Wednesday, January 27, 2021 / 08:30PM / By Proshare Research / Header Image Credit: shinjuku-fuuzoku.info
With the Nigerian economy easing out of a slow-growth slump, the Central Bank of Nigeria's (CBN's) monetary policy committee (MPC) in its first meeting for the year 2021 decided to retain the Bank's Monetary Policy Rate (MPR) at 11.5%. Further, it voted to retain the asymmetric corridor of +100/-700 basis points around the MPR, the monetary lords equally decided to retain the CRR at 27.5% and to retain the liquidity ratio at 30%. The policy choices were guided by the need to find a balance between curtailing the rising domestic inflation rate and propelling faster-paced economic growth. The Bank played the house card by attempting to achieve both.
Rather than raise interest rates to curb rising domestic inflation or cut rates to push growth faster, the Bank opted to target growth by extending the period of validity of its 5% intervention fund rate for another twelve months and curb inflation by targeted credit in the food and transportation value chain. The approach appears to be part of what has been described as its 'heterodoxy' or unconventional monetary policy driven by COVID-19-induced socio-economic events.
CBN's monetary policy approach has been inspired by the high rate of both headline inflation of +15.75% and food inflation of +19.56% and the need to ensure that the present growth trajectory is not halted (see Illustration 1 below).
Illustration 1: CBN MPC's Trilemma; Navigating a Sandstorm
Weighing MPC Policy Options
Many analysts had predicted that a decline in the MPR rate would fuel a higher rate of inflation. Although a reduction of the MPR would readily make credit available to private businesses at lower costs, thereby spurring increased production and employment, this would come at the cost of rising inflation, given existing structural rigidities, domestic insecurity, and declining headroom for applying conventional monetary policy tools to persisting macroeconomic problems (see Chart 1 below).
Chart 1: Nigeria's Inflation Rate (%)
Source: NBS, Proshare Research
The CBN noted that a rise in inflation rate above +12% was growth retarding. The rapid growth in consumer prices leads to increasingly negative inflation-adjusted investment yields which cap investment flows either as foreign direct investment (FDI) or foreign portfolio investment (FPI). The rise in inflation and the slide in yields on fixed-income government bonds and bills have pushed equity prices up as investors pivot from the negative yields in the fixed-income market to higher returns in the market for equities (the NSE ASI grew by +50.03% YTD in December 2020).
However, analysts have expressed worries that the flight of the local equities market could lead to heavy overpricing of stocks on the wings of what economist Robert Schuller, famously called 'irrational exuberance'. The spike in equity prices without an attendant growth in corporate earnings and economic production could lead to a bubble waiting to burst.
This may, in part, explain why the CBN did not choose to cut the MPR to encourage lower interest rates and cheaper money market credit. Nevertheless, this comes at a price. Not raising MPR has prevented the CBN from reeling in domestic inflation which has hurt real domestic asset values and discouraged local savings. A fall in savings translates to a fall in investments (over different time frames) and leads to slower economic growth which contradicts one of the CBN's goals in 2021.
Given the need for a jump in productivity the CBN rightly argued that an increase in the cost of funds would stifle domestic investment. However, a fall in domestic inflation through an increase in the MPR without resolving the fundamental issues of insecurity, port delays, logistics disruptions (as a result of poor roads and unofficial charges by non-state actors), and infrastructural deficiencies would smother the economy.
The CBN has been backed into a policy trap orchestrated by the high prevailing domestic rate of inflation which has provided less headroom for expansionary monetary policy and a lower policy rate. This suggests that the present level of money supply will be sustained, and a decline in the inflation rate and an improved growth rate would be predicated on policies employed by the fiscal authorities as well as other developmental finance policies that the CBN may embark upon.
