Mitigating Inflationary Pressure with Retention of Policy Rates



The resolve of the monetary policy committee to hold rates at their current positions, thus maintaining successive tight regime with a view to continuing to checkmate inflation and further encouraging inflow of foreign direct investment, has been greeted with diverse reactions by analysts, write Kunle Aderinokun and James Emejo

Citing among other things, the fragile macroeconomic conditions and the strong headwinds confronting the economy, particularly the implications of the twin deficits of current account and budget deficits, a 10-member-board of the Monetary Policy Committee (MPC) voted to leave the monetary policy rate (MPR), the benchmark interest rate, unchanged at 14 per cent.

Also, banks’ cash reserve requirement (CRR) and liquidity ratio (LR) were retained at 22.5 per cent and 30 per cent respectively while the Asymmetric Window at +200 and -500 basis points around the MPR was further maintained.

The MPR is particularly important to stakeholders across the economy because it is the rate at which the CBN lends to commercial banks and often determines the cost of fund in the economy.

But with MPR at 14 per cent and inflation rate currently 18.3 per cent, the economy is already feeling the harsh impact of the cost of borrowing with the attendant negative effect on investment.

And amid the current economic recession and scarce liquidity in the system partly occasioned by drop in oil revenue to government, rising unemployment among others, the stakeholders had long desired a cut in MPR to make borrowing attractive to investors as well as induce spending to aid the recovery of the economy.

While a few others commended the MPC decision especially where all options had been explored by CBN, the refusal of the apex bank to ease the monetary policy regime came as a disappointment to some analysts who felt the country may have missed a chance to quickly recover from the current recession

However, one of the high points of the MPC meeting was the plea by the CBN Governor, Mr. Godwin Emefiele, to government to pay debts owed to contractors in other to reflate the economy.

According to Emefiele, the inability of government to honour its obligations to contractors had affected businesses and called the integrity of the financial system to question.

Similarly, Minister of Agriculture and Rural Development, Chief Audu Ogbeh, recently lamented the economy might have been starved of as much as N80 billion, following delays by government to release money into the system, largely because of the newly introduced zero-budgeting system which continued to slow down budget implementation across the country.

In her analysis on the outcomes of the MPC meeting which was the last this year, economist for Sub-Saharan Africa at Renaissance Capital, Yvonne Mhango, supported the MPC on the retention of policy rates as she believed a rate hike without a full liberalisation of the foreign exchange market was not an option. According to her, hiking the rates without ‘a properly functioning FX market would be a waste of firepower.”

Similarly, analysts at Time Economics noted that, “The MPC’s decision to keep its major policy rates unchanged was an attempt to walk the tightrope between supporting growth and curbing inflation, and attracting foreign investors without raising domestic borrowing costs.”

According to them, “With inflation at 18.3 per cent and the MPR at 14 per cent, the real interest rate was -4.3 per cent. Real interest rates dropping further into negative territory would have made Nigerian assets less attractive to foreign investors. However, raising the MPR would have increased borrowing costs for local borrowers. This presented an additional difficulty for the MPC as it had to balance the conflicting requirements of foreign and local investors.”

Time Economics explained that, “The combination of a slowing economy and rising inflation, a condition known as stagflation, put the MPC in a quandary, as any changes to the Monetary Policy Rate (MPR) intended to solve one of these problems would have exacerbated the other.”

Besides, economist and ex-banker, Dr. Chijioke Ekechukwu, said import substitution and the revival of the agricultural sector could provide hope of recovery from the recession.

According to him, “It was expected that the MPC would retain the MPR because increasing same would have stifled the economy more. With the inflation rate increasing and the aggregate income and GDP dwindling by about 2.2 per cent in the last quarter of the year, it was an indication that CBN could have attempted to increase the MPR in order to cushion the cost of inflation.

“They however realised that that would worsen the disposable income of an average consumer and further deepen their hardship. Fighting Inflation however is a function of identifying the remote causes of same which in my opinion, are not things that can be resolved even in the second quarter of next year.

“Until we stop importing petroleum products which create the largest demand on our foreign reserve, until we resolve the Niger Delta impasse by reducing the bursting of pipeline in order to increase our production and supply capacity, until our exports start increasing and generating some foreign currencies and reducing pressure on imports, we will still be far from fighting inflation.

“The government palliatives to the agricultural sector however are many and should be fully utilised by those in agriculture and agro production. This is actually a right step to grow this sector. CBN should also increase the sectoral allocation of commercial bank credits to agriculture and allied products.”

