Nigeria's Central Bank Digs From A Pit - A Review of Year-End 2019 MPC Decision


Tuesday, November 27, 2019/  05:30PM / By Teslim Shitta-Bey, Managing Editor/ Image Header Credit: EcoGraphics



The Central Bank of Nigeria (CBN) has had a hard time dealing with economic headwinds in 2019. Rising inflation rate (+11.61% in October 2019) and slowly growing Gross Domestic Product (GDP) (+2.28% in Q3 2019) have created a policy dilemma, and if exchange rate stability raises further concerns, then the CBN would have to resolve a trilemma. In this situation, all monetary policy choices become plagued by unintended consequences. In the meantime, analysts note that the CBN's monetary policy decisions reached at the end of its recent policy committee (MPC) meeting between November 25 and 26, 2019 highlights the following key issues and actions:




  • MPR remained at 13.5%, the same as it was in the previous two quarters of 2019
  • Retained asymmetric corridor at +200/-500 around MPR
  • CRR stayed at 22.5%
  • BLR froze at 30%
  • Additional monetary loosening, according to the Bank, would increase inflation, so the Bank decided not to increase M1 and M2
  • Tightening of monetary policy would increase the cost of credit in a fragile growth environment, the Bank decided not to increase the policy rate
  • Concerns about Foreign Reserve growth and falling international oil prices convinced the CBN not to increase liquidity to protect exchange rate stability



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Desired CBN Expectations


  • Fiscal authorities adopt a BIG BANG approach by way of freeing up public sector liquidity through privatization of redundant public assets
  • An increase in VAT (from 5% to 7.5%) to reduce the budget deficit and put less strain on the public debt market and reduce the cost of debt. A 50% VAT increase would, however, be inadequate to completely close the budget gap.
  • The Government builds fiscal buffers (addition to the Excess Crude Account (ECA)) to protect budget implementation in 2020 as oil prices drop below the budget benchmark of $60 per barrel (see illustration below). 



Illustration 1 Crude Oil Price Movement 2019


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  • Benchmark Oil price budget should not be increased by the national assembly as it would thin down surpluses required to provide fiscal buffer for price shocks in 2020


Analysts note that if the Banking system regulator had opted to push Interest rates up, inflation would have fallen, but GDP would have slid, leading to an undesirable rise in domestic unemployment (currently put at 23.1% as at Q3 2018).



Recent Inflation and GDP numbers published by the National Bureau of Statistics (NBS) for Q3 2019 create interesting possibilities for the economy going into the new year 2020.


Chart 1 Nigeria's Monthly Inflation Rate Jan. 2016-Sept. 2019



Text Box: Inflation trend line January 2016-September 2019Proshare Nigeria Pvt. Ltd.

Source: National Bureau of Statistics (NBS), Proshare Research


NBS statistics show that since 2016 domestic inflation rate has fallen steadily from 18% in November 2016 to 16% in March 2017 and 14% in January 2018. By the end of 2018 inflation rate had softened to comfortable levels of between 11% and 12% per annum, a range sustained throughout the second (Q2) and third (Q3) quarters of 2019. In the last quarter of the year (Q4), however, the national inflation rate has shown signs of a reversal as a number of government polices such as the recent partial closure of the country's land borders and the restriction on foreign exchange for the import of food products have put upward pressure on the food Price Index (fCPI). Inflation rate, which had dropped to +11.02% in August, rose to +11.24% in September and then increased further to +11.61% in the latest figures for October 2019.


The inflationary pressure is not likely to ease quickly as normal year-end demand increases for the Yuletide season will sustain rising fast-moving consumer goods (FMCG) costs and the prices of clothing and other similar items would turn upwards. Price hikes would likely cool off towards February 2020 as the surge in spending in December will taper off into January next year.   


Nevertheless, core inflation may not rise by much over the period as removing transport and food costs from the consumer price index (CPI) will likely defer to stickiness in the underlying direction of average prices.


At Last GDP Numbers Head North


Recent gross domestic product numbers have shown that the economy is growing despite the CBN's unusual monetary policy measures that involve restrained money supply growth and targeted interventions in the supply of credit to specialized industry segments at lower than commercial interest rates, a policy that has drawn the disapproval of the International Monetary Fund (IMF) and conservative local economists.


