Thursday, September 27, 2018 08:32AM / OpEd By Proshare Research
Introduction: Rules versus Discretion
The monetary policy committee (MPC) held its statutory meeting on the 24th and 25th of September 2018. The bank’s phobia for inflation has left it hugging rules for safety rather than tilt towards discretion. Therefore, the bank choose to clamp on inflation itself, while remaining ‘indifferent’ to intermediate variables for too long, especially growth.
The bank’s recent approach of managing this is to tweak around its cash reserve ratio (CRR) in order to embolden sectors that are considered to be growth elastic.
This new approach has shown some willingness to accommodate discretion through base money, at the same time leaving the monetary policy rate unchanged. Fact is, there are no easy choices in economics any more, especially with the growing volatility in the external economy, the dynamic of which has plunged monetary policy to become more “rule driven”.
Yet, such an approach has failed to curtail the effect of external disturbance(s), obviously denting the precision of monetary policy. The current fall-out in Argentina, Russia and South Africa captures the limitation of rule driven approach in the face of growing external volatility.
Eventually, Central Banks in both emerging and frontline economies are recognizing that they are pitched up against another phase of “first round effect’’. Such path has only presented monetary policy with the illusion, that it could dodge the bullet by meticulously sticking by the rules.
The Central Bank of Nigeria is not an exception, and like most central banks in both developing and frontline economies; they are battling with the reality that ‘winter is coming’. More than ever before, the warm summer of cheap monetary policy has come to an end, the persistent occurrence of capital outflows have robbed them of sleep.
What Has Changed?
Growth Story Far Off; An Unfolding Storm in a Tea Cup
Growth at the end of Q2 2018 grew at a slimmer pace from 1.95% at the end of Q1 2018 to 1.5% thus reflecting two subsequent quarters of deceleration in growth, more worrisome is the shrinking in growth experienced in both the oil and agricultural sectors. Moreover, the lag in fiscal expenditure and the faint in the financial sector amplified the shrink.
Another factor which has weighed down the pace of growth is the slack in supply which eroded output. Such erosion in supply is accompanied by the upshot in implicit price deflator from 176.2 to 185.15, as reflected in an uplift in prices across sectors witnessed in the national account.
Fig 1: GDP
Even though growth remains within the positive territory, the drags attributed to aggregate output has dampened the quality of the recovery so far. The growing proximity to the election cycle could derail capital spending and thus embolden negative output gaps till the end of the year.
The CBN took this further by hinting at a cautionary tale to fiscal authorities. The possibility of a complete relapse into negative territory is real, capturing a roaring storm in a tea cup scenario similar to the macro -picture in South Africa.
Price Movement - The Resurgence of a Concave
Fig 2: Inflation
Inflation, for the first time in nineteen months, diverged from its earlier trajectory as it rose slightly from 11.14% to 11.23%. The rise in inflation was anchored on the back of rising food inflation. This confirms fears of a concave emerging regarding price movements. In reaction, the real interest rates dipped faintly from 2.86% to 2.77% at the end of the month.
Money Supply - Weaker Credit to Private Sector
Fig 3: Money Supply
Broad money rose faintly by 0.06% from N24.81 trillion at the end of June 2018 to N24.97 trillion at the end of July 2018. The rise in broad money was on the back of 1.36% increase in quasi money. Net foreign asset dipped from N18.33 trillion to N17.78 trillion, reflecting a 3% dip in net foreign asset. The dip in net foreign asset was due to the fall in external reserve, underpinning the pressure on the stock of flow.
On the other hand net domestic asset rose from N6.48 trillion to N7.19 trillion, underpinning a 10.9% buffering in net domestic asset. Credit to the private sector slipped from N22.281 trillion to N22.261 trillion. The current indifference to the real sector will linger on for some time due to the focus by deposit money banks on pruning down on their loan asset and managing high NPL ratios.
Purchaser Manager Indexes; Relishing a Price Breather
The purchasers mangers index rose from 56.8 in the month of July to 57.1 in the month of August, thereby making it 17 months of successive expansion. At the same production level also rose from 59 in the month of July to 59.3 in the month of August. Input prices decelerated from 60.7 in July to 59.3 in August. In the same vein, output prices also expanded at a decelerated pace from 50.3 to 50.1.
Fig 4: Purchaser Manager Index
Evidently, PMI continue to relish a price breather, which has consistently serve as a leg wind.
Evidently, conventional monetary policy could be a letdown in fully achieving policy objective especially in today’s new normal; where a confident green back is consistently causing ripples across financial markets globally and thus amplifying the fear of further cracks in exchange rate due to rising capital outflows.
Regardless, the evident symptoms of growth breaks, such as limited fiscal buffers, lack of fiscal rule and accentuated structural rigidity has made it harder to do away with rules. Even though there is a need to be more keen on forward indicator and quantity variables in order to build a multi indicator approach.
Certainly, the duo will provide the needed support for the purported M3 framework with regards to appropriately balancing the credit needs of government and the private sector on the medium to long term.
The Central Bank’s lack of willingness to face the bridling reality and what to do about time consistency in price movement which is difficult to achieve when there are pediments of time inconsistency in exchange rate. The necessity to sweep the exchange rate window clean from the ambiguity of price discriminatory elements cannot be underemphasized at this particular point in time.
However, there is a limitation to how far monetary policy rate (MPR) alone can serve as a last line of defense especially in the face of rising capital outflows and inherent cobwebs in the exchange rate window.
We are of the opinion that it is difficult to achieve a full recovery without putting in place a unified exchange rate corridor and addressing structural rigidity head on.
Obviously, the bank’s stance to retain the status quo, portray the limited appetite to shock the market at this point in time. As the bank braces up for a chilly hilly winter mired by rising inflation, growing liquidity, persistent run of capital out flows and plummeting external reserves and the macro picture fully back dialing into negative territory as fiscal policy fails to provide the needed push. Certainly monetary policy is hard pressed but has not reached its point of limitation. That said, the current stance falls largely in line with market expectation.