Stepping Up Fight against Inflation

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Beyond monetary policy, there is need for greater coordination between policymakers to win the fight against inflation, writes Obinna Chima

The 13-page communique released by the Monetary Policy Committee (MPC) at the end of their two-day meeting in Abuja on Friday, evidently revealed the concern of the committee members about the inflationary pressure the economy is presently facing.

The MPC members expressed concern about the rising inflation, which increased consecutively in the last four months as at December 2019, to 11.98 per cent. This is significantly higher than its target range of between six and nine per cent.

The rising inflation level was attributed to a combination of structural and supply side factors, expansionary fiscal policy; and growth in money supply arising from rising liquidity surfeit in the industry due to changes in the Central Bank of Nigeria’s (CBN) open market operations (OMO) policy. 

The CBN had last October, completely prohibited individuals and local firms from investing in both its primary and secondary OMO auctions. Owing to this policy, investing in OMO bills is now be for banks and foreign investors alone.

Therefore, in furtherance of its primary mandate to maintain price and monetary stability and in view of the anticipated medium-term liquidity surfeit from maturing OMO bills held by local private and institutional investors, which would not be rolled over, the Committee considered it prudent to raise the cash reserve requirement (CRR) to curtail liquidity surfeit in the banking system.  

Precisely, the MPC members voted to raise the CRR by 500 basis points to 27.5 per cent, from the 22.5 per cent it was, as a response to the growing threat of inflation to the economy.

The CRR is used to determine the minimum deposit commercial banks must hold in reserves with the CBN rather than utilise the fund in investment or lend it out as loan. This determines the level of liquidity for banks.

However, the committee decided to leave the Monetary Policy Rate (MPR), otherwise known as interest rate, unchanged at 13.5 per cent as well as the Liquidity Ratio at 30 per cent. 

In justifying the MPC action, the CBN Governor, Mr. Godwin Emefiele, said the increase was necessary considering the magnitude of excess liquidity expected in the system following the anticipated effect of the Value Added Tax (VAT) which was recently increased by the federal government from five per cent to 7.5 per cent and which takes effect by February 2020. He further expressed concern that the pending maturing security bills could all together add as much as N12 trillion to existing liquidity in the system.

Emefiele, said the Committee by a decision of nine members, voted to alter the CRR by 500 basis points from 22.5 to 27.5 per cent, while leaving all other policy parameters constant, adding that two members voted to leave all parameters constant.

He said the committee expressed concern about rising inflation. 

Emefiele is confident that increasing the CRR at this time is fortuitous as “it will help address monetary-induced inflation while retaining the benefits from the Bank’s LDR policy, which has been successful in significantly increasing credit to the private sector as well as pushing market interest rates downwards.” 

He said: “The Committee further encouraged the management of the banks to be more vigorous in its drive to improve access to credit through its pursuit of the Loan-to-Deposit ratio policy as doing this would help, not only in creating job opportunities but also help in boosting output growth and in moderating prices.

“It is noteworthy that Gross credit in the industry grew by N2 trillion between May 2019 and December 2019; channeled primarily to the employment-stimulating sectors such as agriculture and manufacturing, in addition to increased lending to the retail and SME segments, which is expected to help boost domestic output growth in the short to medium term. 

Clearly, high inflation distorts consumer behaviour. It can also destabilise markets by creating unnecessary shortages. Similarly, high inflation which is not the desire of any economy redistributes the income of people and brings about weak purchasing power. That is why the central banks globally, are never comfortable with this ‘evil.’

Analysts’ Position

To analysts at Nova Merchant Bank Limited, while the action by the MPC would result in additional five per cent CRR debit across banks, it was still unclear if the current effective CRR will be taking into account when debiting banks. 

They estimated that that with total banking sector local currency deposits of N16.6 trillion, the policy would result to an additional CRR charge of N831 billion. “However, as system liquidity currently stands at N435 billion, we do not rule out the liquidation of some banks’ bills to fund the excess. 

“Accordingly, we expect short term adjustment in interbank rates before further moderation on liquidity surfeit in the coming weeks. 

“However, we do not see a likely repricing of loans across the banking sector given the limit created by the LDR policy and the short-term nature of this spike,” they added.

According to analysts at Nova Merchant Bank, the policy would help the CBN reduce cost of liquidity mop-up within the banking system and combat possible foreign currency speculation induced by the impending liquidity. 

“While we believe the policy is counterintuitive and could increase banks’ CRR weighted average cost of funds, the materially lower rates will largely mute the possible repricing of loans as banks scout to meet the LDR limit to avoid further sterilisation of funds as CRR. 

“Also, with banks cautious of possible debits when bidding for forex, we see CBN achieving some control and limiting possible forex speculations. Muted impact on rates in the medium term, but liquidity will remain buoyant,” the bank added.

They, however, anticipated short-term adjustment in interbank rates before further moderation on liquidity surfeit in the coming weeks. 

“On liquidity, with the expected maturities largely dominating the NTB, bond and corporate instruments, we see further crunch in yields, at least for the rest of first half 2020 wherein the maturities are dominant. “However, if forex pressure intensifies (due to an unexpected decline in crude oil prices), we do not rule out an upward adjustment in the OMO rates to make it more attractive for foreign portfolio investors given the sizeable liquidity at the NTB compared to OMO. 

“As it stands, the higher than expected foreign portfolio inflows so far in January, with CBN now a net buyer at the investors and exporters’ window, will further allow for lower OMO rates in the interim,” the report added.

On her part, the Chief Economist, Africa and Middle East, Standard Chartered Bank, Razia Khan, argued that the presently liquidity overhang and low market interest rates stemmed primarily from the CBN’s decision to bar resident non-bank financial institutions from participating in OMOs.  

This, she stated largely represents the adjustment still underway as the market reacts both to the new restrictions on resident NBFIs, and simultaneously, large OMO maturities.

 “Given the punitive CRR that banks face in the event that they fail to meet the stipulated minimum LDR, it is not entirely clear that the ‘normal CRR’ rate itself needed to be raised. 

“Today’s announcement is however still a tightening of liquidity, and near-term, we would expect market interest rates to adjust to this, most likely at the very front-end of the curve.  

“Continued OMO maturities will still prove to be an offsetting influence, but the floor in yields should now adjust higher, sending a message on a) the CBN’s intention to preserve currency stability and b) its ongoing concern over the price level,” she added.

However, analysts at Cowry Assets Management Limited, welcomed the decision of the MPC to increase the CRR, saying it would create an outlet to ease built up pressure of increased financial system liquidity which was created by its restrictive OMO policies. 

“In doing so, and by not reviewing the MPR upwards, we feel the monetary authority remains in alignment with the fiscal authority’s goal to boost output growth, in part, by making credit available at affordable cost to real sector players,” they added.

To analysts at Anchoria Asset Management Limited, the increase in the CRR was a contractionary monetary policy expected to reduce the money supply in the circulation due the increase in loan to deposit ratio by 500 basis points to 65 per cent from 60 per cent and the restriction of local corporate and individual to OMO bills. 

Commenting on the effect of the increase, they stated that, “theoretically, we expect to see a reduction in banks’ system liquidity which would either force banks to increase deposit by soliciting from customers or increase activities of banks in the interbank markets.

“In the short term, we expect banks to flow into the interbank market which would increase the open buy back and overnight rate.”

Therefore, the latest development shows that the central bank may sustain its tightening bias longer as it continues to deploy measures to constrain liquidity and inflation.