GDP Growth: How Far Can Monetary Policy Go?


Sunday, December 22,  2019  /07:10AM  / By FDC Ltd/ Header Image Credit: FDC Ltd


The year 2020 is poised to be one of economic unpredictability at both the global and domestic levels. While the US-China trade spat has forced revisions to the global growth outlook, markets will also keep a keen eye on elections in the US and the policy re-sponse of advanced economies to a global slowdown. For Nigeria, economic progress is projected to continue at its tepid pace before it accelerates. According to the Economist In-telligence Unit (EIU), Nigeria is forecast to grow at 2% in 2020 - unchanged from 2019. This remains below the population growth of 2.6% and implies that per capita income will fall further. However, the IMF still believes that GDP growth will increase to 2.3%.


Growth will be constrained by infrastructure challenges (power shortages, poor rail, road and port facilities). In addition to the infrastructure deficit, the country is also faced with insecurity, elevated inflation and tight credit conditions. With lower oil prices expected to continue, the revenue forecast appears weak even with a projected increase in tax revenue and improvements in tax collection. High debt-servicing costs leave little headroom for the fiscal authorities to manoeuvre and this has left monetary policy as the main lever to drive an economic recovery.


Monetary Tools...Fiscal Problems


The monetary policy framework of the Central Bank of Nigeria (CBN) is one of explicit-inflation targeting. It has maintained a neutral stance by holding rates unchanged four times in the last year, due to rising inflation expectations and exchange rate pressures. However, it has deployed unor-thodox measures to stimulate lending as economic growth becomes a stronger consideration. This has yielded positive results as credit to the private sector has risen by over N1.1 trillion since the CBN, in July 2019, mandated deposit money banks to maintain a minimum loan to deposit ratio (of 60% by September 30th, 2019 and then to 65% by December 31st, 2019. Lending rates are declining as a result as deposit money banks scramble to meet the loan to deposit ratio require-ment. The CBN has managed to lower lending rates without reducing the monetary policy rate.


Concerns about the impact of this policy on the health of the banking sector - through the possi-ble erosion of asset quality - have become secondary considerations. The National Bureau of Sta-tistics in its Selected Banking Sector Data - 2019 disclosed that the profile of non-performing loans has declined from N2.24 trillion in Q3'18 to N1.1 trillion at the end of Q3'19.4 Falling non-performing loans at a time of increased credit to the private sector implies that deposit money banks are becoming more innovative in their risk management.


Unintended Consequences


The CBN's inclination towards boosting the supply side of the economy is likely to trigger contradictory pressures in 2020. Policy measures such as the hike in value added tax, the implementation of the minimum wage and cost reflective electricity tariffs will be inflationary. Inflation is already well above the CBN's upper target limit of 9%. The CBN has made it clear that an interest rate cut will only be considered when inflation enters a sustained downward trend and falls below the upper target limit of 9%. Any attempt at monetary loosening now could trigger capital outflows and put pressure on the exchange rate at a time of low oil prices.


Falling interest rates lower the real returns on fixed income assets while also lowering the marginal propensity to save and increasing the marginal propensity to consume. This analysis implies that people will save less and therefore invest less while also consuming more and therefore importing more. The CBN's plan to hike the loan to deposit ratio even further may therefore result in in-creased pressure on the exchange rate.


One Down, Three to Go


But monetary tools can only do so much. Adding gross domestic product (GDP) growth via cred-it growth to its price stability mandate is laudable considering how fragile and tepid the economic recovery has been. However, tightened credit conditions are just one constraint to growth. And the only one that recent policy guidelines by the CBN can have a positive impact on. The huge infrastructure gap, insecurity and rising inflation are bigger constraints to output than tightened credit conditions. Many would even argue that tightened credit conditions are a consequence of the impediments to growth - which require fiscal policy solutions.


The threat of rising inflation is the CBN's reason for adopting a tightened monetary stance. How-ever, one of the reasons why inflation continues to rise is because increases in money supply are not matched by accompanying increases in aggregate output. Higher productivity and output have in turn been held back by a lack of adequate infrastructure required to drive businesses and incentivize private investment. Deposit money banks in turn consider the risk of lending in such an environment and so include a premium on their loans which in turn increases the cost of borrowing.


While fiscal spending power is projected to be limited in 2020 as a result of weak oil revenues, pressing security needs and debt-servicing costs will take priority. This makes the outlook for im-proved infrastructure in the near-term rather bleak. Therefore, bridging the infrastructure gap (an estimated $350 billion in the next 10 years5) will boost productivity and aggregate output to levels that match money supply - thereby lowering inflation. A fall in inflation will then give the CBN room to loosen monetary policy as substantial growth in lending to the private sector will remain unlikely until the monetary policy rate is lowered.


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