Why is CBN Fighting Inflation and not Stunted Growth?

25 Nov 2012

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The Monetary Policy Committee of the Central Bank of Nigeria (CBN) may have stirred the hornet’s nest with the retention of a tight monetary rate at its meeting last week as analysts reckon that the tight policy may have outlived its usefulness in the face of the current frightening rate of unemployment and stunted growth brought about by the attendant high interest rates, reports Festus Akanbi

Given the severity of the prevailing economic imbalances which manifested in the growing unemployment situation and low productivity, occasioned by the twin problem of a regime of high interest rate and fall in purchasing power, induced by the recent partial removal of fuel subsidy, quite a number of experts had painted a grim picture of the economy before last week’s Monetary Policy Committee Meeting. And their consensus was that a cut in the rate would be the best for the nation’s economy for now.

Labour Market
The unemployment rate, which can be defined as the number of people actively looking for a job as a percentage of the labour force, was last reported at 23.9 percent in 2011 in the country. Historically, from 2006 until 2011, Nigeria unemployment rate averaged 14.60 percent reaching an all time high of 23.90 percent in December 2011 and a record low of 5.30 percent in December 2006.

The Statistician-General of the Federation and Chief Executive Officer of the NBS, Dr. Yemi Kale, who gave the figures, said the total number of unemployed Nigerians rose from more than 12 million in 2010 to more than 14 million in 2011, with the figure increasing by 1.8 million between December 2010 and June 2011.

The figure churned out by the National Bureau of Statistics (NBS) was not only a source of worry to economic watchers, but also to the Trade Union Congress of Nigeria (TUC), which in a recent communiqué raised the alarm that unemployment in Nigeria was approaching a “worsening” state.

The congress challenged the government to rise to the occasion by creating enabling environment before the situation gets out of hand.
Analysts lamented that as thousands of Nigerian school leavers continue to roam the street in search of jobs, the regime of high interest rate in banks has made it economically unwise for business promoters to run to banks for funds. Consequently, business owners are left with the choice of either shutting down completely or effecting a cut down in their operations. Whichever option out of the two is adopted will naturally lead to loss of jobs with the attendant threat to economic growth.

Maintaining the Status quo
However, this grim situation notwithstanding, the Monetary Policy Committee of the Central Bank of Nigeria (CBN) at its last week meeting took a unanimous decision to maintain the current monetary policy rate (MPR) at 12 per cent with a corridor of /- 200 basis points around the midpoint; and retain the Cash Reserve Ratio (CRR) at 12 per cent; the Liquidity Ratio at 30 per cent and Net Open Position at one percent.

CBN Governor Mallam Sanusi Lamido Sanusi said the committee considered and rejected an option to increase rates in response to the uptick in headline and food inflation; as being potentially pro-cyclical considering the structural nature of recent inflationary pressures.  He said the committee also acknowledged the merit of the arguments in favour of an option to reduce rates but rejected it as it would likely send wrong signals of a premature termination of an appropriately tight monetary stance.

According to Sanusi, the decision was based on inflationary risks and uncertainties surrounding the weak global economy. Up till the eve of the all-important MPC meeting last week, many economic affairs commentators had argued in favour of an end to the CBN’s tight monetary policy stance and the need to boost growth and lending to the real sector. This is because the apex bank had voted for the current contractionary policy stance since October 2011 when the MPR was raised by 275 basis points.

And in the estimation of the financial advisory firm, Financial Derivatives Company Limited, the sustainability of a contractionary stance and its stifling impact on growth and the economy justifies the need for a change in policy direction. It argued that the over-dependence on interest rates as a tool for adjustment is precarious.

Inflation Scare
Justifying the committee’s decision not to yield to calls for easing of the rates, the CBN governor said, “Developments in the domestic economy in the past three months highlight some new pressure points to macroeconomic stability. The committee was of the view that despite the high interest rates, additional shocks to the economy emanating from the devastating floods, imported inflation and the upward adjustment in electricity tariffs continue to stoke inflationary pressure.

The nation’s annual inflation rate increased by 0.4% to 11.7% in October, primarily as a result of exceptional factors such as the flooding which resulted in an increase in food inflation to 11.1%. The impact of the flooding in 12 states of the country was immediate but was not as severe as expected. Core inflation declined for the fourth consecutive month to 12.4%. This, according to the MPC, has created some uncertainty as to the appropriate policy stance to apply.

