Divergent strokes to central banking in Africa’s largest economies

Just days after the 25-26 January monetary policy committee (MPC) meeting of the Central Bank of Nigeria (CBN), President Muhammadu Buhari declared publicly he was not going to “kill the naira” by devaluing it, confirming views that the CBN is probably now no more than any other government agency under his direction. Last week, this column highlighted how much of the CBN’s decisions are probably ‘directed’ from the State House. The president’s comments on the naira, just after the CBN kept mum on a widely expected policy move on the currency, vindicates this view; albeit he is clearly unapologetic about this. The argument for devaluing the naira at this time is a strong one. A situation where a central bank gets to determine who gets foreign exchange is prone to corruption. Naira devaluation would also support the economic diversification objective of the government. When imported goods become expensive, people tend to look for cheaper and often domestic alternatives. The consequent increased demand eventually boosts local manufacturing. President Buhari is an intelligent and experienced man. It is not likely that this understanding eludes him. His concern about how a weaker currency would affect Nigeria’s majority poor is genuine, however.Some of that concern is also political; and this aspect should not be underestimated.

President Buhari’s power derives from an almost fanatical followership amongst the country’s majority poor, many of whom cannot afford the imported goods that a strong naira helps keep cheap. However, short of subsidies, naira devaluation would automatically lead to an increase in the regulated prices of petroleum products. This is because the pricing template used by the regulator is calculated in US dollars. The price of a litre of kerosene – fuel used for cooking by the poor – was increased in January by 66percent to 83 naira from 50 naira – effective on 1 January but based on data as at 29 January. Still, that increase is based on a US dollar exchange rate of 197naira. Were the naira to be devalued so soon afterwards, Nigerian authorities would have had little choice but to increase the prices of petroleum productsby at least the same rate. Thus, had the CBN gone ahead at the January MPC meeting to devalue the naira by 27 percent to 250 naira say, Nigeria’s poor would have had to pay 105naira for a litre of kerosene, a more than 100 percent price increase from 50 naira just a month ago. As the regulated price of petrol would have been hiked as well, transportation costs would have risen in tandem. Potential labour action subsequently would have created the first scalable void in the support base of the president that the opposition could exploit. This scenario would likely still play out when the needed weakening of the currency is eventually done.

The optimal ‘political’ choices before the Nigerian president therefore are whether to continue subsidizing the costs of petroleum products and thus increase an already expansionary budget or keep the naira strong and avoid the incremental foreign exchange costs. President Buhari has clearly decided keeping the naira strong – albeit artificially – would be less expensive. Simply put, naira devaluation would be politically difficult for President Buhari at this time. Were the CBN independent, however, these considerations would be inconsequential. Nonetheless, the CBN has signaled a new foreign exchange framework would be announced soon. There are varied opinions on what it would look like. It would probably include measures to stem disruptions from hot money. For instance, the CBN could say it would only provide foreign exchange to investors who hold on to their investments for a minimum period else they should procure it from autonomous sources. A wider exchange rate band could also be introduced. Some of the hitherto ad-hoc foreign exchange measures would likely also be formalised; specifying for instance, industries and segments of the economy that would get preferential access to foreign exchange from the central bank. While much bolder actions are required, a framework would at least provide some predictability.

The South African Reserve Bank (SARB) is determined to maintain its independence, however. The Bank raised its benchmark rate by 50 basis points to 6.75 percent at its MPC meeting in January. Although the inflation outlook has deteriorated significantly, it is clear the SARB also needed to make clear to South Africa’s National Treasury, President Jacob Zuma and markets that though it worries about weak growth and the costs of a potential ratings downgrade to junk status, its credibility and independence matter more to it. A central bank’s credibility is crucial to its effectiveness. Investors and analysts are better influenced in times of crisis when they know the central bank is credible, the comments of its officials are honest and the information they provide is accurate. The consequent trust often pays off when the central bank needs key stakeholders to help prevent or manage a systemic crisis. It must be pointed out though that the vote was close. 2 members of the MPC preferred a more moderate increase of 25 basis points, 3 members wanted a 50 basis points hike and a member preferred no change at all. Finance minister Pravin Gordhan probably preferred a moderate rate hike to guard growth. In any case, markets were pleased by the move with the rand strengthening below the 16.0 psychological level afterwards.

With the benefit of hindsight, the upside risks to inflation in South Africa are probably more heightened than earlier thought. Whereas at the November 2015 MPC meeting, the SARB expected inflation to be higher than its target – 3 to 6 percent – only in the first and fourth quarters of 2016, the Bank now forecasts inflation would remain outside of the target throughout the year. Worse still, the SARB sees inflation averaging at 7 percent – 5.8 percent previously – in 2017, in part due to base effects. The marked deterioration in the inflation outlook is primarily due to expectations of further rand depreciation and likely higher drought-induced food price inflation. Electricity tariffs may also be increased during the course of the year.The SARB also acknowledged that negative domestic events turned out to be more significant for the rand than the rate hike by the US Fed in December. Expectations of further rand weakening are still driven by domestic factors. So, even as the growth outlook is bleak somewhat – the Bank sees downside risks to its 0.9 percent growth forecast for 2016, the SARB may need to quicken the pace of its current tightening cycle if it is to bring inflation back within target at the earliest possible time.

The dilemma faced by the Nigerian and South African central banks are similar. In both countries, inflation is rising in tandem with dampening growth. Structural reforms – most of which are unpopular – are needed to reverse the weak growth trend. And the political environment in both countries is very challenging. Still, the independence of the respective central banks is dependent on how much they need global capital and how determined their governors are. In the South African case, the SARB governor can always rely on markets to fend off any attempts by the central government to curtail its powers. Nonetheless, a popular – or populist – South African president could succeed in clipping its wings. To be fair, attempts at reining in the CBN started during the administration of former President Goodluck Jonathan. Widely perceived as meek, even he succeeded in bending the central bank to his will; no small feat considering how formidable the then CBN governor Sanusi Lamido Sanusi was. Under a powerful President Buhari, the CBN would still have had little chance of remaining independent under a strong leadership. However, as a central bank is also the government’s banker, its leadership needs to be strong enough to be able to overrule the country’s president when needed; never mind that the current one is believed to be incorruptible. Recent revelations that foreign exchange in billions of US dollars were removed from the CBN in cash and shared amongst the country’s political elite during the Jonathan administration points to why. There is probably a need to further empower the central bank governor in order to ensure that he or she is able to prevent such pillage in the future. In any case, the South African experience shows a central bank’s independence is more assured when its economy matters to global market participants. It also helps if a country’s fiscal authorities depend on global capital for financing. As Nigeria now finds itself with probably a prolonged need for that kind of capital, there is an opportunity for its central bank to break the stranglehold the central government seems to always have on it.

Rafiq Raji