CRR as Viable Option to Guarantee Price, Economic Stability

James Emejo writes that by raising the cash reserve ratio (CRR) of deposit money banks (DMBs by five per cent, the Central Bank of Nigeria (CBN) may have finally found its way around rising inflation, which poses a threat to macroeconomic stability

Worried by the benign effect of the continuing rise in inflation in the economy in recent months, the Central Bank of Nigeria (CBN) had, in a surprise reaction, raised the CRR by 500 basis points to 27.5 per cent from the current 22.5 per cent.

Following the deliberations resulting from the two-day meetings of its Monetary Policy Committee (MPC), the first in the year, the CBN further resolved to hold the monetary policy rate (MPR), which gauges interest rate at current level of 13.5 per cent as well as the liquidity ratio at 30 per cent.

The CBN Governor, Mr. Godwin Emefiele argued that the apex bank had acted to fulfil its key mandate of ensuring price stability, adding that the CRR hike had become inevitable considering the magnitude of excess liquidity expected in the system due to the anticipated effect of the value added tax (VAT), which was recently increased by the federal government from 5 per cent to 7.5 per cent and which takes effect by February 2020.

He had further expressed worry over the anticipated medium-term liquidity surfeit from maturing OMO bills held by local private and institutional investors, which could all together add as much as N12 trillion to existing liquidity in the system.

The headline index had defied the CBN’s interventions in recent times and continued to pose a challenge to the economy. The CBN which has the mandate to stabilise prices, had set an inflation target of about six per cent to nine per cent in its current five-year roadmap.

Inflation had assumed a downward direction in recent consecutive months when it dropped in January 2019 to 11.37 per cent from 11.44 per cent in December in 2018.

The headline index further reduced to 11.31 per cent in February and 11.25 per cent in March but resorted to the upward trajectory in April when it climbed to 11.37 per cent- and further to 11.40 per cent in May- before falling to 11.22 per cent in June, 11.08 per cent in July, 11.02 per cent in August before returning to 11.24 per cent in September, 11.61 per cent in October and 11.85 per cent in November and now 11.98 per cent in December.

The rise further dampens the prospects for lower interest rate regime in the economy as well as reduction in the cost of borrowing.

The MPR- the rate at which the apex bank lends to commercial banks- is currently at 13.5 per cent.

However, some analysts while lauding the CBN for taking proactive measures to stem inflation, expressed concern that fighting inflation by tweaking the CRR might erode the gains so far achieved in the improvement of credit flow to the private sector and further compound inflation.

An economist, Mr. Odilim Enwegbara said raising the CRR could further exert pressure on borrowing and as well compound inflation.

Enwegbara stated:“If you increase cash reserve ratio, you are automatically reducing liquidity availability. By this action you are reducing the lending ratio to the real sector.”

“Of course, liquidity crunch only compounds a country’s economic problems, especially a country that is in need of promoting investment, jobs and prosperity that lifts millions of its citizens out of poverty. That is why as high cash reserve ratio puts more pressure on interest rates, it automatically pushes inflation up.

“So, rather than achieving the main reason for mopping, which is to reduce inflation, high cost of borrowing increases inflation. This defeats the earlier monetary policy goal.”

Chief Executive, Financial Derivatives Company, Mr. Bismarck Rewane, in his summation of the MPC decisions, however regarded the CBN’s hiking of CRR as a smart economic and proactive intervention to forestall a looming crisis.

But he said that move could as well as send the banks scampering for deposits because their liquidity will be greatly eroded by the policy adding that they could also adjust lending rates in response to the CRR hike.

However, Emefiele, while reassuring that the MPC had already taken all the concerns raised by analysts into consideration believed the increase in CRR “would not constrain lending the way we’ve already started seeing lending grow in the economy.”

Emefiele added, You will all recall that in January 2017, inflation peaked at 18.7 per cent and the monetary policy realising that price and monetary feasibility remains its core mandate certainly could not say idle and allow inflation to continue to rise, particularly above 12 per cent where we think it is growth retarding.

“So monetary policy took those decisions to be very aggressive through tightening and using all forms of monetary policy instruments available to the bank to drive down inflation.

