Up against the Tide Godwin Emefiele

CBN Governor, Mr. Godwin Emefiele

As many of us already know, balancing the objectives of price stability with output stabilisation, especially in the face of external headwinds, remains a challenge to monetary policy and central banks, particularly in emerging and developing economies. Since the global financial crisis, many central banks have begun to promote structural transformation and economic growth, beyond the singular mandate of price stability. Consequently, policy toolkits now contain instruments that are aimed at developing the financial sector, engendering wider financial inclusion, and aligning financial policies with sustainable development and growth.

As some of you may know, the global financial crisis of 2008 – 2009, which was trigged by the housing price bubble in the United States, created considerable uncertainty in the global financial market and uncovered the weakness of many economies. It also exposed the inadequacies of conventional monetary policies in tackling the challenges that came as a result of the crisis. As a result, the United States and several countries within the Euro Area fell into a recession between 2008 – 2009.

Before the onset of that crises, policymaking at central banks had been dominated by neo-liberal and orthodox doctrines, as promoted by key Bretton woods institutions like the International Monetary Fund (IMF). These tenets emphasised price stability as the sole and exclusive mandate of central banks. However, lessons learnt from recent crises in addition to the global financial crisis, have raised doubts on the validity of this position. What became obvious, following the GFS crisis, is that conventional monetary policy tools were not sufficient in dealing with the complexities resulting from the Crisis; such as debt overhang and stagnating economic growth.

As a result, Central Banks in the US and in the Euro Area had to utilize unconventional tools in their efforts to achieve their macroeconomic goals of output growth and price stability. The use of unconventional tools such as quantitative easing and forward guidance, led to a growth recovery in the US, as well as a reduction in the unemployment rate.
On the reverse side and not withstanding its achievements, it is conceivable that unconventional policies could heighten tradeoffs such as its resulting effect on the balance sheets of Central Banks.

In this discussion, I will highlight the CBN experience with unconventional monetary policies tools in light of the extraordinary challenges the Nigerian Economy faced as a result of drop in commodity prices between 2014 – 2016. I will also discuss some of the key challenges confronting the Bank in the formulation and implementation of unconventional monetary policy tools –including the reaction of key Bretton Woods institutions to our approach.

The Policy Remit of the CBN
Though the 2007 CBN Act specifies price stability as the overriding mandate of the Bank, permit me to highlight here, that the operationalisation of this mandate is somewhat tricky. What exactly does price stability denote? Paul Volcker and Alan Greenspan, former Governors of the US Fed, have defined it as what obtains when “the public no longer takes account of actual or prospective inflation in its decision-making”. For the CBN, it is achieved when inflation lies within the tolerance band of 6–9 percent. Within this band, we believe that the evolution of relative prices is able to optimize the micro objectives of firms and households while maximising total utilitarian welfare of the economy.

For an economy like ours, which is yet to attain its full potential, utilitarian welfare maximisation requires a functional consideration for real growth. Thus, growth objectives cannot be overlooked. The CBN Act 2007, in recognising this, provided the Bank with the legal backing to undertake developmental functions that are consistent with price stability. This has enabled the Bank to simultaneously promote the development of financial markets and stimulate the growth of the real sector.

Recent Experience of the CBN
Ladies and gentlemen, the CBN’s experience with heterodox policies expanded during the recent economic crisis that begun in 2014 due to a number of global shocks, three of which were simultaneous and significant in shaping the trajectory of the Nigerian economy, namely:
i. Widespread and rising geopolitical tensions along critical trading routes in the world: This began around March 2014 with the United States’-led sanctions on Russia for its role in precipitating the conflict in Ukraine. Other areas include Britain’s desire to pull out from the European Union, and rising trade tensions between the United States and China, with its attendant implications on global trade and capital flows;

ii. Softening crude oil prices: The significant drop in the price of Bonny light, Nigeria’s crude, from US$115 per barrel in June 2014 to US$31 per barrel by January 2016 exposed the structural vulnerabilities of an oil dependent economies like ours; and
iii. Normalisation of monetary policy by the US Fed: In October 2014, the US Federal Reserve commenced the tapering of its quantitative easing programme towards a more conventional monetary tightening cycle. This decision led to acute capital flow reversals especially from emerging markets and heightened financial fragilities in these countries.

