Making Nonsense of the Monetary Transmission Mechanism, By Uddin Ifeanyi
…despite the “neutral” tone of the communique from its last meeting, the CBN has tightened domestic monetary conditions since its policy committee since then… While the CBN may, thus, placate sections of the Nigerian public who describe these processes in nationalist terms, it is doing grave damage to the monetary policy transmission mechanism.
Ahead of the meeting, in September, of the Central Bank of Nigeria’s (CBN) Monetary Policy Committee (MPC), I was strongly supportive of the need to raise the CBN’s benchmark rate. Inflation was back up. Difficulties in the food-producing “middle-belt” of the country, with pastoralist and farmers clashing (often fatally) to the loss of the latter, meant that domestic prices might rise for a while yet. While the core component (important because it strips out the effect of the more volatile measures of inflation, including food) of the domestic inflation index might not rise as much, food is about half of the weight of the basket with which inflation is computed in the country.
If we take as given that inflation hurts the poor (and vulnerable) more than it does other segments of society, and that food purchases make up the larger share of the all-in costs of the “average Nigerian”, then it is important that the authorities do all in their gift to rein in rising domestic prices. Besides, the CBN’s main statutory mandate is to keep price rises at levels where they do not skew resource allocation efficiency across the economy. Then, again, poor unemployment figures mean that the plight of Nigerians at the bottom of the pyramid is already nasty, brutish and (if life expectancy numbers are added in) short.
Yet, this wasn’t the only reason for raising the central bank’s benchmark rate. Across the world, emerging market currencies and economies were coming under pressure as the central bank in the United States normalised monetary policy — and the world’s safest asset class, U.S. Treasury Bonds, have seen yields rise of late. Central banks in Argentina and Turkey have had to raise their rates spectacularly to staunch the consequent outflow of non-resident investment. Brazil, India, Russia, South Africa and (even) South Korea have all seen their currencies come under pressure from the strengthening dollar.
True, most of the economies currently in trouble have either poor fiscal or trade balances, or huge external sector debts, or in Argentina’s case, all these vulnerabilities. But to then look at Nigeria’s current numbers and conclude that we are immune to these ructions is to be dangerously focussed on the near-term. The only reason why key numbers on the domestic economy remain healthy is because the global market for our main export earner — crude oil — has held up over the last two years. It’s the reason why the current account is in positive territory. As a key driver of output growth, it has also flattered our debt-to-GDP ratio.
OPEC, the oil producers’ cartel, of which Nigeria is a member, however, thinks that demand for crude oil will fall next year, even as improving supply conditions this year (Venezuela recently added 250,000 barrels a day to its output) carry over into 2019. Softer global markets for crude oil would, therefore, mean that our economy could suddenly become exposed to the threats from new global financing normal.
…it wouldn’t be much of a surprise were the CBN to continue blowing the dog whistle of holding rates below water as a sop to the Cerberus of domestic economic growth, while tinkering behind the scenes with administrative policies that tighten policy conditions all the same.
And who says it is not already susceptible? The CBN is spending hand over fist to keep the naira from depreciating against the dollar (never mind the bit about major traded currencies). It is running down the gross external reserves to do this. Because of the dynamics of our oil sector — export of crude oil from which dollar is earned; import of petrol on which the earned dollars are frittered away as subsidy — the healthy global oil market has not translated into oil earnings driving reserve growth. Very recently, market-based reforms to the CBN’s multiple currency markets saw inflows of funds support supply at the I&E Window. This helped keep the naira’s exchange rate stable. And provided brownie points for the CBN.
But ahead of the general elections, next year, we all knew that this source of supply was going to come under pressure. Non-resident investors were always going to adjust their portfolios to reflect the heightened political risk. And every dollar that left because of this was going to hurt the naira’s exchange rate. Tighter global financing conditions are only worsening this process as we have seen elsewhere.
And like most of these economies, the CBN should have put up its benchmark rate. It did not, I fear, not because of the arguments about how tighter monetary conditions might choke nascent recovery in output growth. But because of its desire to keep the federal government’s borrowing costs low, especially in the run up to an election year. According to one definition of this problem, “Fiscal dominance occurs when (the) national debt has reached levels such that a nation is unable to pay it down with taxes and requires monetary policy support in order to stay solvent. In such a situation, it is difficult to control inflation because raising interest rates can make it impossible for the government to pay its debt.”
…the monetary policy rate (MPR) (currently at 14 per cent) long since divorced itself from any relationship with any part of the economy (barring its direct link to savings rates). But at the end of the CBN’s current trajectory also lies an emasculated Monetary Policy Committee.
Still, this dilemma didn’t stop the CBN from surreptitiously pushing rates on its open market operations (OMO) up significantly. Or from issuing OMO instruments in new longer-term tenor buckets that now imperil the Debt Management Office’s (DMO) domestic debt management policy.
For, you see, despite the “neutral” tone of the communique from its last meeting, the CBN has tightened domestic monetary conditions since its policy committee since then. It has only eschewed the use of policy tools in favour of administrative ones. While the CBN may, thus, placate sections of the Nigerian public who describe these processes in nationalist terms, it is doing grave damage to the monetary policy transmission mechanism. Of course, the monetary policy rate (MPR) (currently at 14 per cent) long since divorced itself from any relationship with any part of the economy (barring its direct link to savings rates). But at the end of the CBN’s current trajectory also lies an emasculated Monetary Policy Committee.
So, would the meeting, next week, of the MPC see a hike in the MPR? Ideally, if we are to salvage what’s left of monetary policy management in the country. Still, it wouldn’t be much of a surprise were the CBN to continue blowing the dog whistle of holding rates below water as a sop to the Cerberus of domestic economic growth, while tinkering behind the scenes with administrative policies that tighten policy conditions all the same.