However, FDC said the fact that leading economic indicators have remained positive for two months and the GDP growth figure for Q3 came in lower than the previous year at 6.48%, sends mixed signals on the direction of the Nigerian economy. In addition to this, the government is resolute in its pursuit for fiscal prudence as reiterated by the Federal Minister of Finance.

Experts Cry Foul
Economic affairs commentators, however, punctured the CBN argument, saying it amounts to insensitivity on the part of the policy makers to sacrifice the nation’s growth for inflation targeting.

They contend that it does not make economic sense to continue to ward off inflation when emerging statistics are pointing to dangers created by the growing unemployment and stagnation in the economy.
In his view, Chief Executive Officer, Resources and Trust Company Limited, Mr. Opeyemi Agbaje, said tight monetary policy is already constraining the economy.

He said, “I totally share that mindset! Growth is declining partly because of tight monetary policy, which is constraining private sector activity. Tight monetary policy is also indicated in growing unemployment and poverty. I believe the policy priority should be employment and economic growth, which may suggest some level of monetary easing.”

Managing Director, Financial Derivatives Company Limited, Mr. Bismarck Rewane, said monetary tightening which was introduced at an emergency MPC meeting in October 2011 was informed by the need to respond to an emergency. He believes the policy has run its course, wondering why the committee still went ahead to vote for monetary tightening at its last week meeting.  He acknowledged the rising figure of the nation’s external reserves and other indices and wondered if it makes sense to be “numerically satisfied” whereas the nation is going through a situation of frightening unemployment.

He said economic management allows for flexibility, explaining that, “there are times when you allow the currency rate to depreciate if the measure will engender growth.

According to him, monetary condition and monetary policy should be allowed to move in opposite directions. He recalled that in October last year, the nation voted for a tight monetary situation because of the loose monetary condition in place then.
“By the time we effect a partial removal of subsidy, a tighter monetary condition was in place but one year down the line, those loose conditions are no longer in place. They are no longer threatening the monetary stability and one had expected the CBN to relax the policy at the last week meeting of the MPC.”

Rewane dismissed the fear of inflation, which the committee cited as one of the reasons for its grip on the monetary policy, saying flood is a one-off thing. He maintained that Nigeria has enough buffers to allay the fear even if oil price crashes.

He said one of the ways to lay the basis for economic development is to allow the currency to depreciate. He agreed with the position of some other economic watchers that the apex bank is encouraged to maintain a tight monetary policy because the existing rate is a source of attraction to foreign investors, a development said to have largely contributed to the rise of the external reserves account.
Managing Director, Afrinvest (West Africa) Limited, Mr. Ike Chioke, in his analysis, explained that the retention of the existing rates implies that the status quo remains.

“I see a buffering of the foreign reserves in the months to come on expected inflow from foreign portfolio investors. But therein lies the danger of hot money. Because Nigeria never lacks drama (e.g. Manitoba Contract brouhaha), the political risks could trigger an implosion that could lead to a broad sell-off by foreign portfolio investors that may lead to a rise in yields and even affects external reserve positions.”
When confronted with the possibility of the rate tightening to be counterproductive in view of the complaints of real sector operators that they are being starved of funds, Chioke said, “Rate tightening has already proven counterproductive especially when one considers statements from trade groups like MAN and LCCI who complain of cost of funds. The committee seemed to acknowledge this in its just concluded meeting (a rarity), which is why analysts are projecting a cut in rates at some point in 2013.”
He agreed with the CBN that apart from the recent flooding, other factors that could trigger inflation are beginning to stare economic planners in the face.

The Afrinvest chief pointed out that, “The full deregulation of the downstream sector rumoured to take place in 2013 via the complete removal of the petrol subsidies could serve as an additional inflationary trigger given its multiplier effects on the living costs.”

Banks Concentrate Risks
With the retention of the existing Cash Reserve Ratio, some analysts had argued that banks would be tempted to concentrate their risks on CBN rather than lending to customers.

Chioke said this scenario is already playing out. “This is already the case and we should expect to see more of this as banks prepare to wind down for year end. The interbank market will remain active while the 10% deposit rate with the CBN will continue to remain an attraction to DMBs.”

According to him, “Nigeria is replete with discussions on broadening the economy. Deepening the value chain in the agricultural space will be one major way of diversifying the economy. If the proper land reforms are implemented, real estate will be a winning bet for investors as well. The induced backward integration model has worked in the cement sector and will work across other sectors,” he stated.