Effects on the Domestic Economy
Unarguably, the most important of these factors to impact the Nigerian economy was the plunge in crude oil price. Nigeria’s overdependence on crude oil for over 60 percent of fiscal revenue and over 90 percent of FX inflows, meant that shocks in the oil market were transmitted entirely to the economy via the FX markets as manufacturers and traders who required FX for input purchases were faced with dwindling supplies.

Average monthly inflows of FX into the CBN fell from over US$3.4bn in June 2014 to a low of US$1.4bn in September 2016. The decline in FX earnings was further complicated by the foreign capital flow reversals due to rising yields in the USA. The impact of these on our economy was evident in the rising pressure on the naira-dollar exchange rate.

With the drop in FX inflows, the exchange rate at the parallel market rose from about N200/US$ in August 2015 to N525/US$ in February 2017. Inflation also rose from 9.6 percent in January 2016 to over 18.7 percent in January 2017. Our external reserves fell from about US$31bn in April 2015 to US$23bn in October 2016, and activities in the industrial sector witnessed a lull as manufacturers struggled to get access to key inputs needed in the production process.
Other vulnerabilities include, slowdown in government spending (following the fall in government revenue), build-up in the demand for foreign exchange, and high exposure of the banking sector to the oil and gas sector.

Driven largely by the downside effects of these shocks, real GDP growth plunged sharply from 6.2 percent in 2014 to a 1.6 percent contraction in 2016. Nigeria effectively slipped into a technical recession in the second quarter of 2016 and maintained negative growths in ensuing quarters of that year. Disaggregation of the 2016 outcomes showed the worst contraction of 2.4 percent in quarter three and a turning point thereafter.

Addressing the Recession: The Monetary and Fiscal Policy Mix
In a bid to contain rising inflation and to cushion the impact of the drop in FX supply on the Nigerian economy, the monetary and fiscal authorities took extraordinary measures to tackle these extraordinary challenges. Some of the measures we took, a number of which are indeed unconventional, include;

· Monetary Policy: Over the intervening period, the CBN embarked on a cycle of tightening which culminated in a July 2016 hike in the Monetary Policy Rate from 12 percent to 14 percent. This decision was expected to rein in expected inflationary pressures that may result from exchange rate pass-through to domestic prices and ensure that inflation expectations are well anchored. It was also expected to stimulate increased capital inflows to the country, which should improve accretion to reserves.

· Conserving our FX: We introduced demand management approaches to conserve our reserves and support domestic production of certain goods in Nigeria. In this regard, we analysed our import bill, and encouraged manufacturers to consider local options in sourcing their raw materials, by restricting access to foreign exchange on 41 items (now increased to 43). Four of these items alone constitute over N1 trillion of our annual import bill.
· FX Market: In April 2017 we introduced an Investors and Exporters (I&E) window, which allowed investors and exporters to purchase and sell foreign exchange at the prevailing market rate. In addition, exchange rate management was further liberalized following the operationalisation of the “Revised Guidelines for the Operation of the Nigerian Inter-bank Foreign Exchange Market” in June 2016. The commencement of this policy guideline introduced the Naira Settled Foreign Exchange Futures Market.

· Risk-based supervision: The weakening of the naira, following the shift to a more flexible foreign exchange mechanism along with the exposure of several banks to the oil and gas sector, impacted somewhat on the balance sheets of domestic banks. To support the health of the banking system, the CBN took a number of steps, including:

o Monitoring compliance of supervised institutions with the foreign exchange management framework issued in June 2016 through our risk-based supervision methodology.
o Monitoring the financial position and performance of supervised institutions;
o Assessment of the risk profile and governance management practices of banks and in the event of major deteriorations on any key risk indicator, we engaged with the affected bank in order to mitigate concerns and shore-up their capital base.

· Development finance intervention: The CBN increased its lending to the agricultural and industrial sectors, through targeted intervention schemes such as the Anchor Borrowers Program, Commercial Agricultural Credit Scheme and the Real Sector Support Facility. In particular, we sought to improve domestic supply of four commodities (rice, fish, sugar, and wheat), which consume about N1.3 trillion annually in our nation’s import bill.

· The Anchor Borrowers Programme (ABP) which was launched in November 2015, was designed to build partnerships between small holder farmers and reliable large-scale agro-processors, with a view to increasing agricultural output, while improving access to credit for farmers.

· Our targeted focus on the agricultural and industrial sectors were driven by the vast opportunities for growth in these sectors given our high population. It was also instrumental in taking Nigeria out of the recession. In 2017, over 50 percent of the contributions to GDP growth came from the agriculture and industrial sectors. These sectors have the ability to absorb the growing labor pool of eligible workers in our effort to meet the household consumption needs of the Nigerian populace. If efforts were made to improve productivity gains in these sectors, it will reduce our dependence on imported items that could be produced in Nigeria.

