The monetary policy committee [MPC] of the Central Bank of Nigeria [CBN] left interest rate benchmark unchanged last week ruling out any possibility of ending monetary policy tightening in the short- to medium-term. The committee’s deliberations and decisions reflect the constraints, even frustrations it is presently facing in moving in the long expected direction of low interest rates, which the present governor of the CBN, Mr. Godwin Emefiele, promised at the time of assumption of office last June.
There is no doubt about the limited choices available to the monetary policy making committee in the light of conflicting signals in the domestic and global economic conditions. Pressure on the naira exchange rate stands in the way of reducing interest rates – which is Emefiele’s key strategy in fulfilling his promise of empowering the real economy.
A further constraint has come from the upward creep of inflation rate, which seems to complicate monetary policy making at this stage. MPC fears that inflationary pressure might persist in the months ahead, as a decline in agricultural output in the second quarter is expected to have a lasting impact on domestic prices while political spending is expected to rise going forward.
Rising inflation is in spite of sustained liquidity mop ups and delayed releases of budgetary allocations. There are large excess reserves in the hands of banks, which are deliberately held back from the real sector operators, resulting in serious cash flow problems in the economy at a time of over liquidity of financial markets.
The pressure on the local currency is coming from a pullback by foreign portfolio investors this year. Nigeria has attracted higher values of investment inflow every year since 2010. After recovering from a plunge in capital importation to $5,703 million in 2009, foreign investment inflow reached a peak of $21,318 million in 2013.
The momentum has however eased in 2014, with investment inflow dropping by 40.8% year-on-year at the end of the first quarter. Investment in shares is the main driver of capital inflow, which accounted for 73.5% of total inflow in 2013. Foreign investors seem to be concerned about the prospects for peaceful conduct of the forth coming general election amid the growing security challenges facing the nation.
The indication is that the slacken inflow of financial capital is expected to persist for the next six months or so when the general election is expected to be concluded. From the supply side of the market therefore, the pressure on the exchange rate is expected to sustain. On the demand side, it is believed that a good part of the growing electoral spending anticipated will come by re-importation of flight capital by politicians, who are generally known to hide their treasures in foreign countries. Such inflows could significantly counter the pressure on the naira and help the CBN manage the exchange rate of the local currency over the next critical six months.
In the light of the above scenario, it can be expected that no serious monetary policy changes may be anticipated from the CBN until the elections are over in the first quarter of next year. Rising inflation and increasing political spending do not warrant a downward move in interest rates.
Declining investment inflow and rising pressure on the exchange are rather pointing to a need for higher interest rates. This explains the committee’s split between retaining the current stance of monetary policy and further tightening it. Irrespective of the prevailing circumstances, monetary authorities should not contemplate an upward movement in interest rates – which will be greeted with a public outcry.
Since these trends appear to be short-term in nature, it makes sense for the CBN to maintain a somewhat neutral policy stance for now and manage the liquidity flows and the demand and supply functions in the financial markets until the short-term trends that are jolting the system are over.
The authorities should however not lose sight of the fact that the current policy stance is being maintained at a great sacrifice by households and the business sector. High interest rates are choking off a lot of businesses and liquidity curbs are hurting both producers and consumers to the detriment of domestic output and growth in employment.
Cash flow is considerably retarded, meaning that what leaves the hands of spenders is hardly replenished. Businesses are building large amounts of trade payables to take advantage of interest free supplier credits in a high interest rate situation. This explains the caution on the part of banks to lend to businesses unable to grow sales and unlikely to collect trade and other payables when due. To this extent, the committee’s recommendation to encourage banks to lend their excess reserves to the real sector isn’t going to find the right environment for a positive response.
Consumers should be empowered to spend if businesses have to expand and create new jobs. Right now, the multiplier effect in the economy is working on a negative side – distributing cash flow difficulties, declining sales volume, job cutting and income losses to all corners of the economic society. It is no time for banks to be drawn out of their shells of caution and pessimism.
We expect the CBN and its MPC to adopt pragmatic approaches in dealing with these uncommon challenges. As long as we depend on portfolio inflow to stabilize exchange rate, CBN is more likely to move in the direction of further tightening of monetary policy, as MPC has just alerted the nation. Such a move might appear inevitable if no serious adjustments are made to counter the likely effects of the ending of US monetary policy easing programme next month. It will however be a brutal deal for the domestic economy if allowed to happen.
A fundamental approach is to seriously step up the inflow of foreign direct investment, which will reduce our dependence on portfolio inflow for financial markets stability and permit a low interest rate move, which will be stimulatory to domestic production and consumption.
