MPC and the Search for an Eclectic Policy


Thursday July 26 2018 10:08 AM / Proshare Research  


At the end of the third (3rd) statutory   monetary policy committee (MPC) meeting for the year 2018, expectedly   the committee   left all its levers unchanged. One thing was obvious the macro scenario remain distant off from “one strand has put a finger in the wound” and why? 

A second look at the nation’s weaning per capital income coupled with wobbling capital formation reaffirms such position. Combined with the recent bout in foreign reserves fueling a ‘’risk on’’ scenario, headwinds similar to that of 2014 has emerged.   

Fig 1: Foreign Reserves     

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Source: CBN  

To put it out fair, monetary policy initially had its work cut out especially in the face of persistent lags in fiscal policy coupled with lack of adequate pre-conditions to growth.  Policy responses from monetary end have remained largely passive; a downside to risk credit creation.

Concurrently, passing the buck of growing the economy to the fiscal side, at a point where the fiscal side is bedeviled by too many ‘’unknowns unknowns’’.   

Such circumstance does not only undercut expectations but causes aggregate supply to experience an under heat. Although, the bank contemplates running heterodox, well that is one thing we can all agree on: Main stream economics has long been boring, besides it is fast losing it allure.

However, we failed to realize that inflation targeting is repulsive to an eclectic monetary policy, partly contributing to the breakdown in monetary transmission.

Obviously, this has led to a dearth of eclectic policy by the monetary side. The growing desperation for one cannot be under-emphasized.   In a dramatic fashion, the bank in search for an eclectic policy hinted on revising the money supply, by introducing M3.  In addition the central bank also intend to intervene directly to improve credit  deepening  by serving as guarantee of  commercial papers issued by large corporations and lower rates to 9% for selective sectors.       

Current Account:   Where Do We Really Stand? 

The recently published balance of trade reflected a surplus current account at the end of the first quarter of 2018. As the nation’s surplus current account rose from N3.658 trillion to N4.468 trillion, therefore reflecting a 22.1% and 30.8% compare to the previous and corresponding   quarter.

Increase in current account was largely due to 10.1% increase in export of crude coupled with a 3.6% dip in non-oil export which eventually leading to an increase in the current account to GDP ratio from 3.6% to 4.79%. 

Fig 2:  Current Account among Selected Countries

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 Source: CBN

Comparatively, Nigeria’s current account is considered to be healthier than many other countries. Given this particular cycle of interest rate normalization, countries with lean current account are vulnerable to currency strains, and why?

Countries having liquidity stains are experiencing a bloodletting in their currencies; it is not surprising to see certain emerging economies being punished by the market .The fast evolving cycle forces their hand to keep rates high even when inflation stand at historical low levels, an example is Brazil and South Africa.

As earlier mentioned, Nigeria has a strong current account regardless the inherent multiple rates which has begun to weigh on foreign reserves thereby forcing the bank to intervene on multiple fronts, at some point the toil will show on the naira.  Most importantly the decline in foreign reserves beam caution, as import cover gradually diminishes.   

Price Movement; A Step Further Towards Single Digit

Headline Inflation maintained its disinflationary path as it caved inwards by 0.36 in the month of June from 11.61% to 11.62%.  At the same time over shooting our forecast by o.47%, largely due to resilient food price. The current correlation between food and headline inflation which stand at 0.99 compared to 2016, when it stood at -0.85. Apart from Brent crude which has a profound effect on price, more recently food inflation partly guides price movement.

The ongoing herds men and farmers crisis in the food belt region pose a threat to disinflation. At same time the surge in month on month inflation currently plays out as upside risk to disinflation, given elevation in liquidity.

Fig 3: Inflation  


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Source: CBN

It is important to point out that hiccups witnessed in food inflation stream from supply not demand. Regardless we strongly opine that inflation will maintain its current southward trajectory.  We don’t foresee any heavy structural break that could pose a threat. Beside to quell the rising inflation phobia, rates have been disinflationary when compared to the 2 prior election year.     