· Furthermore, improved productivity in the agriculture and manufacturing could also help in reducing our dependence on proceeds from crude oil. In 2017, Nigeria’s total revenue from exports of crude oil was US$23 billion, relative to Indonesia, which earned close to US$22bn from the export of palm oil in 2017. Nigeria has vast amounts of arable land that can be put to good use in the cultivation of not only palm oil but also cotton, cocoa, tomatoes and rice to mention a few. Supporting growth in the agriculture and industrial sectors is critical in our efforts to create a diversified wealth base for the country.

Doctrinal Critique of our Policies by Bretton Woods
While many of these measures were an attempt at using unconventional tools to mitigate the effects of a slowdown in growth, they were initially criticised by adherents of conventional monetary policy tools.

In the view of some critics for instance, our FX policies constitute exchange restrictions, rationing of FX, discretionary allocation based on priority categories, and a multiple currency practice. Many are also unaccepting of our 41 items restriction and its recent increase to 43 items, regardless of its apparent successes. While there is sufficient evidence of significant reductions in our annual import bill, increased non-oil output and exports, and a robust BOP position, these critics assert that we are restricting trade and creating unfair competition.

To our critics, who are against the imposition of the FX restrictions, conventional Monetary Policy requires that to encourage domestic production, we should impose higher tariffs and levies. However, our experience in Nigeria has shown that this practice has never worked due to certain inefficiencies in attaining these objectives.

Our development finance initiatives in growth driving and employment generating sectors have equally not gone down well with the proponents of conventional monetary policy tools. While they acknowledged our measures have had a positive impact on output and employment, they assert that these tools constitute quasi-fiscal activities. They also maintain that implicit interest rate subsidies can have distortive effects on resource allocation.

Our argument for the unconventional Monetary Policy approach has always been that just like fiscal, monetary Policy could, at a time when development challenges abound, complement the efforts of the fiscal in employment generation, wealth creation and attainment of other growth objectives.

Policy Outcomes and Exit from Recession
Regardless of these scathing views and critiques, the fact remains these unorthodox policies were well conceived, and has been yielding significant gains for the Nigerian economy. Noticeable successful outcomes are gleaned from:

i. GDP– After 5 consecutive quarters of negative growth beginning in the first quarter of 2016, a coordinated approach by the fiscal and monetary authorities supported a rebound in the nation’s economy during the second quarter of 2017. The recovery has been driven largely by improved non-oil activities especially the agriculture sector which expanded consistently by about 3.5–4.3 percent reflecting efforts at diversifying the economy. This was nonetheless, reinforced by the pickup in the oil sector as oil prices rallied in 2017. The recovery, which has been sustained for eight consecutive quarters, is expected to strengthen in the short- to medium-term.

ii. Inflation– As a result of the implementation of a tighter monetary policy regime, intervention programs in the agriculture and industrial sectors, as well as improved FX inflows, inflation began to decline, from its peak of 18.7 percent in January 2017. It currently stands at 11.37 percent as at April 2019.

iii. Reserves– The introduction of the I&E window, along with improvement in domestic production of goods have helped shore up our external reserves. Transactions have reached over $48 billion since the inception of the window and our foreign exchange reserves has risen to US$45bn in April 2019 from US$23bn in October 2016. Nigeria’s current stock of external reserves is now able to finance over 9 months of current import commitments. With improved availability of foreign exchange, the exchange rate at the I&E FX window has remained stable over the past 24 months at an average of N360/US$, and the parallel market exchange rate has appreciated from N525/US$ in February 2017 to N360/US$ today.

iv. Anchor Borrowers Program– The program has helped to bolster agricultural production by removing obstacles faced by small holder farmers. We have also improved access to markets for farmers by facilitating greater partnership with agro-processors and industrial firms in the sourcing of raw materials. So far the program has supported more than 1,059,604 small holder farmers across all the 36 states of Nigeria, in cultivating 16 different commodities over 1.114 million hectares of farmland. It has also supported the creation of over 2.5m jobs across the agricultural value chain.

v. Industrial Sector– Activities in the industrial sector also witnessed significant improvement between August 2016 and February 2019, as the Primary Manufacturing Index rose from a low of 42 percent in August 2016 to 57 percent in April 2019. This development was attributed to sustained supply of FX and the dogged implementation of our FX restriction on certain items.
vi. Because of our unconventional FX and development finance policies we have recorded spectacular improvements in domestic production of most of the targeted items. Local manufacturers are consequently reporting major boosts to their revenue and profit.

