Making Sense of Our New Policy Direction, By Ifeanyi Uddin
The central bank’s (CBN) rate-setting committee, the Monetary Policy Committee (MPC), ended its November meeting (last week) with arguably the boldest steps it has taken of late.
While the decision to move the mid-point of the naira from the fictional position (N155/US$1) it has been held at by the CBN for some time now was well-nigh inevitable, the 8.4 per cent devaluation that now sees the new mid-point at N168/US$1 was a pretty bold move. (Albeit with the markets having moved rapidly in the wrong direction since then, it does now look a bit tepid). Not only does this movement bring the naira’s reference price at the official market (the weekly retail Dutch Auction System- rDAS) closer to the current market position, by widening the corridor around the mid-point (from the old 3 per cent either way to a much broader 5 per cent), the committee indicates an increased tolerance of naira price volatility.
All of this is consistent with the markets’ expectations of policy direction given current demand/supply imbalances in the global market for crude oil (a daily supply excess of around 2 million barrels — a little below Nigeria’s official daily output, and about 100,000 barrels more than just about every third party’s estimate of our actual output number), and the consequent pressure on the crude oil price (down to US$72 per barrel by Friday, last week). Other key variables in the markets’ decision mix include the extent of the demand pressure on the naira, and recognition that unlike the situation with the most recent external shock to the economy (2007-2009), we do not, now, have much to go on by way of fiscal buffers.
In result, the effectiveness of the new monetary policy measures would depend on how well the CBN has read market signals. Important considerations in this regard are two-fold — both best expressed as questions.
The first poser requires that we consider how justified the apex bank is in its conviction that much of the liquidity it has created to drive new credit growth has ended up fuelling current dollar demand? Recall that earlier this month (on a Thursday) the apex back pushed banks’ spare change out of its overnight vault (the standing deposit facility — SDF) in order, it hoped, that these monies might drive credit to the real sector.
Now there has been much talk about why domestic banks have been reluctant (or unable) to create new loans at levels consistent with anecdotal evidence. It would seem that the structural impediments to this include a low domestic absorptive capacity (all that slack from decrepit physical and social infrastructure). Still, no sooner had the CBN kicked banks out of the SDF window than it priced instruments issued at its open market operations at 11% per annum. There was, therefore, scant opportunity to test how easily new bank liquidity could feed into new credit creation, before banks’ spare change found their way back into the CBN’s vaults via a different window.
The second consideration is the CBN’s belief that current levels of dollar demand are not consistent with the trend levels of the economy. (Reserves are good enough to support 7 months imports at current consumption levels). However, it helps to keep in view the fact that lower oil prices and the absence of fiscal buffers are themselves inputs into the decision making processes of economic actors. Assuming that the latter are rational, there combined effect should be to push the demand needle up (creating a new more volatile normal).
In order to address the liquidity build up therefore, the CBN moved the policy rate (MPR) from 12 per cent to 13 per cent; and raised the cash reserve requirement on private sector deposits to 20 per cent from 15 per cent with immediate effect.
This would be effective policy prescriptions were it true that much of the current dollar demand is speculative.
However, there is clear evidence of economic entities front-loading demand in expectation of further fall in the naira’s exchange rate. To the extent also that the new CBN mid-point for the naira pushes interbank rates up further, both the precautionary and speculative needs to hold dollar assets would only renew demand pressure. In part, this would be because the markets fail to believe the CBN’s claim that it is able to meet “legitimate” demand for dollars on an ongoing basis.
Invariably, the success of these policy measures would require that the oil price holds. However, even the CBN admits that falling oil prices are likely to be a long-term phenomenon. OPEC’s refusal, Thursday last week, to support prices by cutting its output quota only further reinforced this perspective.
In which case, the CBN would have to resort to administrative measures to support policy going forward. It would help if structural reforms to ease supply constraints in the economy were implemented as a matter of urgency; but the long lead times on this would mean that respite for the economy is not around the corner.
Overall, the economy should see a drop off in aggregate demand with immediate impact on the fast moving consumer goods and distributive trade sectors.