Limitations to orthodox monetary tightening

The monetary policy committee (MPC) last week attracted headlines for the right reasons with an 150bps hike in its policy rate to 13.00 percent. This was a textbook response to a spike in inflation and mirrored the stance of most counterpart authorities in advanced and developing economies.

We note that, while all 11 members at the meeting supported an increase, it was a small majority (of six) that voted for a hike of this magnitude.

They were emboldened by the national accounts for Q1 ’22, which the communique “noted with delight.” A sixth successive rise in real GDP (and a fourth in per head terms, albeit marginal) was driven by 6.1 percent year-on-year (y/y) growth in the non-oil economy.

While oil again disappointed, we find that the figures for some sectors such as trade, manufacturing and construction suggest that the recovery has some solid foundations. Trade (retail) is the best barometer of activity across the economy, and managed 6.5 per cent y/y.

The communiques tend to cite the reasons for tightening, no change and loosening. This time it offers several for its decision. We are unsure about some of the reasons given. The hike is intended to stop galloping inflation. The pick-up has some well-rehearsed domestic drivers such as shortages of gasoline, electricity tariff rises and insecurity in food-growing areas of Nigeria.

At the same time, there are some external influences beyond the control of monetary policy, examples being the spike in food prices due to the conflict in Ukraine and additional global supply chain disruptions following from the Chinese government’s draconian stance on Covid-19.

We hesitate to define what is meant by galloping inflation in the committee’s words but the communique now sees continuing upward pressure on prices due to robust money demand in the run-up to the presidential and legislative elections in Q1 ’23.

This undermines the MPC’s hope that the rate hike may moderate FGN borrowing as interest costs rise. It is the public spending (including the CBN’s many credit interventions) that is underpinning the economic recovery. Elections on the conclusion of a two-term presidential election tend to be fiercely contested and we do not think that those in early 2023 will be any different.

The hike clearly reduces negative real interest rates yet we are sceptical that it creates incentives for foreign capital inflows, as sought by the committee. Anecdotal evidence may tell us that the pipeline of delayed external payments has declined but portfolio investors can secure yields of +/- 13 percent for long bonds elsewhere without worries around profit repatriation.

In the same vein, the MPC routinely notes the strong run on the local stock exchange this year, with the all-share index almost 25 percent higher year-to-date. It might have added that the driver has been demand from local institutional and retail players.

There are some success stories as Nigeria moves on from the pandemic, and not only the listed telcos. The same story about the pipeline applies, however.

These reservations apart, the committee made the right decision last week. Confronted with mediocre growth and rising inflation, its response mirrored that of most central banks. There was tightening in South Africa the previous week as central bank forecasts saw inflation rising above the target range this quarter, and the Bank of Ghana has hiked several times.

Read also: Nigeria’s rising inflation poses threat to consumer spending – Fitch

Inflation has accelerated since the start of the year with the conflict in Ukraine and the committee in Nigeria had to respond with tightening to improve investor sentiment. A repeat of its favoured wait-and-see stance, which only prevailed on a six to four vote in March, would have sent a poor signal.

According to the textbook, monetary authorities tighten in the face of strong inflationary pressures and the MPC duly delivered. We all know the many flaws in the transmission mechanisms that dilute the impact of monetary policy but they are not reasons not to act.

We have seen the argument in some quarters that, because the MPC has pushed through a sizeable rate hike on conventional grounds, we can perhaps hope that the CBN will now adopt a conventional foreign-exchange policy. The argument makes the comments of analysts to the newswires more “punchy” and therefore more printable but is wishful thinking in our view.

The CBN prides itself on its “heterodox” positions, a good example being the expansion of its role in development finance. We do not see the evidence that it will scale down these initiatives, as urged by the IMF and many more: indeed, the MPC views such as central to Nigeria’s emergence from recession and favours more, not less credit interventions. (The CBN is heavily represented on the committee, it should be said.) While the monetary stance has tightened, the fiscal remains accommodative.

The heterodoxy extends to FX policy, which is unlikely to change before the elections in Q1 ’23 at the earliest or the subsequent end of the CBN governor’s second term. “Market-determined” rates in multilateral parlance have no place in the central bank’s playbook.