half of 2018, upward pressure of prices driven largely by substantial expansion of fiscal policy, which would arise from the late passage of the 2018 budget, outstanding balance from the 2017 budget and pre-election spending, to retain the interest rate.

Emefiele said eight of the nine members of the committee who were part of the meeting voted for the retention of the rate while one rooted for further tightening.

The MPC decision was made a day after the NBS report showed that despite the favourable oil price environment in the first quarter of 2018, the decline in non-oil sector output during the period weighed heavily on the Nigerian economy, resulting in a GDP growth rate of 1.95 per cent, down by -0.16 per cent from 2.11 per cent recorded in the fourth quarter of 2017.

But the NBS had explained that the 1.95 per cent GDP growth was still better than the -0.91 per cent GDP growth rate recorded in the corresponding period in 2017. Aggregate GDP in Q1 2018, however, stood at about N28.5 trillion in nominal terms, higher than the N26.03 trillion recorded in Q1 2017. The rate of growth was, however, lower relative to the growth recorded in the first quarter of2017 by -7.70 percentage points at 17.06 per cent but higher than the preceding quarter by 2.14 percentage points at 7.22 per cent.

This therefore prompted the call for a reduction in the benchmark interest rate, to support growth in the economy.

But Emefiele explained that the MPC decided not to lower the MPR for now as a pre-emptive measure to guard against possible inflationary pressures that the late implementation of the 2018 budget and election expenses might exert on the economy.

“It is very true that we said until inflation drops to single digit before we take a decision on reducing the interest rate, but you will also observe, in the course of this presentation, we explained the expansion of fiscal activities that we foresee, beginning from around May or June this year.

“At this time, the fact that we are still on the 2017 budget; the 2018 budget will eventually kick in around June or July, there will be an acceleration in the rate of spending and we also expect a lot of election spending.

“These indications, expectedly, are meant to expand the economy and spur growth which I will say is commendable, but we also know that those expansionary fiscal measures will gradually lead to an inflationary increase and if that happens, it will reverse the gains we have recorded over time.

“The committee considered the forecast of high liquidity injection in the second half of 2018, upward pressure of prices driven largely by the substantial expansion of fiscal policy which will arise from the late passage of the 2018 budget, outstanding balance from the 2017 budget and the pre-election expenditure,” he explained.

Emefiele stated that the MPC felt that further tightening would ensure the mop up of excess liquidity, mindful that despite the moderation in inflation, the current inflation rate was still above the single digit target and that the real interest rate only turned positive in the review period.

“The objective of the policy stance, therefore, would be to accelerate the reduction in the rate of inflation to single digit, to promote economic stability, boost investor confidence and promote foreign capital flows with complimentary impact on exchange rate stability.

“Conversely, the committee believes that raising the interest rate would, however, depress consumption and increase the cost of borrowing to the real sector. Moreover, such policy will make deposit money banks to reprise their assets,” he said.

Nevertheless, the Chief Economist for Africa at Standard Chartered Bank Razia Khan pointed out that while ordinarily there ought to be some concern about the inflationary impact of pre-election spending, current conditions in the economy make it difficult to overplay the threat of much higher inflation.

She explained: “Inflation is on a down trend, courtesy of recent forex stability. It will likely decelerate further. The economy is weak. Outside of lending to the government, money supply is contracting.

“In our view, it would have made more sense for the CBN to front-load its easing, reversing course later if it became clear that pre-election spending – in its multiple forms – was likely to be a problem.

“However, the CBN is especially concerned about investor profit taking and the likelihood of capital outflows at this point in time. We interpret the decision to keep all rates unchanged as suggesting that forex stability – even with oil back at $80 per barrel – remains paramount, and the CBN will not do anything to risk this. Not even easing, when the opportunity presents itself.

“The CBN also seemed to indicate that it remained uncertain of the monetary transmission mechanism even if it did cut the policy rate.

“While the MPC continues to hint that easing remains on the cards when conditions eventually permit it, there is far less clarity on when everything might eventually fall into place.”

On his part, the chief executive of Financial Derivatives Company Limited, Mr. Bismarck Rewane, said the weak GDP numbers coincided with the drop in the Purchasing Managers’ Index (PMI) for April that was reported by FBN Quest, as well as the decline in consumer confidence in the first quarter.

According to Rewane, it pointed to the fact that the economy was being strangulated by high interest rates.

“The reality is that if they don’t bring down those interest rates and increase credit to the private sector, they are just going to strangulate this economy. The economy will remain sub-optimal.

“Look at the sectors that contracted, which is more interesting. The only sector that employs people that expanded was manufacturing. But trade, construction, transport, all of them contracted. So, those sectors are still in recession, and agriculture also slowed down,” he said.

To analysts at Renaissance Capital, there would be no change in monetary policy rate and other monetary policy tools until around the July and September meetings.

“We see the policy rate being cut by one percentage point at the July and September meetings, respectively, bringing it down to 12 per cent at the end of 2018.

“This is not likely to have a meaningful policy easing effect, as open market operations will keep yields elevated,” it added.

The financial advisory firm revealed that at a conference it held recently where its officials interacted with some bankers in Lagos, “the banks said lending rates were unlikely to fall on the back of rate cuts, as treasury bill yields are of greater influence”.

The chief executive of Cowry Asset Management Limited, Mr. Johnson Chukwu, said the slowdown in GDP should be of great concern to the policymakers.

“This slowdown at a time when there were no major bottlenecks in the economy should worry everyone. Bottlenecks in the sense that there was enough forex liquidity, the crude oil price was above $60 per barrel.

“So, maybe the issue has to do with the cost of funds and availability of credit because if this slowdown continues, we may slip back into a recession. So, if anything happens to oil production today, we may be in a difficult position,” he added.

But the Senior Economist at Exotix Capital Christopher Dielmann said the MPC decision was largely based on the high level of inflation that continues to plague the country as well as rising US treasury rates painting the macro backdrop to this decision.

“As growth continues to lag and inflation falls towards single digit, we expect a policy rate cut as early as the MPC’s next meeting in July,” Dielmann said.

Clearly, while most Nigerians would love to see a reduction in interest rate, the MPC members have found themselves in a delicate situation as they seek to find a balance between the likelihood of inflationary pressure few months into an election year and the need to ensure that the foreign portfolio flows does not cease.

The objective of the policy stance, therefore, would be to accelerate the reduction in the rate of inflation to single digit, to promote economic stability, boost investor confidence and promote foreign capital flows with complimentary impact on exchange rate stability. “Conversely, the committee believes that raising the interest rate would, however, depress consumption and increase the cost of borrowing to the real sector