MPR: Fear over Liquidity Risks Persists as CBN Maintains Statusquo

The Central Bank of Nigeria (CBN) last week continued with the culture of rate tightening as it voted for the retention of the existing Monetary Policy Rate (MPR) at 12 percent. Analysts, however, share in the fear of the CBN that the prevailing political and economic conditions could trigger unrestrained spending with the attendant strains on the economy, reports Festus Akanbi

Up till Tuesday when the Central Bank Governor Sanusi Lamido Sanusi announced the decision of the apex bank’s Monetary Policy Committee (MPC) at the end of its meeting, opinions were divided as to whether or not the time was ripe for the committee to soften its stance on the prevailing Monetary Policy Rate (MPR), the benchmark rate for banks to lend to their customers. This is because for almost one and a half years, the statusquo had been an MPR of 12 per cent with a corridor of +/-200 basis points around the midpoint.
However, with a vote of seven members to three, the committee did not only retain MPR at 12 percent, it also left the Cash Reserve Requirement (CRR) unchanged at 12 per cent and Liquidity Ratio at 30 per cent, with the Net Open Position at 1.0 per cent.

CBN’s Explanations
The CBN Governor, who faulted the claims that the existing MPR was a constraint to lending because of the corresponding high interest rate, listed the ongoing military action in three states in the North-east and the attendant increase in spending as one of the reasons why the financial regulators has to be firm as far as the monetary policy is concerned.

“The recent military action in the North-east will result in additional spending. Although the government has announced that there will be no supplementary budget, the Coordinating Minister for the Economy and Minister of Finance (Ngozi Okonjo-Iweala) has already announced that there would be a drawdown on a Contingency Vote embedded in the 2013 Budget to cover emergencies. Overall, the committee is of the view that government spending will constitute a major risk to the inflation and exchange rate outlook, thus advising prudence in monetary policy action at this time,” Sanusi said. He warned that there could be further tightening if the crisis escalates.
Besides, Sanusi disagrees with those who believe the existing MPR is tight, saying emerging fundamentals in the nation’s economy do not support the claims of some of these critics, hence the reason for maintaining the status quo.

He said, “Personally, I don’t think we should change rates for the sake of changing rates. I think we should respond to situations. The government will spend money. We will keep monetary policy very tight. If the spending gets excessive, we will respond appropriately. The risks, if there is any from the fiscal side, are that we may actually have to tighten policy further if this warrants. I don’t think that at this point in time, a reduction in rates is not imminent.”

To support the CBN’s stance on MPR at 12 percent, Sanusi said the committee noted that in spite of increased borrowings, yields on FGN bonds have been declining steadily, signaling the impact of increased inflows while equity prices have been on an upward trend.
He added that the evidence did not, therefore, support claims of monetary policy being too tight.

What to Expect
Managing Director, Cowrie Assets Company Limited, Johnson Chukwu, explained that the implication of the retention of Monetary Policy Rate (MPR) at 12%, liquidity ratio and Cash Reserve Ratio by the Monetary Policy Committee (MPC) is that the current pricing of financial assets – loans, deposits, bonds, T/Bills, etc will remain largely unchanged. “That means that lending rates in the economy will remain pricey and the supply of credits to small and medium scale enterprise will continue to be scarce,” he added.

He believed the military action in the North-east is bound to affect agricultural activities in the zone. Given that agriculture accounts for over 40% of the Nigeria’s nominal Gross Domestic Product (GDP), any factor that limits agricultural production such as the ongoing war in North-east will certainly affect the nation’s GDP.

In addition to the impact on GDP, the economy may experience an uptick in inflation rate as a result of shortage of food supply from the North. This was partly the reason for the increase in inflation rate to 9.1% in April, up from 8.6% in March; and may worsen in subsequent months with the ongoing arms conflict between the Federal Government and Boko Haram.

War or No War, No Threat to GDP
Regional Head of Research, Africa, Global Research, and Standard Bank Razia Khan did not believe the war against terror in some parts of the country could jolt the economy in a serious manner.

According to her, the state of emergency in three states in the North may weaken agricultural sector performance in a fairly localised way (this is unlikely to impact on Nigeria-wide GDP, but risks to the price level should be watched). She is of the opinion that the prevailing tight monetary policy is yielding results with the continued inflow of foreign investments into the country.