Peer Review
In assessing Nigeria’s recovery efforts and performance, it is essential to conduct a comparative assessment of our peers. Strikingly, it will be discovered that Nigeria did not fare badly vis-à-vis other emerging market economies like Brazil, South Africa, Turkey, and Argentina, that had similar economic experiences. Amidst the growing challenges, Nigeria has managed to keep real GDP growth positive and has avoided a double-dip recession in contrast to some other emerging markets economies.

In comparison and following its 2016 contractions, the South African economy recorded a double-dip recession with renewed contractions of 2.6 and 0.7 percent in the first and second quarters of 2018, respectively. Its economy grew by .8 percent in 2018. In Argentina, though the economy was in recession throughout 2016, moderate upticks which peaked at 1.9 percent quarter two of 2017 ended that recession. However, the Argentinian economy fell back into a recession as GDP growth declined by 1 percent in 2018.

The Brazilian economy had been in recession since 2015 and only emerged from it the first quarter of 2017 with a growth rate of 1.0 percent. Since then the growth has slowed progressively until the last quarter of 2017 when growth remained flat. Economic recovery still remains tepid with a GDP growth rate of 1.1 percent in 2018.

Possible Complexities of Heterodox Monetary Policy
While developmental mandate enhances the ability of central banks to foster economic growth, this may come with appreciable hitches. Essentially, policies designed to attain price stability may in fact lack congruence with the goal of economic growth. There is, therefore, the need for a clear understanding of what the limits of central banks are when it is compelled to assume a growth mandate together with the traditional price stability goal. Some of the challenges include:

Multi-mandate risks: Some of the risks that might arise from central banks’ increased mandate are identified;
Trade-offs may possibly arise from the pursuit of growth and price stability objectives. Unconventional monetary policy tools could inadvertently cause liquidity surfeit and undermine price stability.

Developmental roles may expose central banks to undue political pressure to the detriment of the economy.
Balance Sheet – Following the 2008 financial crisis, many central banks, including those of key advanced economies, quickly realised the inadequacy of the conventional approach as they hit the lower limits of adjustments to their interest rates. They thus looked for other approaches to bolster the real economy. These banks (including the US Fed, the Bank of England, the European Central Bank, the Bank of Japan etc.) experienced considerable expansions of their balance sheet while adopting an unconventional monetary policy approach.

Their experiences show that growth financing monetary policy may lead to unsustainably expanded balance sheet of the central bank especially if there are no robust means of contracting the balance sheet when the need arises. An expanded balance sheet could portend inflation risk (as monetary aggregates grow) and financial stability risk (due to excessive credit expansion).

Regardless of these probable complexities, the cost-benefit analysis of undertaking unconventional monetary policies indicates that the societal gains of such policies outstrip whatever challenges that may subsist. The experience since the global financial crises show that growth consideration cannot be sacrificed over the long-term for an exclusive focus on price stability, because unabated real contractions (and the associated persistent negative output gaps) can only lead to declining potential output. An outcome which is entirely dangerous for any economy given the structural fall in its long-run growth trajectory.

Way forward
Ladies and gentlemen, relative to our peers, the favourable outcomes and strengthening outlook of the Nigerian economy is traceable to the timeous adoption on non-traditional policy methods. The CBN has been able to reduce inflation, build our FX reserves, maintained FX market stability, and foster real growth. Nonetheless, challenges still remain. The pace of population growth at about 2.6 percent still outstrips real growth rate while inflation is outside our tolerance band. Unemployment rate and incidence of poverty remain at unacceptable levels.

I am happy to note that much of the success we see today is due to the adoption of heterodox macroeconomic policies. Within the CBN, our unconventional methods (especially in the management of the FX market and our development financing) supported by the orthodox approaches (in the form of our timely adjustments of monetary policy rate) have been able to optimally balance the delicate objectives of price stability and real output growth. We will continue to develop policy instruments and device ways of ensuring that an optimal mix of heterodox policies is continually deployed to engender the overall wellbeing and prosperity of the Nigerian economy. Our overall aim remains the concurrent attainment of price stability, real growth, full employment, and poverty reduction.
A lecture delivered by Emefiele at the distinguished leadership programme lecture series at the University of Ibadan on May 24, 2019