October 10, 2011 / 2049hours / CBN
The Monetary Policy Committee (MPC) held an extraordinary meeting on 10th October, 2011 in response to unusual developments in the global and domestic economy, with potential negative impact on domestic liquidity conditions and renewed threats to price and exchange rate stability.
The global economic horizon remains highly uncertain, with the signs getting more ominous as policy makers find it increasingly difficult to take the necessary economic decisions that may avert a new wave of recession. Three self-reinforcing negatives continue to define the global economy: the sovereign debt crisis in the Eurozone, significant undercapitalization of internationally-active banks, and negative market sentiment leading to continuing flight to cash as a safe haven and de-leveraging. The first and second aspects intensify the third, and without confidence and some appetite for financial assets and credit, the debt crisis and financial solvency concerns in turn become deeper.
As a result of these concerns about the Eurozone, coupled with the US deficit problem, inflation in emerging markets, debates about a soft or hard-landing in China and other pessimistic scenarios, there is a trend towards reversal of capital flows to emerging and frontier markets, and a recent depreciation in the national currencies of many economies in Asia and Latin America including India, Indonesia, Malaysia,South
Korea , Brazil, Chile,Colombia, and Mexico, among others.
In Africa, the national currencies of Kenya , South Africa , Gabon , Ghana and Nigeria have also been under pressure. Central banks have generally responded through direct intervention in the foreign exchange market to stabilize the currency and, in some cases, a significant hike in policy rates. It is worthy of note that fund managers have not been eager to exit environments with relatively high real rates of interest and benign inflation outlook.
The Domestic Economy and Committee’s Deliberations
The growth outlook for the economy does not appear to have changed much, driven largely by the positive forecasts for the non-oil sector as noted in the last MPC communiqué. Inflation had come down to 9.3 per cent in August but, as indicated in the same communiqué, a combination of monetary, fiscal and structural factors continue to advise against complacency.
The naira has come under increasing pressure, and has recently traded outside the band of N150 +/- 3.0 per cent. In the Committee’s view, the increasing pressure on the domestic currency has been emanating from a number of sources not all of which can be addressed by purely monetary interventions. First, there are concerns about the likely impact of a double dip recession on oil prices and already declining foreign reserves. Second, there are also concerns about the delay in implementing fundamental economic decisions that will shore up reserves. Specifically, it is estimated that simply passing the Petroleum Industry Bill (PIB) and removing subsidies on Premium Motor Spirit (PMS) will add at least US$10 billion to national reserves annually. The petroleum subsidy for 2011 alone is estimated to be about US$6 billion. A substantial part of oil production (about 40 per cent) is currently in deep offshore wells. Based on the terms agreed in the 1990s when oil price was under US$30, royalty from oil wells deeper than 1,000 metres is zero per cent and the nation is paid only 20 per cent of the profit by oil companies after deducting their expenses. As a result, the country has had limited benefits from high oil prices and increasing output, with most of the gains going to multinational oil companies under an inequitable fiscal arrangement.
Similarly, the Committee expressed concerns about the genuineness of demand for petroleum imports. This year alone, oil importers have bought over US$7.0 billion from wDAS, thereby, depleting the Nation’s external reserves. This demand, in the Committee’s view, might have been fuelled by rent-seeking and subsidies.
It is imperative that the enabling legislation for correcting fiscal terms be put in place under a Petroleum Industry Bill (PIB) that reflects international best practice. Unfortunately, discordant voices are delaying these processes to the long-term detriment of the economy. Whereas the labour unions have genuine concerns about the impact of subsidy removal on the poorer segments of society, the stark reality is that the country is living above its means.
The Greek government recently passed a budget in which 33,000 public sector workers had to be retrenched as a result of failure to take difficult but necessary economic decisions in the past. Nigeria cannot afford to delay, any further, the reforms of the petroleum industry.
Third, the draft 2012 budget and the underlying assumptions are based on an oil price of US$75 per barrel and an output of 2.4 million barrels per day. This makes the 2012 budget even more expansionary than the 2011 budget and further dampens any hope for an early fiscal retrenchment. The fiscal authorities have clearly signaled a commitment to medium-term consolidation and indeed the projected deficit in 2012 is lower than the deficit in the 2011 budget. This notwithstanding, the projected increase in spending, particularly the high levels of recurrent expenditure, would suggest increasing pressure on prices in general.
