Thursday, November 28, 2013 / By Abimbola Hakeem Omotola / Proshare Project Research
The core mandate of the Central Bank of Nigeria (CBN) as stipulated by the constitution is to maintain price stability, that is, to keep price of goods and services from persistently rising (inflation) or decreasing (deflation), while also maintaining internal and external balance of payment and exchange rate stability. To effectively do these, the apex monetary authority in the nation is equipped with a broad range of policy instruments such as the Monetary Policy Rate (MPR), Open Market Operation (OMO), Cash Reserve Ratio (CRR), Liquidity Ratio and treasury securities; used to influence markets’ decision and the economy at large in order to deliver on its core mandates of price and exchange rate stability.
The new economy has however ushered new sets of challenges. Unlike the advanced economy where growth has been thinning and inflation muted, inflow of roving private equity capital driven by globalization and surging growth rate in the global economy’s “Last Frontier”, as Kingsley Moghalu aptly described Africa in his book, has come with increased and more diverse inflationary risks. The challenge before the CBN is how to mitigate these risks to maintain price and exchange rate stability while at the same time creating conducive atmosphere for stable and sustainable growth and economic development. Questions now arises as to what are the factors causing these inflationary pressures in the economy and how has the CBN faired in overcoming these challenges to tame inflation and ensuring the purchasing power of Nigerians does not weaken?
Inflationary Drivers in Nigeria and the Challenges Posed to the CBN
Inflation rate is primarily measured in Nigeria as the percentage change in the consumer price index which has the food and core index, to give the headline inflation. The CPI measures the price of the representative food and services components such as food, alcoholic beverages, energy, housing, clothing, transport, health, communication, transport, et al. The consumer price inflation which captures the movement in the prices of essential commodities and service that reflect the welfare of Nigerians is put under consideration by the CBN when taking monetary policy decisions, as the measurement is strategic to its core mandate of ensuring the purchasing power of Nigerians does not weaken.
The debate from the theoretical angle on the cause of consumer price inflation has been going on for quite some time and has been robust. While the neoliberal/monetarists will argue that the quantum of money supply is what primarily drives inflation which is harmful to economy growth, the structuralists also try to make us believe that inflation is fundamentally being driven by structural factors and it is required for economic growth.
Factors causing inflationary pressures in Nigeria could be examined from both the demand and supply side. Over the last two decades, the Nigerian economy has benefited immensely from the increase in crude oil price. This has driven up oil receipts and government revenue, consequently heightening fiscal expenditure. It is based on this and other reforms carried out to open the country to private investments that has led to the unprecedented economic growth and prosperity of the rising middle class that the country has been experiencing. With FG fiscal expenditure increasing steadily from just a little over N1 trillion in 2001 (57% recurrent) to over N4 trillion in the 2012 fiscal year (recurrent now over 70%), fiscal expenditure has remained a permanent inflationary driver in the economy as it has fundamentally escalated domestic consumption but not domestic manufacturing by the same proportion. This creates pent-up demand that could not be met by domestic production due to the comatose manufacturing sector but by imports, thus making the economy exposed to imported inflation. The financial system also frequently builds up excessive liquidity when the often reckless federal government distributes revenue to its organs. The allocation is usually domiciled in commercial banks rather than the CBN, which exposes the system to inflationary risk due to the excessive liquidity.
It is a fact that the new global economy is driven by private equity capital that seeks large markets and competitive investment destinations. With interlinked financial markets, monetary and fiscal policy decisions taken externally could and do trigger actions that affect domestic macroeconomic indicators like inflation and exchange rate. Capital and trade now flow to the advantage of countries that possess competitive business and economic environment. Nigeria, no doubt has the potential to be competitive, but for the structural problems in the economy which do not entirely fall within the scope of the monetary policy. The structural problems hampering real sector growth and causing inflation could be found in the institutions, public utilities and infrastructure, cost of borrowing, security, corruption goods hoarding and hedging, et al. All these have contributed to the un-competitiveness of the manufacturing sector and made the country revenue dependent on the oil sector and import dependent for manufactured goods and even agricultural products - which have exposed the country to imported inflation and external commodities price shocks. This supply side inflationary factor which relates to exchange rate movement on the domestic price level has increasingly been a source of worry to monetary policy makers.
When oil prices significantly drop, the impact is felt in the country’s fiscal revenue earning, foreign reserve and consequently, the exchange rate which is usually depreciated to reflect the situation in the oil market, making it more expensive to import. A close example was during the global financial crises when inflation rate went up near three fold between 2007 and 2009 partly due to the depreciating naira exchange rate.
