Thoughts on MPR adjustment by the CBN

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ne of the key outcomes of the Monetary Policy Committee (MPC) meeting of the Central Bank of Nigeria, which held on 25th and 26th July 2016 is the upward adjustment of the Monetary Policy Rate (MPR). The Committee’s decision to yet again raise MPR, this time by 200 basis points to 14% while leaving the asymmetric corridor unchanged at +200/-500 basis points translates to benchmark lending rate of 16% and deposit rate of 9%. However, liquidity ratio and cash reserve ratios were maintained at 30% and 22.5% respectively. According to the CBN, the decision was made against the backdrop of rising inflation while acknowledging the dire need to reverse the economic free fall and stimulate economic growth.

Indeed, these are difficult times for the CBN. In spite of various measures put in place to attract the greenback such as the liberalization of forex market and introduction of hedging instruments, dollar illiquidity and naira depreciation continue to upend the various mitigating strategies so far proffered. Blame falling oil prices if you will, but certainly not the CBN. But are the gods to blame for our current economic quagmire? If I may paraphrase the words of Edmund Burke (the late Irish statesman) in his essay titled “thoughts on the cause of the present discontents” -nothing indeed can be more unnatural than the present convulsions of an economy so endowed yet in such a bad state. If the wealth of the nation is the probable cause of her turbulence, I imagine it is not proposed to introduce resource poverty as a constable to keep the peace -political, economic and social peace. A critical interrogation of the statement contains certain undeniable lesson about the present distressing situation. But let us leave Burke and return to my present discontent on CBN’s decision to increase rate.

Importantly, a critical prognosis of the causal factors or triggers of inflationary pressure should define the appropriate response and administration of policy prescription. These factors were rightly and sufficiently identified by the CBN itself when the apex bank situates the triggers in structural factors such as pass-through cost of naira devaluation/depreciation arising from forex scarcity and its attendant cost of imported inputs, increased electricity tariff, high transport cost amongst others. Curiously, CBN’s decision to err on the side of inflation containment is, to me, a wrong choice at an inopportune time. We all understand, and feel in practical pocket terms, the impact of upward trending inflation index of 16.5% year on year as at June 2016 and 0.9% higher compared with May 2016, according to data from the Nigerian Bureau of Statistics (NBS). We also recognize the crying need to rein in on inflation but more importantly questions remain on the suitability and timing of this action.

Clearly, current inflation is not driven by excess aggregate demand, excessive leverage or financial system liquidity surfeit but anchored on structural factors that are better managed with fiscal tools. In addition, it is doubtful if expectations of future demand-side triggers are likely to have significant disruptive impact on inflation. So, should the CBN be seen targeting inflation through rate adjustment at this time and, in any event, how efficacious are the previous upward reviews aimed at stemming the rise in inflation? Against the backdrop of the prevailing economic realities of low capacity utilization and general output contraction in the domestic sector, unprecedented unemployment levels, growing social discontent with pockets of violent eruptions and anti-social behaviors across the country, the whole idea of curtailing inflation with increase in rate is deeply flawed, a misjudgment with likely counterproductive outcome.

The ultimate objective function of the MPC decision on MPR and inflation containment, as gleaned from policy statements and actions, is not an end in itself, but more about rates recalibration to achieve positive inflation-adjusted yield on naira assets to attract foreign investment (Foreign Portfolio Investment -FPI, mainly)  and ease foreign exchange liquidity squeeze. A wrong call by the CBN, I would argue. There is an embedded and mistaken assumption by the MPC that with further hike in asset price in the Nigerian market and the search for higher yields by investors, will automatically attract dollar investments to the country. This is a faulty assumption with unintended consequences. Aside its disruptive impact on exchange rate volatility, the notion that a benign FPI policy will translate to forex liquidity or,somehow, provide significant level of succor, is at best illusory given our current circumstances. The reasons are not far-fetched. A historical analysis of capital flows in Nigeria over the years reveals a higher frequency of excess portfolio outflows over inflows, month on month thereby, creating net outflow positions, based on data from the Nigerian Stock Exchange. Therefore to hinge our forex panacea on portfolio flows is more like a Ponzi scheme arrangement which is not sustainable, in the absence of buffer from other sustainable (or less unsustainable) sources of forex inflow.