NBS GDP numbers released last week showed that the revised GDP figure for Q2 2019 was +2.12% and the figure for Q3 2019 was +2.28%, the recent number tries to catch up with the estimated population growth rate of +2.6% and the economic recovery and growth plan rate of +4.5% in 2019.


The CBN's heterodox approach to monetary policy management has had patchy success. The containment of inflation rate has been commendable, but this has come at the cost of a slower GDP growth rate (2.28% Q3 2019) and higher unemployment (23.1% Q3 2018) and underemployment levels (20.1%, Q3 2018).


By keeping different layers of exchange rates the Bank has encouraged huge internal transfer pricing by multinational (and a few domestic) companies operating in the country, who would legitimately access foreign exchange at the official market rate and skim off the excess of the transfer price to repatriate the amounts to Nigeria for sale to domestic Nigerian importers/exporters in need of foreign exchange at a margin of at least US $50 or 16.13%. Of course, the likelier modality for the art of the deal would be to trade the funds abroad between willing buyer and willng seller at the local Nigerian IEFX window rates.  

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Working Past The Trilemma


The CBN's three nominal challenges are Inflation rate, foreign exchange rate and interest rate. The foreign exchange rate should normally be a default rate that is a function of inflation rate and interest rate, but this classical notion of economics is outdated.


Inflation Rate


So far, the CBN has kept a tight lid on inflation growth, until recently when border closure and limited access of importers of food items to the official foreign exchange market has led to a rise in domestic food prices. The tight monetary policy has, however, resulted in a slower than potential growth in gross domestic product (GDP) and a likely rise in unemployment (no data is available for contemporary unemployment rate except the +23.1% figure for Q3 2018). By keeping a highline for domestic interest rate and curtailing from of money supply (M1 and M2) inflation rate will remain between +11% and +12% in 2019 and perhaps Q1 2020, but with unemployment gaining greater attention a policy shift could be expected by Q2 2020 at the very latest.


Foreign Exchange


A major reason for the CBN's tight fist over money supply growth is its objective of ensuring exchange rate stability. The CBN has successfully kept the naira to US $ rate at roughly N360/$ over the last eleven months; this has built predictability in investor's expected market returns in dollars and given importers and exporters a solid anchor for taking business decisions. To achieve this stability, however, the CBN has had to relieve itself of control over the country's foreign reserves, meaning that the size of the country's foreign reserves is inversely related to the amount of oil revenue earned. The implication has been that when oil prices decline, the reserves go down as the monetary regulator takes money from the foreign reserve piggybank to "stabilize" or wedge up the external value of the naira. Local and international economists have viewed this approach to exchange rate management with suspicion, but so far, the CBN appears to have been able to sustain the tactic.



Interest Rate


Domestic interest rate has started to decline but remains at double digits. Indeed, lending rates in Q4 2019 fell to between 17% and 19% as against 19% and 23% in Q2 2019. The fall in interest rates reflect a slower rate of "crowding out" of private sector borrowing by the fiscal authorities. Treasury bill yields have started to flatten as bond prices rise, and the CBN deliberately prevents participation by individuals in open market operations (OMO) of Treasuries.


The problem economist see with domestic cost of funds is not commercial rates but the single-digit intervention rates charged by the CBN, which allows privileged sectors and individuals arbitrage the domestic loan markets. As the CBN tries to force growth through preferential market rates for specific industrial activity the more it distorts domestic pricing and provides capital at an unsustainable rate, as manufacturers and traders cue in prices at rates that are not market reflective and could be subject to major shocks if oil prices dip beow a certain threshold that would make it difficult for the CBN to sustain its lending subsidy.




Illustration 2 Central Bank of Nigeria Q4 2019 Policy Dilemma

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Goodbye 2019, Hello 2020


With the CBN holding its last MPC meeting for the year, monetary policy is on a familiar track, how well the regulator sticks to the route plan would depend on external shocks in the international oil market and unexpected issues in the local microeconomy. Analysts expect Q1 2020 to be uneventful in terms of policy initiatives, but a sharp change in the global oil market in the new year could put paid to a fixed policy outlook as the CBN attempts to rebalance the economy against external realities. The rise in VAT and greater efficiciency in public sector management, as well as the sell-off of idle public assets, could combine to reduce pressure on the monetary authorities in the coming year, all things being equal in the lingo of economists.

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