MPR: Again, CBN Reinforces Anti-inflation Credibility

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The lobby by some members of the banking community for moderation in the monetary policy rates was high before last week’s Monetary Policy Committee meeting of the Central Bank of Nigeria. But at the end of the meeting, the CBN maintained the statusquo, a position, which has continued to draw the support of leading economic watchers, reports Festus Akanbi
For the 13th time in a row, the central bank held interest rates steady at 12 per cent last week, in a trend, which has been maintained for two years with a warning that it would not hesitate to further tighten the noose next year should pre-electoral spending continues to surge.
The liquidity ratio was maintained at 30 per cent; the corridor around the base rate was kept at plus or minus 2 percentage points.
CBN Governor Sanusi Lamido Sanusi said rates were on hold because while inflation had fallen within its new target of between 6-9 per cent, there were concerns about the inflationary impact of fiscal spending ahead of 2015 elections.
Sanusi said signs of moderating inflation – it is currently at a 5-year low of 7.8 per cent – and a stable naira needed to be balanced against the likelihood that election spending would put pressure on the fiscal purse.
“The outlook for 2014 portends some potential headwinds that may lead to further tightening in monetary conditions,” Sanusi said, citing tapering of the U.S. Federal Reserve’s bond buying programme and interest rate tightening in Europe as risks to portfolio flows and therefore the naira.
“It is the year in which election spending is likely to take place domestically, thus bringing more pressure to bear from the fiscal side,” he said. “As a result, we are not yet at the end of the tightening cycle.”
Election Spending
The fear expressed by the apex bank was justified by the last minute cancellation of 2014 budget presentation by President Goodluck Jonathan to the National Assembly last Tuesday. The development was said to have been caused by the disagreement between his team and lawmakers over his administrations’ plans to curb spending. Lawmakers have indicated they wish to raise spending in the budget for next year above the government’s own proposed budget, ahead of presidential and parliamentary polls in 2015.
In July’s rate decision, the hold in rates was accompanied by a significant tightening of liquidity, with reserve requirements on public sector deposits going up to 50 per cent, from 12 per cent previously.
Economic watchers who had anticipated a softening stance from the MPC had based their permutations on the favourable inflation figures in recent times and improvement in the nation’s Gross Domestic Product for the third quarter of the year. 
Improved GDP Figures
The National Bureau of Statistics (NBS) estimated that real Gross Domestic Product (GDP) grew by 6.81 per cent in the third quarter of 2013, which was higher than the 6.18 per cent in Q2, and 6.48 per cent Q3 of 2012 respectively. Overall, growth for 2013 was projected at 6.87per cent, up from 6.58 per cent in 2012, indicating that the economy is remaining on its steady growth trajectory.
The non-oil sector remained the major engine of growth recording 7.95 per cent compared with a decline of 0.53 per cent for the oil sector in the third quarter of 2013.
Agriculture, wholesale and retail trade, and services continued to be the drivers of non-oil sector growth contributing 2.50, 1.96, and 2.82 per cent, respectively.
The relatively strong domestic growth forecast in an environment of sluggish global growth and sturdy signs of deflation reflected the continuing favourable conditions for increased agricultural production and incentives for strong macroeconomic management.
The moderation in consumer price inflation, which began in the fourth quarter of 2012, continued in the third quarter of 2013. The year-on-year headline inflation moderated to 7.8 per cent in October 2013 from 8.0 per cent in September.
The Monetary Policy Committee therefore observed with satisfaction that in the last four months, all the three measures of inflation continued to be within the single digit inflation target. However, the committee noted the potential risks to inflation of increased aggregate spending in the run-up to the 2015 elections.
As expected, reactions to the latest monetary policy directives of the CBN were spontaneous.
In an interview with THISDAY, Standard Chartered’s Head of Africa Research and a well-known commentator on African markets Razia Khan disagreed with critics of the CBN’s refusal to lower the rates. Although some critics believed the tight monetary stance, especially the policy on public sector fund would erode the gains of the banking sector reforms because of the withdrawal of public sector funds.
Khan said what the apex bank did was to wean banks off their dependence on public sector liabilities.
