• Friday, June 21, 2024
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Growth concerns must trump inflation as CBN decides today


At exactly 2:17 pm, on the 22nd day in the month of March, Godwin Emefiele, the Central Bank of Nigeria (CBN) governor, shocked market watchers when he announced that the 12-man Monetary Policy Committee (MPC), which he chairs, had unanimously decided to review the Monetary Policy Rate (MPR) upward to 12 percent from a pre-level of 11 percent.

At the conclusion of the two day meeting, the committee also voted to increase the cash reserve ratio, CRR to 22.5 percent from 20 per cent to 22.5 per cent, while maintaining the liquidity ratio at 30 per cent with an asymmetric corridor of plus 200 basis points and minus 700 basis points.

MPR is a tool for controlling and managing cost of funds and interest rates while CRR is basically used to control money supply and ultimately the inflation. Liquidity Ratio is a safety net policy to cushion and protect banks and the depositors from adverse drop in the liquidity of banks.

“From our discussion with the Central bank, interest rates were raised because they were more concerned with curbing the inflation trajectory, rather than addressing economic growth,” said Yvonne Mhango, sub-Saharan Africa economist at Renaissance Capital, in an interview with BusinessDay.

Propelled by rising costs of energy and food, inflation was indeed getting out of hand in Africa’s largest economy, breaking out of the single digit threshold to 12.8 percent (year-on-year) in March, in sustenance of similar digits of 11.4 percent recorded in February. But wasn’t raising rates, and by implication, mopping up liquidity in the economy rather brash? Given that we had a cost push inflation and not demand pull.

“Of course it was brash and misguided. There was no premise to hike rates given the fact that it was due to cost shocks,” said Ayo Teriba, CEO of consulting firm, Economic Associates Ltd, in response to questions.

“In at least eight years, there has been no reason to raise rates because we have never had demand pull inflation. It has always been cost driven and would fizzle out with time,” Teriba said. Inflation occurs when the price of goods and services are rising by some degree across the whole eThis is caused by two factors, each of which is related to basic economic principles of changes in supply and demand, and these factors range from cost-push to demand-pull.

When there is a decrease in the aggregate supply of goods and services stemming from an increase in the cost of production, we have cost-push inflation. Cost-push inflation basically means that prices have been pushed up by increases in costs of any of the four factors of production (labour, capital, land or entrepreneurship) when companies are already running at full production capacity.

With higher production costs and productivity maximized, companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level (inflation). On the other hand is demand-pull inflation, which occurs when there is an increase in aggregate demand, categorized by the four sections of the macro economy: households, businesses, governments and foreign buyers. When these four sectors concurrently want to purchase more output than the economy can produce, they compete to purchase limited amounts of goods and services. Buyers in essence bid prices up, again, causing inflation. This excessive demand, also referred to as “too much money chasing too few goods”, usually occurs in an expanding economy.

In contrast, Nigeria’s economy is far from expanding.

GDP growth contracted by 0.34 percent in the first quarter of 2016 and “it appears impracticable that the second quarter would not follow suite since factors that led to the contraction in Q1, intensified in Q2,” analysts say. If interest rates could be hiked in March amid rising inflation; signs are fast emerging it may happen again, especially as inflation has risen unabated.

Rising inflation is in no way unique to Nigeria.

Low income countries are reeling from weakening currencies as commodity prices bottom out , but some-including Nigeria- are making the mistake to defending their currencies with monetary policies.

A key problem with a CBN that tightens monetary policy to respond to negative supply shocks, analysts say, is that it will sharply reduce nominal GDP. A sharp drop in nominal GDP will cause debt-to-GDP to rise sharply which increases the risk of a banking crisis. Mozambique followed a similar route (hiking interest rates by 300 basis points to 17.25 percent), last week, in a bid to defend its currency, the metical.

“Mozambique’s economic crisis may grow bigger as the central bank tries to curb the fall in the metical by tightening monetary policy rather than allowing inflation to rise,” analysts familiar with the matter tell BusinessDay. Tosin Ojo, head of research at consulting firm, Cardinal Stone Partners Ltd, says tightening monetary policy amid a cost-push inflationary environment is inconsistent with global practices.

“The world over, Monetary Policy Rates (MPR) are not hiked to control inflation when it is not driven by demand pull,” Ojo said in response to questions.

The United States Example

In a succession of moves necessitated by the financial crisis and the Great Recession that officially ended in mid-2009, the United States Federal Reserve (Fed) drove interest rates to zero on Dec. 16, 2008.

This would go on for seven years precisely, until rates were pushed up to 0.5 percent on Dec.16, 2015. The reason for the hike was not far-fetched.

“I feel confident about the fundamentals driving the U.S. economy, the health of U.S. households, and domestic spending,” Fed chief Janet Yellen said during a press conference. “There are pressures on some sectors of the economy, particularly manufacturing, and the energy sector…but the underlying health of the U.S. economy I consider to be quite sound.”

Indeed the US economy was “quite sound”. Gross Domestic Product (GDP) jumped 2.4% by 2015 year end. The agriculture, industry and services sector expanded 1.6 percent, 20.8 percent and 77.6 percent respectively. Inflation was also below 2 percent (1.7).

The US example may be insinuating that interest rates are sliced amid slowing economic growth and raised when the economy becomes “quite sound”.

“Slashing interest rates drives down the cost of borrowing and strengthens the purchasing power of consumers. Indeed interest rates are cut to incentivise economic growth,” analysts contacted in writing this article said.

MPC meets for the 245th time

Maybe not at 2:17 pm and certainly not on the 22nd day in the month of March, but amid similar underlying factors, Emefiele will today announce the consensus of the committee’s 245th meeting in what keen observers call the single most decisive meeting of 2016. The MPC will have two options from which to choose a path to rekindle growth in Africa’s largest economy as it slides into recession for the first time in 12 years.

The options before the MPC are to either chase inflation or pursue economic growth. Inflation climbed to 16.5 percent (year-on-year) in June, and is the highest since 2005 according to data by the Nigerian Bureau of Statistics (NBS). High costs of energy and imported items were the drivers of June’s inflation, the NBS noted in a report published last week Monday.

“The big challenge is that the inflation is not being driven by a rise in demand but rather a leap in costs,” Abiodun Keripe, head of research at investment bank, Elixir Investment Partners Ltd said in an interview with BusinessDay.

“Chasing inflation will akin to chasing shadows,” Ayodeji Ebo, an investment banker with investment bank, Afrinvest.

“They should focus on monetary policies that can spur growth to ease the pressure on the economy which is technically in a recession,” Ebo said.

Policy makers in Africa’s largest economy may be creating another problem as they seek to solve another if they give pre-eminence to managing inflation, according to Taiwo Oyedele, a partner and head of tax and regulatory services, consulting firm, PriceWaterhouseCoopers (PWC).

“The spike in year-on-year inflation rate in June is not as a result of excess money supply; rather it is due to the increase in price of electricity and imported goods. In other words, mopping up excess liquidity is not the right policy direction,” Oyedele says.

Oyedele thinks Nigeria’s fiscal and monetary policy ought to align to a significant extent.

President Muhammadu Buhari, 73, signed Nigeria’s N6.1 trillion ($30.6 billion) budget, the biggest in the country’s history and up 20 percent from the 2015 budget, as the nation looks to spend its way out of an economic slowdown and diversify its $492 billion economy. The country’s fiscal policy holds strong on stimulating economic growth, as investments in capital projects, which account for 30 percent of the budget, are intended to revive business activities and create jobs.

It is in the economy’s best interest that today’s decision is growth driven than inflation driven.