CBN Governor, Sanusi Lamido Sanusi
Obinna Chima examines the impact of aggressive monetary policy tightening on Nigeria’s economic growth projection
Generally, the interbank market plays a crucial role in the transmission of monetary policy as well as in allocation of assets within the financial system.
Unarguably, robust and smooth functioning interbank markets, which are short-term funding channels for commercial bank to borrow from each other, supports economic growth.
A deep and liquid interbank market supports financial intermediation. This is because banks’ ability to withstand liquidity shocks and provide lending to one another is crucial for both financial stability and real economy.
Shortage of funds in the interbank money market can stifle growth as households, businesses and corporations would be denied of liquidity. These, analysts stressed could even lead to credit risk.
That is why the abnormal character exhibited by interbank rates last week, due to the severe scarcity of funds that followed the aggressive monetary tightening by the Central Bank of Nigeria (CBN), has been a source of concern to most financial market experts.
Interbank rates rose significantly to a two-year high of about 35 per cent on the average last Wednesday. There was also a report that banks had to sell off securities and forex positions at a loss to meet their liquidity obligations during the week.
Although rates dropped slightly to an average of about 27 per cent last Friday, analysts argued that the development portends bad omen for Nigeria’s economic growth.
The MPC, which met in July had raised the cash reserve ratio to 12 per cent from eight per cent and had also reduced the forex Net Open Position (NOP) limit from three per cent to one per cent.
It however retained the Monetary Policy Rate (MPR) at 12 per cent with symmetric corridor of +/- 200 basis points.
The move was aimed at supporting the traumatised naira, which is always under pressure due to the high appetite for imported goods and services by Nigerians.
The committee had also observed significant downside risks to growth in the near-term, especially, with the volatility in oil prices as well as the threats of inflationary pressure which re-emerged since this year.
Inflation stood at 12.9 per cent in June. The apex bank has never hidden its disdain for double-digit inflation rate. The National Bureau of Statistics (NBS) is expected to release July inflation figures this week.
“Borrowing by government to cover large fiscal deficits in the 2012 budget, the upward review of electricity tariffs and import duty on wheat and rice in July,” the MPC added.
But the Executive Secretary, Financial Market Dealers Association (FMDA), Mr. Wale Abe, pointed out that the hike in rates would bring about pressure on the cost of funds and interest rates.
According to Abe, the real sector would be worse-off as businesses would now find it very difficult to borrow.
He explained: “To a large extent, the CBN has been able to achieve stability in exchange rate, but at a very high cost to the economy. Firstly, our economy needs to grow and what has been denied the economy now is growth. Forget about the indicators which shows that GDP is at 7 per cent.
“What has happened is that the only way the CBN can keep exchange rate within the band is to ensure that interest rate is moved upward. Not necessarily in terms of adjusting MPR, but by mopping up liquidity, through the use of Open Market Operations (OMO).
“So what we see is that as soon as funds are injected into the system, even from the fiscal side, there would fix income instruments to mop up the funds. There is always a threshold of liquidity that is kept in the system, such that it does not alter the position in the market place.”
Head, Equity Research, FBN Capital Limited, Mr. Olubunmi Asaolu, blamed the structural imbalance in the Nigerian economy for the action taken by the CBN.
He also pointed out that the situation in the macro-economy was also weighing down on equities on the Nigerian Stock Exchange.
“Nigeria’s import demand is just too high. Most of the things that we can produce locally are being imported and because of that, there has been a lot of pressure on forex. I think the MPC is just stuck as I don’t see anything else they can do. We hope that there would be some improvement on the fiscal side of the economy,” he added.
Despite the measures adopted by the regulator to save the naira, Currency Analyst Consultant at Forex Time Trading, West Africa, Mr. Bade-Ajidahun Oladahun, expressed disappointment over the performance of the local currency against the dollar since this year.
According to Oladahun, the performance of a currency is a reflection of the performance of its economy.
He said: “So what is happening in the economy is having a direct impact on our currency. With the global recession, we have seen a lot of countries make effort(s) to grow their economies, but what we see in Nigeria is that government keep churning out plans that are poorly implemented.
“The excessive demand that we are seeing is causing the naira to suffer. What I can see is that the CBN and ministry of finance are moving round a circle without any improvement. With what is happening, the dollar is going to continue to take its toll and would continue to smash the naira.
“If you look at the movement, you will notice that if the naira takes one step forward, it takes three steps backward and that is very disappointing.”
Downside Risk to Growth
Nevertheless, experts believe that pursuing price stability at the expense of growth could hurt economic growth. According to them, monetary policy decisions that leads to aggressive hike in interest rate results to lower investment activities and shrinks consumer spending.
To the Managing Director/Chief Executive Officer, Financial Derivatives Company Limited, Mr. Bismarck Rewane, the impact of the 400 basis points hike in CRR was expected to significantly affect the lending ability of banks as the amount of cash that banks have to keep with the CBN will increase.
“Subsidising the naira and keeping a cap on inflation is one thing, strangling growth is another. The CBN is now treading on a tight rope that could lead the economy to a hard landing,” he warned.
Also, analysts at Renaissance Capital (RenCap) declared that while the policy measures would help stem naira weakness, the higher CRR is negative for growth as it would curtail new lending, “particularly in an environment where liquidity has been particularly tight since May.”
“We think increasing the CRR will keep credit growth from strengthening and undermine new lending; particularly to the small and medium enterprises (SMEs) that the CBN has taken pains not to hurt with higher interest rates, which would be negative for GDP growth,” the research and investment firm added.
But the Managing Director/CEO, Keystone Bank Limited, Mr. Oti Ikomi, assured that the liquidity position of the market would improve once Federation Account Allocation Committee (FAAC) funds, expected to be released this week, hits the system.
“Clearly the decision by the MPC was not intended to push rates so high, that was not the whole idea. The monetary tightening was to stem the attack on the naira. But at the same time, there is an implicit goal of low inflation.
“So, it is always a careful balancing act between making sure that there is not too much pressure on the naira and at the same time that interest rates don’t go too high. This is because if interest rates go too high, the ability of borrowers to access funds cheaply would be retarded,” the Keystone Bank boss explained.
However, policy makers and regulators must understand that the problem with the Nigerian economy is not about price stability. The fact is that the economy is largely unproductive and does not add value and there is need for critical sectors of the economy to be revamped for effective transmission of monetary policy.