When asked if the current stance of the CBN would not rub banks of the gains achieved so far, she said, “It depends on what we mean by ‘gains’.  The role of the CBN is not to make banks super-profitable for taking little risk. The role of the CBN is to effectively regulate the sector, and to ensure price stability. From a financial stability perspective, there remains a need to wean banks off their dependence on public sector liabilities. (How exposed would these banks be otherwise, if oil prices were to collapse?). 
Price Stability
“From a price stability perspective, there was a need to boost the monetary policy transmission, by making deposit rates more responsive to changes in the policy rate.  In order to make this more effective, there needed to be more competition for funds in the banking sector, so banks would actually pay up for liabilities.  The easiest means of effecting this was to initiate greater competition for funds amongst the banks.
Banks Not at Risk
“CBN tightening does not put the banks at risk. It forces them to intermediate more effectively. If banks are paying up for deposits, some may even start lending to the real sector, in order to preserve margins,” she said.
Reacting to the argument of a school of thought, which believes that the apex bank is putting its anti-inflation credibility on line by maintaining a tight policy, which is capable of starving the real sector of funds (since banks are already denied investible funds), the Standard Chartered chief said, “Not at all.  Nigerian monetary policy, by any standard measure, has not been all that tight. If you consider 12 month smoothed inflation (which should give you a decent enough proxy of inflation expectations), it is only recently that this has fallen much below average monthly interbank rates (which allows for s/term volatility in the interbank rate). So from this perspective, real interest rates only recently turned positive, and are not excessive by any means.  So by that definition – looking at the difference between inflation expectations and market interest rates (the overnight rate), monetary policy cannot be considered to have been excessively tight.”
According to her, “Achieving low inflation is what the CBN needs to do to boost its anti-inflation credibility, without changing course on monetary policy every time there is a little criticism of what it might take to achieve low inflation.
“Investors believe in the CBN’s anti-inflation credibility. This is why fixed income investors, who are most sensitive to inflation risks, have invested record amounts in Nigerian markets,” she said.
Diminished Fiscal Buffers
Did she share the fear about the diminished fiscal buffers brought about by the decline in both external reserves and excess crude account? Khan said “Nigeria is still too dependent on a single commodity.  Were the country to experience a shock to oil earnings, it no longer has a substantial buffer it can draw down on in order to see it through that shock. Moreover, the ECA contributes to FX reserves, and ECA depletion has put pressure on reserves as well. So the augmentation of budget revenue with ECA proceeds has reduced both Nigeria’s external and fiscal buffers. It is not a good position to be in. Investors will be seeking greater clarity. The current political impasse raises the risk of higher spending than that outlined in the MTEF framework, so it is a concern.”
Another economist who reacted to the outcome of the MPC meeting was Head, Research and Intelligence Olufemi Ademola.
He contended that it is not a direct objective of the CBN to preserve gains made by banks or even to make banks profitable in the first instance. The core objective of the apex bank, according to him, is to ensure that they are strong (in terms of risk management), they are efficient and they present an accurate financial position at all times, even if they make losses.
“In fact, I believe that the significant increase in profitability by banks in the 2012 financial year was not entirely anticipated by the CBN.
“In addition, a significant portion of the profits made by the banks were made from securities trading and placements, rather than risk assets creation. In other words, the banks collect deposits from the public sector at little or no cost and invest in government bonds and treasury bills on which the government and CBN (by issuing T-bills through OMO) pay interest. The implication is that the public sector is paying interest to the banks on its own money. And since the CBN is fighting to remove excess liquidity from the financial system, sterilising public sector deposits appears to be a more effective tool to achieve this.”
Ademola said research had shown that inflation in Nigeria is not a monetary phenomenon, saying the problem is more structural than liquidity; a fact that the CBN also agrees with. 
Continuous Monetary Tightening
“Continuous monetary tightening in addition to infrastructure challenges will eventually lead to high inflation as productivity suffers. So in a way, I agree that if this tightening continues for too long, its effect on checking inflation will weaken completely.”
Saying there is no cause for alarm on the state of the nation’s external reserves, Ademola said Nigeria’s external reserves are important to finance the country’s imports and also to defend the Naira against severe volatility.
“A country’s external reserves are expected to finance at least 3 months of importation before it becomes a problem, and right now at about $45 billion, Nigeria’s external reserves can finance over a year of imports. So, while the decline and/or non-accretion to the reserves is worrisome, it shouldn’t really create any serious panic for now.
