Thursday, July 25, 2019 / 12.00PM / Teslim Shitta-Bey, Managing Editor / Header Image Credit: Channels TV
Central Bank of Nigeria, CBN, on 23 July, 2019 announced that its monetary policy rates would remain unchanged from those set earlier in May 2019. The implications will be that the following policy rates will prevail over the next three months:
The decision to keep rates constant, according to the CBN governor was to observe the effects of policies such as the reduction of MPR from 14% to 13.5% in May 2019 on domestic credit supply and reviewing the impact of the Bank’s decision to compel deposit money institutions (DMBs) to retain a minimum lending-to-deposit ratio (LDR) of 60%. The CBN was of the opinion that these policies will aid the acceleration of economic growth.
CBN’s optimism that its policy rate cut and its LDR instruction will stimulate credit and hence economic growth is misplaced. The 50 basis points cut in the Bank’s policy rate will not lead to a reduction in local lending rates because underlying economic and business risks that have prompted high lending rates still prevail. The slow 2.01% growth in gross domestic product, GDP, and falling consumer spending will combine to keep manufacturers’ inventories of finished goods high and put upward pressure on holding costs. A loss of liquidity will translate into higher finance costs as manufacturers ratio of operating cash flow to interest expense continue to fall. Manufacturers will find themselves unable to generate adequate operating cash flow to cover short term debt obligations.
The risk of repayment default in a slow moving economy will require banks to charge higher rates for borrowing to cover perceived default risk. The higher default risk premium charged on bank lending would be impervious to policy rate declines. The additional fact of high lending concentration with 100 persons or institutions responsible for over 65% of total domestic bank borrowings from DMBs reduces the impact of policy across the economy as lending to smaller businesses with higher credit risk will be unlikely. However, increased lending to large institutions or high net worth individuals is not likely to jump start growth as the businesses of these entities will not likely grow beyond present levels in the immediate future. The growth paradise desired by the Bank will not occur because weak correlation between interest rates and production output is unlikely to change, despite increased banking sector liquidity.
The recent CBN policies will potentially result in the following course of commercial actions:
A Case of Sour Milk
In answer to a question asked by a journalist at the end of the Bank’s Monetary Policy Committee (MPC) press briefing penultimate Tuesday, the CBN Governor, Mr. Godwin Emefiele, hinted at the possibility of the regulator limiting access of milk importers to foreign exchange from the official market. The governor said the policy move would be designed to encourage local production and processing of cow milk in the country. The CBN’s Governors heart is in the right place but the logic of the policy may require further consideration.
At a period when unemployment in Q3 2018 was 23.01% and underemployment was hinged at 20.01% resulting in a combined unemployment and underemployment rate of 43.02% in the third quarter of 2018, the decision to adversely curtail production activity of Nigeria’s largest milk companies needs further attention.
Chart 1 Quarterly Unemployment Rate 2017-2018
Source: National Bureau of Statistics
The immediate consequences of the Bank’s intended policy include the following:
The CBN’s developmental interventions in the past four years have increasingly blurred the lines between monetary and fiscal policy. The blurring of the lines between macroeconomic policy authorities will foreseeably lead to a conflict between the Ministry of Finance (MoF) and the Bank. The conflict is avoidable and unnecessary but the CBN must allow the fiscal authorities drive real sector growth while the Bank itself manages the nation’s nominal financial flows while providing oversight for intermediaries; this is best global macroeconomic practice.
The problem of the CBN taking on fiscal roles began in 2015 with the delay in the appointment of a Minister of Finance; the CBN Governor became the de facto coordinating minister for the economy for six months. This appears to have festered after the appointment of the former finance minister, Kemi Adeosun, who appeared to have ceded part of her macroeconomic responsibilities to the Bank.
The anomalous situation under Adeosun tainted CBN policy clarity and left the bank deprived of Catholic discipline. A growing consensus amongst local economists is that the Bank needs to retrace it steps and keep within the technical confines of monetary policy rather than dabble in the murky business of so called ‘development’ functions.
The Productivity Gap
Nigeria’s major economic challenge is productivity. The low productivity of the industrial and agricultural sectors has impaired the country’s international competitiveness in the non-oil sector and posed a challenge for economic management, growth and employment. To reverse the poor production trend the government will need to take a number of bold policy steps which will include the following:
These fiscal measures will support growth and create an environment that is driven by efficiency and public sector effectiveness. Removal of petroleum subsidy, for example, will begin to plug the fiscal deficit and reduce pressure on the domestic money market, hence reducing interest rates. The CBN will have to keep broad money supply in check (see chart 2 below) to hold down inflation but the more efficient allocation of public sector resources will make up for the temporary price pains. What appears to be happening is that the fiscal authorities are waiting for the commencement of the Dangote Petroleum Refinery before allowing the pump price of PMS to become market determined.
Chart 2 Broad Money Supply January -May 2019
Source: National Bureau of Statistics
The CBN monetary policy stance is unlikely to spur growth as credit expansion will be difficult to achieve in a fragile economy with weak effective consumer spending capacity and major supply-side challenges (weak local currency putting upward pressure on input costs). A vertical domestic investment/savings curve (IS curve) makes monetary policy somewhat ineffective over a certain policy range. The CBN may need to either allow interest rates stay high and allow credit find its natural level or set a loan-to-deposit ratio (LDR) of 60% and let interest rates respond to relative demand: the Bank cannot control lending levels and lending rates at the same time.
As far as the issue of restricting the access of local milk producers to the official foreign exchange market is concerned, the consequence could produce a classic situation of the cure being worse than the disease, as Yogi Berra would have described it, this is “déjà vu all over again!’.