In the dimming twilight of unorthodox monetary policies that marked the tenure of deposed Central Bank Governor, Godwin Emefiele, the new head of Nigeria’s apex bank emerges as a harbinger of change, signaling a profound reset in the country’s monetary policy landscape.
As the nation grapples with economic challenges, the governor’s recent address at the Chartered Institute of Bankers of Nigeria (CIBN) 58th Annual Bankers’ Dinner stands as a comprehensive manifesto, unveiling a roadmap for reforms that have long been awaited by local and foreign investors alike.
Mr. Yemi Cardoso’s speech illuminated key themes, highlighting the efforts to address the impact of the cyclical disruptions in the global economy while shedding light on the domestic challenges that have bedeviled Nigeria’s economic landscape. He may not get praised for just pointing out problems, but he has earned applause for revealing the actions and plans of the new central bank administration to reform the monetary policy landscape.
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One of the crucial areas of reform highlighted in the speech is the foreign exchange market. The commitment to clearing a backlog of FX forward obligations and the adoption of a more market-determined exchange rate are significant moves. Traders and investors have welcomed these reforms, which marked a break from the past interventionist policies.
The speech also emphasised another key aspect of the impact of past and future monetary policy actions; the weakening transmission mechanism of monetary policy tools. The governor admits a gap that has made Monetary Policy Committee (MPC) meetings mostly ineffective in dealing with inflation and an unstable exchange rate. This weakness and the need for reform were cited by the governor, explaining why the meeting in November did not hold in line with the usual MPC schedule.
Understanding the hiccups in the transmission mechanism requires a glance at the recent history of the Central Bank of Nigeria. In the days of former CBN Governor, Muhammad Sanusi II, a hike in interest rates was a tightening signal that influenced the posture of investors and fostered an orderly market direction. In addition, various monetary tools, including Open Market Operations (OMO), Treasury Bills offerings, a change in the cash reserve ratio, and adjustments to the asymmetric corridor around the Monetary policy rate (MPR), combined to influence the direction of interest rates across the banking system in a fairly coordinated manner.
Nigeria’s current monetary recalibration should aim to restore a system where policy adjustments act as clear signals, guiding investors and bringing predictability to market dynamics.
But fast forward to the Emefiele era, this harmony dissipates. The once-coordinated dance of monetary tools loses its efficacy, a concern underscored in the governor’s speech, rendering MPC meetings less impactful. The ongoing reforms aspire to resurrect the lost coordination of the transmission mechanisms. Governor Cardoso’s pledge to evaluate and enhance the effectiveness of monetary policy tools signifies an effort to restore the precision of policy adjustments cascading through the financial system. These reforms pave the way for reinstating a more predictable and stable market direction, benefiting investors and the overall economic landscape.
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Nigeria’s current monetary recalibration should aim to restore a system where policy adjustments act as clear signals, guiding investors and bringing predictability to market dynamics. A functioning transmission mechanism is crucial for monetary policy effectiveness. The ideal scenario is when the central bank’s actions, such as adjusting the MPR, lead to corresponding movements in interest rates across the financial system. This was largely the norm during Sanusi’s era, but recent deviations from conventional policies have made some actions ineffective or counterproductive.
One of the deviations from a conventional and functional policy is the restriction of the standing deposit facility (SDF), a tool that allows banks to deposit excess liquidity with the central bank at a lower rate than the MPR. The SDF is supposed to act as a floor for the inter-bank rate, which is the rate at which banks lend to each other overnight. By restricting the access and amount of the SDF, the central bank reduces how much it pays banks as interest on the SDF. This action also means that the SDF is no longer effective in influencing inter-bank rates. The lost effect results in very low interbank rates when the market is flooded with liquidity even if the MPC raises its monetary policy rate. Low inter-bank rates increase inflation and make foreign exchange easier to purchase with cheaper naira, which worsens the exchange rate in a country that depends heavily on imports. This development indicates that traditional monetary policy tools cannot address price and exchange rate stability well when they are not used as intended.
The reforms entail costs for two actors. First, the Central Bank bears a burden as it shifts from a regime where banks earned zero interest on large deposits at the CBN. These deposits are to comply with high cash reserve requirements (CRR) that some bankers estimate at 50% for some lenders versus the official 32.5% ratio. The moves to a more transparent and orthodox policy framework should reduce this ratio over time. Indeed, the central bank announced an adjustment of the CRR for merchant banks from 32.5% to 10% in July.
But this also means that the CBN will have to pay more interest to investors in other instruments for liquidity management. This adds to the existing burdens from its unconventional historical approach. Second, the federal government could also be impacted by the policy change, as higher interest rates could raise borrowing costs for the country until inflation declines. No doubt, the legacy of past policies is hard to erase, and the current shift has short-term costs. But the medium to long-term benefits will surpass these transient effects.
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The new CBN Governor has announced a bold ambition in what promises to be a challenging journey towards monetary stability. It will take resolve and commitment from fiscal and monetary authorities to see this through and the journey ahead is not going to be a walk in the park. The costs may be enormous, but perpetuating the faulty approach to monetary policy implemented over the last 9 years only exacerbates the challenges that monetary policy tools are designed to fix. All stakeholders in Nigeria’s economic success should realize that, at the macro and socio-economic level, a stable and growing economy is crucial to address the many social challenges that the governor also highlighted in his speech. Therefore, the ongoing reset must be more than just a mere policy change. The economy requires a firm commitment to rebuild trust and stability, as it struggles with the pressure of low confidence from local and foreign investors, weak financial intermediation, and high unemployment. The success or failure of the ongoing monetary policy shift will have far-reaching implications for the progress and prosperity of Nigeria and its people.
Famurewa is a Business Journalist and Anchor at CNBC Africa.