“Luckily we were able to do this from 18.72 per cent in January 2017 to about 11 per cent. For some period, inflation remained ticking downward at 11 per cent but suddenly from around August last year, we began to see an uptick in inflation again, ticking up to about 11.98 per cent, which is the rate that we saw it in December 2019.”

The CBN governor further explained, “In reviewing inflation, monetary policy committee felt that because inflation was already getting to the level that it considers a threshold beyond, which it becomes growth retarding, monetary policy felt compelled that we need to begin to look at what can be done to reverse the trend of this rising inflation and prices and hence, the committee felt in its wisdom, realising that there’s a lot of liquidity in the market, particularly also coming from not only the fiscal that is also sending to fund the budget, but also the fact that some actors have been excluded from the OMO and also insisting that OMO, particularly for the local individuals and corporate individuals would not be allowed any longer.

“The committee felt that there would be a lot of liquidity in the market and there was a need for the bank to do something to mop excess liquidity to a level that it considers optimal to be able to run the economy in a way that the level of excess liquidity does not become injurious to the economy. That is the reason the committee felt look, let’s adopt the blunt process of taking this liquidity out by increasing the CRR from 22.5 per cent to 27.5 per cent.”

He said the MPC had further mandated the apex bank to remain committed and focused on the fact that deposit money banks must be compelled to continue to grant loans to the private sector of the economy nevertheless.

Continuing, Emefiele noted: “You would have all observed that as a result of the policy of loan deposit ratio, we have seen loans grow from N15.5 trillion June 2019 to N17.6 trillion in December 2019- that is a N2 trillion growth and in the course of reading the communique, I made it very clear the various sectors including manufacturing, agriculture, retail and all sectors that benefited from this initiative.

“The committee felt that whereas we are trying to remove the excess liquidity from the market, so as to operate within an optimal level of liquidity that is needed for the economy: that the CBN should continue to push on the loan deposit ratio since that was already giving us the kind of results that we expect.”

He said: “So, it’s like let’s keep doing what you’re doing but do not remove your eyes from the ball regarding the excess liquidity and what needed to be done to take this liquidity out so this economy can run in an optimal way that does not create inflationary pressures and by extension exchange rate pressures on the economy.”

According to the CBN boss, the committee noted the persistent increase in the inflation rate, which stood at 11.98 per cent in December 2019. It also noted that the inflation was driven by both monetary and structural factors. Having addressed the monetary factors, the headroom for further monetary policy measures has become constrained, being supported by empirical evidence which suggests that inflation above 12.00 per cent is inimical to output growth in the Nigerian economy.

“He stated: MPC thus called on the fiscal authorities to speedily address legacy structural impediments giving rise to upward-trending price developments. Amongst these, the committee identified infrastructure deficit and the long-standing clashes between herdsmen and farmers, which are constraining domestic production and contributing substantially to the rise in food inflation. The MPC, therefore, urged the federal government to relentlessly seek innovative ways of addressing security challenges across the country in order to boost aggregate food supply.

“The committee further noted the contribution of imported food and other tradeables to the rise in price levels but emphasised the opportunity to ramp up production of domestic substitutes supported by the Bank’s development finance initiatives, particularly in agriculture and manufacturing sectors.

“The committee noted the improvement in the financial soundness indicators, growth in assets of the banking system and the gradual switch in the composition of DMB assets from investments in government securities to growth in credit portfolio. It, however, noted that lending rates at the retail segment of the market had remained fairly sticky downwards as deposit rates had declined substantially. It also noted that in some cases, DMBs were not encouraging term deposits in their portfolios and therefore, emphasised the bank’s commitment towards the implementation of the loan-to-deposit ratio (LDR) policy.

“On fiscal operations, the committee applauded the government for the recent signing of the 2020 Finance Bill which opens a new vista of opportunities in public financial management. The MPC, however, cautioned that public debt was rising faster than both domestic and external revenue, noting the need to tread cautiously in interpreting the debt to GDP ratio. The committee also noted the rising burden of debt services and urged the fiscal authorities to strongly consider building buffers by not sharing all the proceeds from the Federation Account at the monthly FAAC meetings to avert a macroeconomic downturn, in the event of an oil price shock.”