But what about Foreign Direct Investment (FDI) as possible alternative window of foreign exchange liquidity? FDI and diaspora remittances constitute, on the average, 15% or US$2.55 billion per annum of total capital inflow from 2010 to Q1 2016 –this represents just one month of Nigeria’s import figure of US$2.46 billion for Q1, 2016, according to data from NBS. Though, there was a steep rise in foreign investment from 2010 to 2014, FDI inflows  peaked at US$3.55 billion in 2014 consistent with sustained price of crude oil. I hope the point here is clear.

Following from the above and based on rational thought process, the first order consideration by investors is the ease of externalization of earnings and investment on maturity or market exit. Put differently, foreign investors are not so generous in providing the Greenback to countries in dire need of the dollar especially if there is no guarantee of FX availability at the point of repatriation. Asset yield may be a necessary condition to attract foreign investment but neither yield nor currency devaluation is a sufficient condition unless such investors have a long term view of their investments.

Already, with the increase in policy rate and yields on Treasury Bills in excess of 20%, there is less incentive to lend to the private sector unless local businesses have the capacity to borrow, on the average, at a risk-adjusted rate well beyond the risk free yield. Businesses and households do not have the resilience to absorb this disruption and extremely doubtful if increased nominal interest cost to firms can be passed to consumers with low disposable income. As some economic experts may want to postulate, a disproportionate percentage of the total loan portfolio in Nigeria is held by a few and therefore the burden of rate review is not likely to be widespread. This worldview promotes financial exclusion and precisely why access to capital is priced out of the reach of most Nigerians.

At a time when industrialized economies are pursuing policy deviations and negative real interest rate regime, thereby effectively subsiding cost of goods and services in order to spur growth, a contrarian measure in Nigeria can only worsen our never ending import dependence, expose corporate and household balance sheet to interest rate volatility, exacerbate the unemployment situation and further deepen an already unpalatable misery index.

The argument that benign FPI policy is required, irrespective of the adverse consequences, as part of the adjustment costs towards the objective of improved dollar liquidity and economic growth, is based on faulty assumptions. In any case, of what good is a higher rate at this time when in the long run the intended beneficiaries of its target objectives are long dead? Does that mean we should discourage foreign investment? Absolutely NO. But is this the right policy choice especially when we are not sure of investors’ response to the various incentives being dangled at them? I do not think so. In broad terms, a higher rate is a threat to financial stability and the economy at large due to potential default on household and corporate debt arising from heightened burden of debt servicing.

Our economic woes are home grown (please don’t tell me about the falling price of crude oil), so are the solutions. What we need is an inward-focused solution to our economic challenges. In the absence of a fortuitous global geopolitical or climatic disruption which throws up the price of crude oil, while meaningfully engaging Avengers at home, there is no quick fix to the foreign exchange problem.

I suggest the CBN adopt a more accommodative and pro-productive stance complemented by appropriate and timely fiscal policies to stimulate the economy out of recession. Emphasis should focus on policies that could boost domestic production and demand with less emphasis on import, which in the main, would lead to local currency stability. Once again, the urgent need for structural reform of the economy cannot be emphasised enough with particular emphasis on infrastructure development and economic rebalancing as there are strong statistical evidence which correlates infrastructure index with per capita income of countries.

On a final note, the complementarity of fiscal policy for a synergistic effectiveness of monetary policy cannot be denied. Sadly at the moment, government fiscal policies are less clear. However, anything that will add negatively to the conspiratorial of factors ailing the economy will certainly not improve the fortunes of businesses, consumers and the country at large. If monetary efforts cannot, even if marginally, improve the social and material conditions of the people, it should not make it worse. There is danger in what Lars Svensson (former Deputy Governor, Central Bank of Sweden and Visiting Professor, Stockholm School of Economics) calls “leaning against the wind” and what I would refer to as “over-financialisation” of monetary policies with adverse overall economic consequences. What is needed at this critical point in our chequered economic history is a holistic analysis of policy implications in order to proffer appropriate mitigating steps. Therefore, I vote in favor of a hold decision on MPR at 12% with 1%/-6% asymmetric corridor.

Ubohmhe Glenn