Chart 2: Nigeria's GDP Growth Rate (%)
Source: NBS, Proshare Research
Tinkering with Policies and Removing the Box
What appears to bother Nigerians is how the CBN intends to navigate choppy economic waters in the quarter. Retention of its present monetary policy rates implies that the Bank would need to leapfrog over convention and think in new directions. Economists have argued that there is a trade-off between growth and inflation, therefore the CBN is posed with which of the twin evils it considers less menacing.
Globally the weight of decision-making by central banks favour growth over inflation. The pro-growth argument rests on the need for a quick exit from recession and the desire to see a young demographic find job. In Nigeria, with its weak economic structure, and a high domestic unemployment rate of 27.1% as of Q2 2020, the search for growth is compelling. With a need for non-conventional approaches to complex economic tradeoffs, analysts have argued that a hardnosed-policy option for the CBN would be to tinker with a series of targeted programmes in the mold of the Anchor Borrowers Scheme. At the recent MPC meeting of January 2021, the CBN governor noted that the Bank created a Targeted Credit Facility (TCF) for households and small businesses, noting that N192.64bn had been disbursed to 426,016 beneficiaries, N106.96bn to 27,956 beneficiaries under the Agri-Business Small and Medium Enterprises Investment Scheme (AGSMESIS).
The Bank has been commended for these schemes by analysts but observers point out that the schemes need to be designed and implemented in collaboration with the fiscal authorities and that implementation should be driven by economic data, value-chain identification and optimisation, comparative advantage screening, and relative benefit analysis.
A particular way the CBN, according to analysts, could tinker with growth-inducing policies was through exchange rates and export duties. The argument is that favourable exchange rate and export duty would help drive an increase in productivity and capital inflows which could help turn a recession into expansion.
The numbers by the National Bureau of Statistics (NBS) indicate that headline inflation was stoked by the rise in food inflation, manufacturers have complained about other sources of pain to include foreign exchange (FX) challenges that disrupt the import of goods. According to some manufacturers, the difficulty in obtaining FX as well as delays at the ports have pushed up the cost of imported goods which end up being transferred to consumers.
Although the happenings in the ports are beyond the CBN's control, it underscores the need for a collaborative effort in changing the direction of the economy. Besides, non-oil exporters have expressed their reservations about some of the CBN's export policies. Exporters under the auspices of the Network of Practicing Non-oil Exporters of Nigeria have decried the CBN's pre-export inspection policy. They lamented that the pre-export procedures introduced by the CBN, require exporters to process electronic Nigerian Export (eNXP) forms that are cumbersome. They claim that the procedures threaten export activities, growth, and diversification.
The CBN backstopped a total of N2.8trn in support loans to the FGN in 2020. The support came in the form of Ways and Means, a provision in the CBN act that allows the government to borrow from the Apex Bank. Furthermore, the provisions in the act capped monetary financing of fiscal deficits at 5% of the prior year's revenues. Although this means of finance is somewhat justified in the light of Nigeria's dwindling revenue, analysts note that the funds must be used judiciously to trigger growth. Despite the justification of the means of finance, global credit agency Fitch warned that the "sustained use of direct monetary financing could raise risks of macroeconomic stability".
CBN, What Next?
Local and foreign analysts have noted that the CBN will have to cope with a tough grind in 2021 as monetary policy struggles to support lower inflation and faster growth. Monetary policy in 2021 would be affected by the global growth rate, inflation rate, domestic GDP growth, and international oil prices. Therefore, analysts expect that if the economic recession lingers, the CBN would maintain either a neutral or a dovish position. On the flip side, if the inflation rate continues to gallop, then the CBN would be forced to take a hawkish position.
Whichever way the economic indicators might pan out, priority may have to be placed on capital inflow, productivity, and targeted finance.
The only stakeholder in a casino that permanently holds the ace is the house. The house cleans up income after every stake regardless of who wins or losses a game of poker, except the house, is silly enough to bet with its own money. Unfortunately, in the game of macroeconomics, the CBN is not the house and so, in deciding monetary policy it holds a few cards but it cannot tell whether they are winning hands. In Q1 2021 stakeholders will just have to wait and see.