“On the excess crude oil account (ECA), it was created to act as a buffer to the economy in periods when collected revenue falls below expectations. While it is arguable that the country is in such a period right now and hence the use of the ECA to cover revenue shortfall is appropriate, the cause of the revenue shortfall is a serious concern to economic and political analysts.
The shortfall was caused largely by the increased production losses due to pipeline vandalism at various terminals, continuous crude oil theft, and the consequent high-pressure compressor failures and repair work that caused the frequent shutdown of oil pipelines by oil firms. These are issues that can be resolved to prevent any fiscal exposure to the country,” the BGL official said,
He pointed out that the real fear is the seemingly lack of appropriate strategy and the political will to deal with challenges. “As the ECA continues to go down, the country’s buffer for future shocks is diminishing; hence there is need to cut the shortfall and build another reserves for the future,” he stated.
According to Head, Research & Investment Advisory Sterling Capital Markets Limited, Sewa Wusu, the CBN`s tightening policy measures are anticipatory and are intended to insulate the domestic economy against external vulnerabilities in order to ensure price and foreign exchange stability. He said, “To some extent, the tightening bias should be commended. Although, maintaining a tight policy stance is starving the real sector of funds and slowing down credit expansion by banks, but the point is that there must be a trade-off. The economy has witnessed decline in inflation to single digit levels coupled with stable exchange rate, when compared to other emerging economies like India, Brazil and South Africa in the wake of anticipated QE tapering by the U.S. Fed.
“Absolutely, the CBN is aware of the present challenging operating environment on which banks operate, but as a regulator they see things holistically. Before now, the banks had depended heavily on public sector funds. So there is no way profit margins from that income generating line will not come under intense pressure. We saw this reflected in their Q3, 2013 interim results. 
“My take is that, In the face of these realities, the banks should carve out new business models around the financial inclusion strategy and other initiatives by developing products to attract cheap deposits from non-volatile savings to boost their lending operations. CBN had alluded to the fact that there is still huge liquidity in the economy. The banks should tap into the informal sector with new business models to carve a niche. I think most banks are now engaging seriously in SME financing which is the engine room of real sector growth.”
An Abuja-based development economist, Basil Enwegbara threw his weight behind the MPC decision. He said, “I think this is the single policy of the CBN I fully support even though rather than loosening liquidity it could be tightening financial conditions.
That is why I am of the view that rather than reducing the current cash reserve requirement for public sector deposits from its current 50 per cent, I should be insisting that the CBN should further increase it to about 70 per cent. Or of what use is the apex bank loosening liquidity which has hardly translated to either lowering interest rates or making more funds available to the real sector of  the economy to borrow from? I think the earlier the financial sector stops preferentially treating our banks, the better for the overall economy. Or else why should the banks always want to have their cake and eat it?
“That is why I’m in agreement with our monetary policymakers that the excess liquidity in banks’ balance sheets, rather than growing the economy have unhealthily led to economic financialisation; and rather than excess liquidity directed into the real economy, banks’ short-term profit maximisation being anti-real sector firm financial and investment decisions has notoriously crowded out real sector borrowing at the expense of financial speculation. If this policy will eventually force the banks into alternative sourcing of deposits, it will also make them discover that their long-term goal should be lending to real sector of the economy since if the real sector economy grows, their private deposits will grow.”
He believed CBN should be pursuing policy that drives down the cost of borrowing through a pro-real sector monetary policy. “In other words, Sanusi should be reminded that because low inflation is a function of slow growth, pursuit of growth based monetary policy requires raising inflation and lowering monetary policy rates.
Having warned Sanusi, it is to note that there is a limit he can go with his monetary policy especially when it is the fiscal policy that is wrongly overheating system liquidity.
This is because should the governor loosen his tight financial conditions without corresponding protective measures to reduce import pressure on economy, loosening liquidity should instantly shift pressure on the dollar, leading to possible run on the naira and dollarisation. That is why we either exit WTO or we impose high tariffs on imports so that with imports more expensive than locally made goods, Sanusi could go ahead to loosen his monetary policy stance in a way that both devalues the naira and reduces interest rates with more money available to real sector without risking a run on the naira.” 
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