“In all, by voting to keep interest rates on hold for now, the CBN has once again demonstrated its willingness to continue with a policy that has largely worked for it.  Monetary policy is not overly tight, but the credibility of policy has allowed for greater inflows into Nigeria, triggering a rally in bonds, and allowing for the accumulation of FX reserves – or a more substantial buffer against future shocks.
“Nonetheless, the MPC vote, 7-3 in favour of keeping interest rates unchanged, demonstrates that there is a subtle but important shift underway on the MPC.  Should inflation risks continue to be benign, then calls for greater easing are likely to grow.

In our view the period from July on, which would normally provide more evidence on whether food price inflation will remain capped, as well as a reduction in seasonal pressure on the naira, will provide the key indications on whether policy is likely to change,” Khan said.

Asked to be specific about the seriousness of the fear over the state of emergency in three states in the country, the Standard Chartered official said, “At this point in time, it’s a relative unknown.  If the operations are only needed in the short-term, then it is conceivable that fiscal costs will be contained.  According to Finance Minister Ngozi Okonjo-Iweala, a contingency reserve will be used to finance the operations, meaning that no new budget stresses are envisaged.

However, should operations drag on for longer than anticipated, then existing budgetary resources may not be sufficient?  A supplementary budget would then be needed, in our view. At this point it is difficult to tell.”
Another question posed bordered on the rigid position of the CBN on rates, which critics said are not in support of the clamour for economic stimulation.

Interest Rates not High in Nigeria
She said, “I am not of the opinion that a real interest rates are very high in Nigeria, given the inflation and growth backdrop and that even cutting interest rates 50 or 100 bps might make much difference to growth in the current circumstances, that the CBN necessarily has a ‘rigid’ position. Therefore, the accusation that ‘tight policy’ has been responsible for straining the real sector is overdone.

“By maintaining credible policy, the CBN has attracted greater foreign inflows, and precipitated a rally in bonds that has driven interest rates to much lower levels than might have been possible otherwise.

“So market interest rates – which might be used as a reference point for longer-term lending  (the kind that really matters for the real economy) are actually lower than might have been the case if say, they had cut 100 bps in a way that might make investors doubt the credibility of monetary policy in Nigeria.

“If people look at things clearly, the CBN’s monetary policy credibility should help to bring about sustained, lower interest rates in Nigeria eventually – this is what will benefit the real sector the most.
“Cutting recklessly today, having to reverse that with more tightening tomorrow – such a policy would be very damaging.  The CBN should receive plaudits for its consistency.”
She insisted that the CBN did the right thing.  They are doing the right thing for Nigeria in the long-term, rather than over-reacting to calls for short-term populist measures

“The criticism of the CBN’s so-called rigidity is not based on any appreciation of the factors that lead to overall development (It is precisely the relative dearth of that sort of long-term approach that has held Nigeria back for so many decades.  Investors are right to be concerned about what things might look like once Sanusi moves on),” she said.

Concerns over External Reserves
Is there any prospect of growing the nation’s external reserves in the face of the rising incidence of oil theft?
Khan, who said theft of Nigeria’s oil remains a key concern, said Nigeria is still essentially an economy that is overly dependent on a single resource for its forex earnings, and if those earnings are pressured, the continued accumulation of forex reserves might be called into question.

“In the short-term continued portfolio inflows into Nigeria might help, but if the oil output shock is sustained, even these may slow over time.  “There are no easy fixes and the challenge for the authorities remains to deal with the oil theft.  It is a bigger risk than Nigeria can afford,” she stated.

The investment and financial company, Financial Derivatives Company Limited, in a special report on the MPC decisions, believes there will be no impact in the money market since rates are already disconnected from the MPR. It, however, raised the prospect of increased portfolio inflows in the capital and forex market, following the recent interest rate cut in Europe.  The entry of foreign capital in the forex market will continue to help maintain a strong and stable naira.

On the negative side, FDC said in terms of growth, maintaining a tight monetary stance would continue to slow down credit to the private sector and stifle growth. Already, the NBS reported a decline in GDP growth from 6.99% in Q4’13 to 6.56% in Q1’13.

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