However, an Associate Professor and Head, Banking & Finance department Nasarawa State University Keffi, Nasarawa State, Dr. Uche Uwaleke, said retaining the MPR further jeopardises the prospects for an early exit from the current recession.

According to him, “The decision of the MPC to retain the monetary policy rate and reserve ratios at their present high levels may help to curtail the pressure in the forex market and possibly slow down the pass-on effect of high exchange rate on food and other imported items. Unfortunately, this tight monetary policy stance jeopardises the country’s chance of exiting the present economic recession.

“It will be difficult to jumpstart growth in an economy where the average commercial banks’ lending rate is over 20 per cent with many businesses choking under high cost of doing business. The high MPR at 14 per cent implies high cost of borrowing not only by individuals and firms but also by the government that is depending on deficit financing to bridge infrastructural gap. So, domestic investments are bound to decline with adverse consequences for an economy that has officially recorded a contraction in GDP for three consecutive quarters this year, the latest figure from the National Bureau of Statistics being -2.24 per cent for the third quarter.”

According to him, “The ripple effect of the present MPC stance will compound the problem of non-performing loans in banks which is already over 10 per cent well ahead the regulatory threshold of 5 per cent. This is because high interest rates make repayment of loans more difficult. The stock market which is currently on a bearish trajectory on account of waning investor confidence will be worst hit. Portfolio investors are bound to revise their portfolios in favour of government securities.

“Share prices will plunge further when investors dispose their shares to invest in government bonds and treasury bills whose yields are currently high as a result of the high policy rate of the CBN. I would have wished the MPR and the reserve ratios were slightly reduced with the CBN putting in place adequate measures to ensure that the increased liquidity which will result from such monetary policy loosening is channeled by Deposit Money Banks to the real sectors of the economy and not used to mount pressure on the forex market.”

Also, economist and former acting Unity Bank Managing Director, Mr. Muhammed Rislanudenn, said it was difficult to think about taming inflation by keeping monetary policy rates high with hope of attracting foreign portfolio investment (especially in the fixed income markets whose rates are tied to MPR) and also provide liquidity in the foreign exchange market.

He said, “Even though I wanted to see rate reduction to support growth, it became clear that monetary policy committee may be cautious and still hold the rate at 14 per cent, citing decreasing rate of increase in inflation among others.

However, fast paced increase across inflation index was recorded in October 2016 despite monetary policy committee’s decision to hold rate at 14 per cent with a view to attacking inflation ( latest August figure then at 17.6 per cent before the last MPC meeting which has since increased to 17.9 per cent in September and 18.3 per cent in October 2016).

“The decision naturally traded off growth with GDP now further contracted to negative -2.24 per cent as at September 2016. With an economy deep in recession and largely import-dependent, it is difficult to think about taming inflation by keeping monetary policy rates high with hope of attracting foreign portfolio investment (especially in the fixed income markets whose rates are tied to MPR) and also provide liquidity in the foreign exchange market. That has naturally traded off the growth we needed to pull the economy out of recession and stagflation (as borrowing from deposit money banks become expensive and potentials of loan default and high non-performing loans elevated).”

He, however, added: “The decision is not surprising to most analysts, it was predicted. MPC has limitation of dealing with stagflation without complement of pushing output, growth and employment. MPC seem on defensive and focused on its core mandate of financial stability in respect of exchange rate, inflation and interest rate.

“Meanwhile, Fixed income market will continue to re-price assets upwards in tune with inflationary as well as MPR rates. Treasury bills nominal rate for example is now 17.48 per cent and because treasury bills and bonds are not taxable, real rate will be around 24 per cent. Whether the dollar liquidity will come is left to posterity. For now, FPIs seem to think about other factors beyond rates in taking investment decision.” Executive Director, Corporate Finance, BGL Capital Limited, Mr. Femi Ademola, said retaining interest rate represented a let-down on the part of the CBN towards economic recovery.

According to him, “With the decision of the MPC to retain all monetary policy indicators despite the glaring need to spur growth by reflating the economy, it means that we will keep to be mired in economic recession for the foreseeable future.

“This is because the monetary authority is supposed to lead the charge to reverse the economic recession due to nimble and dynamic nature of its policy instruments. By now passing the buck to the fiscal authority which has a long term and extremely political nature, it would be difficult for the economy to be off recession in early 2017.”