Money Market:  Return to Dynamic Sterilization  

The interbank call rate climax at 23% in the month of June, making it the highest so far in the year. The uplift in standard lending facility (SLF) pinpointed to the uplift surge in interbank rate. Moving forward as the central bank intend to mop up liquidity. The knee-jerk current witnessed in the interbank call is expected to persist for some time.

Especially in the coming period the intermediate objective of the bank will be to alter supply and interest rate in attempt to manage system liquidity. Thus a return to dynamic sterilization is imminent in the second half of the year.      

Fig 4:  Interbank call rate 

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Source: CBN

In reaction to the on- going dynamic, inflation premium has reduced coupled with persistent buffering in real interest rate thereby allowing the monetary authorities to readjust the   Treasury bill rate to the current inflation rate.  Therefore the Treasury bill rate dipped from 11.43% in May to 10.14% June, the instrument has grown lean by 17% alone this year so far. 

Given our position on expectation inflation the Treasury bill rate will cave inwards. Although the present clime still supports the money market, the relative dampening in yield creates an opening for commercial paper.

However the rate on the 3 month deposit seem to be notching upwards, as it rose from 9.89% in May t0 9.97% June: it is expected that positive real interest will further provide the incentive to an upward trajectory in 3 month paper. 

PMI:  Continuous Deceleration in Output Prices

The purchaser’s manager index’s (PMI) expanded from 56.6 in May to 57 June making it 15 month of consecutive expansion. In the same vein production level expanded from 58.8 in May 2018 to 59.9 in June 2018 at its highest level in the last four months.  On the price front, output price expanded at a decelerating pace from 53.8 in May to 53.9 in June.

However input price maintained it earlier trajectory as it rose from 58.8 in May 2018 to 59 in June 2018.  In specific the correlation between the input prices and purchasers manager index in 2017 so far stand at -0.29, while the output price stand at -0.17 underpinning the indirect relationship between price and PM and how the slowdown in prices support expansion in PMI

FIG 5: Purchasers managers’ index

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More than ever, we cannot dispel the current macro reality, one which consists of fragile demand, relatively lean positive feedback loops and positive real interest rate. Taking into consideration that high interest rates could linger longer than expected, under a clime of persistent depression in per capital income. Such possibilities are certainly worrisome and should rid policy makers of sleep.  

More disturbing is the fear of   being caught up in an interest rate trap, while experiencing a secular stagnation which could further depress social wellbeing.    

However, with reserves declining, some degree of caution is needed therefore reducing rates will be counter intuitive at this point: thus it is important the central bank bolster its reserves and avoid the occurrence of possible monetary disturbance.

The chain reaction from a monetary disturbance is a greater evil which could cause adverse feedback loops and quickly erode national income, the Mexican peso crisis and the rubble crisis in is an example.  Moreover the need to keep an eye on possible second round effect is also needed.  Thereby the indifference to a rate reduction at this point is considered more as a lesser evil, even though it is contrary to our pro -growth position. 

The revision of money supply, with the introduction of m3 is widely needed given the present disconnect between money supply and household coupled with the growing size of  the nation’s  net domestic assets over the years. However we remain cautious on the central bank’s policy to intervene directly and why?  

Firstly the framework remain largely blurred and earlier track record of bank directives or selective credit by the central bank have been ineffective. At the same time, bank directives nor selective credit cannot serve as a substitute to a break down in monetary transmission.   

In most countries like India such policy  smoothen seasonal credit and act more as an ancillary   to bank credit to the private sector-repairing the breakdown in monetary transmission and addressing the structural rigidities is inevitable.         

The inability to eliminate the inherent multiple rate in the current exchange rate policy will remain a brick wall to an eclectic policy. it is however important to note that the on-going exchange rate policy made it impossible to determine the appropriate real effective exchange rate (REER) trajectory.             


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