Guessing where the MPC will go next
Ogho Okiti | Monday, 25 September 2017 4:53pm | opinion
The September 2017 meeting of the Central Bank of Nigeria (CBN)’s monetary policy meeting (MPC), starting today, will be the first in a year under seemingly better economic conditions. The economy returned to growth of 0.55% on a year on year basis in Q2 2017, while the rate of inflation has fallen six consecutive times this year, from 18.72% in January 2016 to 16.05% in July. The improved economic situation presents the CBN with a slightly different dilemma compared to what it had faced in the last year; cut rates now to support the fragile recovery or maintain rates to assess further the direction of inflation.
The MPC has maintained the same set of monetary policy instruments for over a year. During this period, it had juggled three related but distinct set of objectives, to varied success. The “do nothing” stance of the MPC was in the face of high and rising inflation, negative growth rate and weakened external balances. So far, only the external variables have improved considerably.
To better understand why the consensus is that most members of the committee will vote to hold rates, I provide a greater level of interrogation of three sets of data and how these may shape their thinking.
Let us interrogate the inflation data, the growth data and the credit data. While the rate of inflation has fallen for six consecutive months, food inflation is still rising, and month on month inflation provides a contrary picture of the decline in inflation we have seen this year. The food inflation is driven by fall in real income and the reduction in food imports. Though agriculture is expanding, it is not expanding enough to plug the gaps in food imports that collapsed following fall in income, which itself followed reduction in oil prices.
Core inflation has stabilized following the stabilization of the exchange rate because core inflation rises faster and is more volatile when the exchange rate market is unstable. Since the start of this year, it has started to fall, and is responsible for the sharp fall in the rate of inflation we have seen this year. Essentially, core inflation is underlined by changes in the exchange rate. What this means for the MPR is not very clear. Food prices are not responding to demand, but rather cost pressures.
On growth, while the 0.55% growth rate recorded in Q2 2017 was the first positive growth rate since Q4 2015, it is not the start of the recovery. Data suggests that recovery had started at Q4 2016 after the deepest contraction on quarterly basis was recorded in Q3 2016. The quarterly dynamics of the growth data show that we reached the depth in growth terms in the Q3 2016. It thus means that the economy had turned positive quarter on quarter by Q4 2016. This suggests that a strong recovery from the worst economic crisis in more than two decades will require more than feeble monetary policy adjustments, but wide and deepened structural economic reforms, especially in the absence of strong oil prices.
In the immediate term, while the consensus is that the Central Bank’s MPC will hold all policy instruments at their current level, no one will be surprised if there is a symbolic cut of 0.5%. More importantly, however, is that present policies favour meeting the insatiable appetite for government borrowing. As widely circulated in the last week, there is no restraint on the government borrowing from across different platforms, both locally and internationally. If the Federal government is not borrowing from the CBN, from which it has already borrowed a huge amount, it is borrowing from the bonds market in addition to issuing Sukuk bonds. There just seems to be no end to government borrowing.
In addition to fiscal restraint, available credit needs to be channeled to the real economy and the private sector. This means that the reduction in rates is not a sufficient condition. If we look at past periods where the CBN has tightened or loosened monetary policy (by raising or cutting the MPR), we will notice that the CBN’s actions tend to have very little effect on the growth of credit to the private sector. I have defined a period of tight monetary policy as beginning when the CBN raises the MPR and ending when it cuts it, and a period of loose monetary policy as the opposite.
Between October 2007 and August 2009, the CBN raised the MPR from 8% to 10.25% before cutting rates to 9.75% in September 2008. Therefore, according to our definition, October 2007 to August 2008 qualifies as a period of tight monetary policy. During this period, credit to the private sector grew by an average of 5.35% per month. From September 2008, the CBN cut the MPR from 10.25% to 9.75%, and again to 8% in April 2009 with a further cut to 6% in July 2009. In this period of loosening monetary policy, credit to the private sector grew by only 1.32%. From September 2010 to October 2015, the MPR rose from 6% to 13%, during which time average private sector credit growth was 1.07%. Between March 2016 and July 2017 when the CBN has increased the MPR from 11% to 14%, average monthly private sector credit growth was barely unchanged at 0.95%
It is clear that, in Nigeria, changes to the MPR do not usually have the intended effect on private sector credit growth. Looking at the average prime (rates applicable to “favoured” customers) and maximum (rates applicable to risky customers) lending rates for banks between October 2007 and August 2008 when the MPR increased from 9% to 10.25%, the prime and maximum lending rates fell from 16.5% and 15.08% and 18.21% to 18.02% respectively. When it fell from 10.25% to 6% between September 2008 and August 2010, the prime lending rate increased from 14.77% to 16.89% (going as high as 19.66% in that period) while the maximum lending rate increased from 19.24% to 22.31%.
This shows that the MPR and the rates banks actually charge their customers tend to move independently of each other. What this means for this month’s MPC is that even an MPR cut might do very little to stimulate private sector lending and spur growth.
In conclusion, focusing alone on rates will not boost growth. We must address the overbearing role of fiscal policy in constraining the private sector.