Also driving inflationary pressures are domestic supply shocks in food and energy prices which mount inflationary pressure on the CPI. Examples include the 2012 flooding in several states which affected agricultural output and the hike in PMS and diesel prices a year ago due to the botched deregulation of downstream oil sector. The effects of both have yet to fully wear out on the CPI due to the base-year effect.
The CPI denotes the cost of living of citizens and for a low income country like Nigeria with a large percentage of the poor, ensuring the cost of living does not skyrocket is of utmost importance. To ensure this, the country relies heavily on the CBN to formulate monetary policies that will mute inflationary pressures and keep inflation benign, despite the challenges.
The CBN Inflation Scorecard: Has Monetary Policies been Effective in Taming Inflation?
To combat the inflationary pressures over the last thirteen years, the CBN has relied greatly on Open Market Operation (OMO) to mop up excess liquidity and control money supply (which is correlated with inflation), and the Monetary Policy Rate (MPR) to indirectly control credit expansion and calm the economy when it is going hot. Reserve requirements have not been utilized much until recently when the CRR was introduced specifically on government deposit.
With several potential and actual internal and external headwinds which put macroeconomic stability at a risk, it is not surprising that monetary policy has been kept tight for the better part of the last 13 years. Except for when the economy is at the risk of economic recessions or financial downturns when monetary policy was eased to accommodate for the period. But generally, how successful have they been in deploying monetary policy to combat inflation?
Inflation rate dropped consecutively for two years between 2005 and 2007, but the gains were later reversed as inflation rate surged the following years. Due to the global financial crisis which threatened financial stability, monetary policy was eased between September 2008 and September 2010 with aggressive OMO suspended and Monetary Policy Rate reduced to 6.0 from 10.25, which was partly responsible for the surge in inflation rate between 2007 and 2010. The measure was however similar to that taken by central bankers worldwide to allow for the financial system to recover from the global financial crisis.
After the crisis moderated and banks returned to profitability, the CBN resumed its monetary tightening policy to curtail the surging inflation rate and allow for exchange rate stability. Aggressive liquidity mop-up through OMO has since resumed while the benchmark indicative interest rate is being held at record 12% for the thirteenth consecutive months. The 50% CRR imposed on public deposit introduced in Q3 2013 has also been retained for the fourth consecutive months; all in a bid to rein in inflationary pressures and ensure exchange rate stability. The policies have achieved a measure of success, with consumer price inflation trending downwards to single digit and presently at a five year low of 7.8%.
Consumer price inflation trending downwards due to CBN's tight monetary policies
It is however very difficult to pass a judgment on the effectiveness of the CBN’s monetary policy in combating inflation if consideration is to be given to the fact that the task of mitigating inflationary drivers in the economy does not entirely fall within the scope of monetary policies which are at best reactionary. The CBN’s performance could however be measured in relative terms. This could be done by examining the inflation scorecard of other central banks in the Sub-Saharan Africa sub-region which face similar internal and external inflation and exchange rate headwinds as Nigeria.
Inflation quickening in Ghana despite aggressive tight monetary policy that have kept benchmark interest rate at 16%
Inflation marginally increasing in Kenya since the beginning of the year
If the inflation performance of Ghana and Kenya is placed vis-à-vis with Nigeria’s, one would be tempted to give the CBN a pass mark. Going into the financial crisis in 2008, Nigeria was more exposed to the crisis that these countries due to the fact that the economy was more integrated with the global economy with a more developed financial markets that has huge foreign participation. Credit must however be given to the CBN and indeed the federal government for the way the crisis was managed. Ghana, at the height of the crisis had inflation rate trending above 20% in 2009, which was far worse than what Nigeria experienced. Despite the hike in petroleum product price and flooding that affected agricultural outputs last year which resulted in severe inflationary pressure, the CBN had patient and brave enough in using monetary policies to combat inflation, which has resulted in the gains made this year.
This is however no time for monetary and fiscal policy makers to rest on their oars; the internal and external inflation drivers and potential headwinds are still much around, though with a muted impact on inflation at present. The gains made on inflation rate are still fragile and could turn into just a blip if reforms are not carried out to strengthen the economy, especially in fiscal discipline and public infrastructure provision to aid real sector productivity and make the economy less susceptible to global macroeconomic volatility. These are important for the CBN to put its foot of the tightening pedal and allow for interest rate to reduce, to spur private sector borrowing, economic growth and development.
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