Fourth, structural bottlenecks in the Nigerian economy that perpetuate import dependence make import-demand highly inelastic.
Finally, real interest rates have been low, partly driven by a cautious approach to monetary tightening at a time of financial system instability. Although the MPC recognized inflationary pressures and has consistently acted prudently in policy tightening based on expectations, a gradualist approach has been the pattern thus far, given the situation with the banking system and equity markets.
Policy Issues and Dilemmas
In the face of the spectre of declining oil prices, declining foreign reserves, increased demand for foreign exchange, fiscal dominance and capital flow reversals, monetary policy must bear a larger burden of economic adjustment. The MPC has, therefore, to make difficult choices, each of which has clear costs and benefits.
One option is protecting reserves by reducing the supply of dollars at the wDAS. This will lead to a rapid depreciation of the currency and the emergence of a parallel market, leading to further pressures on the Naira, imported inflation and a general loss of confidence on the part of investors.
Indeed, the impact on price and exchange rate stability will be such as to undermine the key mandates of the Central Bank. Given the highly inelastic demand for imports, it is doubtful that increasing the cost of dollars will significantly reduce quantity demanded. Indeed, genuine demand will be compounded by high levels of speculative demand.
A second option is to address monetary and liquidity conditions more aggressively. By tightening liquidity and raising domestic interest rates, a number of advantages follow. First, this is the logical response to fiscal expansion, especially with the anticipated capital releases in the fourth quarter as well as repayment of backlog of Nigeria National Petroleum Corporation (NNPC) debt to the Federation account. Second, it provides an incentive for reallocation of portfolios by improving real returns of holding the naira as a store of value. Third, it increases, after a lag, the rates paid on deposits and savings, thus reversing any tendency towards disintermediation and capital flight. Finally, it increases the cost of foreign currency positions held for speculative purposes, and reduces the tendency to pre-pay dollar obligations with naira liabilities.
The option has disadvantages in the form of high lending rates, financial cost to the banking system and possible losses on fixed income instruments due to capital losses. Besides, tightening of liquidity would run the risk of slowdown in credit growth.
Having considered the pros and cons of each option (and combinations of options), the Committee is of the view that given the completion of shareholder meetings on all banks and approvals from the courts for many, the risks to the banking system of tighter liquidity conditions have been significantly reduced, as the banks are in the process of receiving all approvals and fresh capital including AMCON bonds. Now that the banking system recapitalization is complete, monetary policy can be freed from concerns about its impact on financial system stability.
The Committee reaffirmed its belief that maintaining exchange rate stability, especially in times of global uncertainty, is crucial to the mandate of price stability. Moreover, the interest of the economy is best served, by maintaining an unequivocal stance of non-accommodative monetary policy, given the existing fiscal
The Committee also reaffirmed its commitment to improving returns on naira assets and protecting the capital of investors against erosion due to huge exchange rate losses, in order to encourage appropriate asset allocation decisions.
The Committee recognized the need to remain very clear on the Bank’s primary mandate and maintain the credibility it has established so far by sending strong signals of continuing commitment to price and exchange rate stability.
Finally, the Committee noted that the Committee of Governors has already commenced full investigation of compliance with rules governing foreign exchange transactions by authorized dealers and endorsed the declared commitment to sanction all infractions and improve the level of supervision and compliance in the market.
1. The monetary policy rate (MPR) is raised by 275 basis points from 9.25 per cent to 12.0 per cent (by a vote of 8 in favor and 1 in favor of status quo);
2. Maintain the current symmetric corridor of +/-200 basis points around the MPR (by unanimous vote);
3. The cash reserve ratio(CRR) is increased from 4.0 per cent to 8.0 per cent from the maintenance period beginning October 11, 2011 by a vote of 7 to 2 (2 members voted for a 6.0 per cent CRR);
4. The net open position (NOP) is reduced from 5.0 per cent to 1.0 per cent of share-holders funds with immediate effect and with full compliance by Friday, October 14, 2011 (by unanimous vote); and
5. It was further agreed that the reserve averaging method of computation be suspended in favour of daily maintenance until further notice.
Sanusi Lamido Sanusi, CON
Central Bank of Nigeria
October 10, 201