In his view, Managing Director/Chief Executive, Cowry Asset Management Limited, Mr. Johnson Chukwu, explained that, “The retention of the Monetary Policy Rate (MPR) will have the effect of warding off pressure on the exchange rate and the external reserves. A contractionary monetary policy as the rate retention implies limits the ability of banks to create credits. The lack of credits in the economy in turn constrains the demand for imports which helps the country preserve its external reserves.”

Cost of Borrowing Still High
He, however, stressed the need for the MPC to relax its grips on monetary policies at its subsequent meeting, Chukwu said, “The cost of borrowing has been one of the major constraints to the performance of the real sector as it is almost impossible for businesses that rely on credits for their funding to report profitable results after meeting their financing costs. It is therefore imperative that the monetary authorities work towards relaxing the monetary policies at their subsequent meetings to allow for the growth of the real sector.”

According to him, the minister of finance, who is responsible for the management of fiscal policy, should be the one to drive growth by directing the CBN to roll out policies that will promote growth.

He cited the case of Brazil, which in spite of the stark reality of inflation chose to relax its rules in order to promote growth in the system.
He maintained that although one of the responsibilities of the CBN is to achieve price stability, he said that managing the economy is beyond price stability.

Chukwu recalled that the United States inflation rate is higher than its monetary policy rate, ditto for a number of European countries. These countries, he said, allowed the rate to trend down because of the weakness in the economies and the desire to promote growth.
He pointed out that “other factors that may lead to an uptick in inflation in the coming months include the high demand for goods particularly consumer goods normally associated with November and December as a result of the Christmas season. This seasonal demand pressure normally leads to demand push inflation towards the end of each year.”

The Cowry Asset Management chief said, “The retention of cash reserve ratio will not necessarily affect the banks allocation of the earning assets in favour of government instruments or CBN guaranteed instruments.

“The amount of banks’ deposits sterilised in CBN as cash reserve increases the weighted average cost of funds for the banks and compels them to seek for investment instruments that can yield compensating returns. With declining yield from FGN bonds and other government instruments, the banks will rather look for quality credits than increase their holding of government instruments.”

On the need to free the nation’s economy from over-dependence on imports, Chukwu said, “I think that a number of policies are already being implemented by the government to grow other sectors and reduce our dependence on importation. Such policies, however, do not yield instantaneous results as in most cases that require time to mature. For instance, the Obasanjo government policy on cement has led to establishment of several cement plants in the country and gradual elimination of cement imports. The Jonathan government is currently driving a similar policy on cassava, rice and sugar which will in due course lead to reduction in the importation of wheat, rice and sugar.”

Price Stability
In his remarks, Chief Executive, Financial Market Dealers Association of Nigeria (FMDAN) Mr. Akinwale Abe threw his weight behind the apex bank for the latest monetary policy.
Abe said the apex bank took a very good decision that would make the relatively stable monetary policy environment continue.
He said: “Exchange rate is stable; interest rate though might be seeing as high but helps to support price stability and tightening policy of CBN.

“Inflation jerked up because of core food inflation, which is expected to arise from flood disaster, so it needs to be keenly watched, through quantitative tightening So CRR had to also remain so that liquidity could be checked.
“The high interest rate attracts foreign investors and so, keeps portfolio investors as well as FDIs coming into Nigeria and therefore helps to stabilise the naira because of foreign exchange supply aside from our reserve. It was wise to retain all in order to maintain stability.”
Another commentator, Samir Gadio, an emerging-markets strategist at Standard Bank Group Ltd, said “What we’ve seen in recent months is the steady decline in consumer prices, in year on year inflation, and we still expect this trend to persist in the medium term.”
An industry operator, who spoke with THISDAY at the weekend, said while the CBN was right in hedging the financial sector from the looming rise in inflation, he added that major decision on the overall economy would be determined by the turn of events between now and December ending.

Managing Director, GTB Securities Limited, Mr. John Ogar, who made the point, said the apex bank’s desire to achieve fiscal consolidation is a desirable thing, explaining, however, that the financial authorities would have to wait till December before taking a more decisive decision.
According to him, “It is then we will see how the United States of America is able to resolve the present fiscal cliff which is causing uneasiness in the global community”. Other external factors which will determine the CBN’s next line of action, according to the GTB Securities chief, is the recurring economic crisis in Europe.

He, however, noted that in terms of foreign exchange reserves accumulation and economic outlook, there is no cause for alarm.

Tags: Business, Nigeria, Featured, Inflation

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