The Central Bank’s Benchmark Rate and the Rest of the Economy, By Uddin Ifeanyi
Despite the country’s large debt profile, the oil and gas sector remains a big driver of economic output. Until government demonstrates that it can more efficiently use domestic resources, ought we to continue policies that evacuate the citizens’ pockets in order to keep a profligate government supplied?
The decision, last week, by the Central Bank of Nigeria (CBN)’s policy committee to trim its benchmark interest rate by 100 basis points to 12.5 per cent has been much commented upon, including by those who think the economy may benefit from lower rates. According to this perspective, government may now borrow money cheaply (locally) both to make up the recent balance of payments shortfall (one consequence of lower crude oil earnings), and to offer stimuli to both enterprises and consumers in order to support the economy through the coronavirus pandemic-induced trough. Again, there are those who have always argued for lower rates as a sop to domestic businesses. If this latter cohort is to be believed, banks may now more easily lend money to entrepreneurs whose enhanced activity will drive domestic output growth.
If lower rates are that desirable, one might ask, what’s to stop the central bank from driving rates to zero ― if not even below that? Surely, not because cash-rich sectors of the economy might then prefer to keep their hoardings in pillows beneath their sleepy heads? Nor because without net interest margins, banks’ value proposition vanishes? Negative interest rates in Japan and the European Union have raised these worries and more. But beyond all the fancy conversation around the central bank’s decision is the fact that the CBN’s benchmark interest rate, the Monetary Policy Rate (MPR), long since became unhinged from domestic prices.
For years now, it has had no influence on headline inflation. Nor on the domestic cost of money. Consequently, much of the dialogue around the implications of the rate reduction on economic outcomes is so much expenditure of hot air. Much, but not all of it. For there is a part of the CBN’s recent grab-bag of initiatives in aid of economic growth that helps make sense of the reduction. In pushing much of the pool of domestic savings out of the market for short-term money market instruments last year, the central bank created a problem: Depositors’ money sloshing around banks’ vaults looking for profitable outlets. Afraid that all this liquidity might end up seeking safe haven in dollars, the central bank embarked on its untraditional cash reserve management process. This moved the effective cash reserve requirements for banks past the nominal 27.5 per cent rate.
With some banks handing as much as 70 kobo on each new naira of deposits to the central bank, they had to find ways to sweat the residue. But by kicking domestic savers out of the money market, the CBN has also crashed rates. Banks not only saw a diminution in loanable funds. But along with reduced rates on these loans, they faced a further quirk of the system.
By cutting its benchmark rate, therefore, the central bank has only helped those banks reduce their outlays on interest at the retail end of deposit-taking. We could argue through several daybreaks whether or not this is a correct goal of policy. No less deserving of debate is whether the suppression of interest rates…in order that government may borrow more cheaply locally is desirable policy right now.
Aeons ago when the central bank understood the relationship between domestic savings and investment and saw how positive real returns on retail deposits could drive its financial inclusion strategy, it had pegged savings rate at 30 per cent of the MPR. With the MPR at 13.5 per cent, it didn’t take depositors long to figure that money in a savings account was the next best thing since the rice intervention policies. Even big businesses promptly converted their cash hauls into savings accounts deposits, where they earned about 4.05 per cent interest annually.
Of course, banks with huge savings accounts deposit bases began bleeding red. By cutting its benchmark rate, therefore, the central bank has only helped those banks reduce their outlays on interest at the retail end of deposit-taking. We could argue through several daybreaks whether or not this is a correct goal of policy. No less deserving of debate is whether the suppression of interest rates (remember that across tenors money market rates are currently south of the headline inflation numbers) in order that government may borrow more cheaply locally is desirable policy right now. “Financial repression” is how the literature characterises this policy. But of bigger import, today, is not so much the loss to domestic savings (that is government’s gain). Although this does matter. Far more important is that we acknowledge that whether as a share of GDP (19.28 per cent in 2018, and lower than in Angola, 26 per cent; and Bangladesh, 33 per cent) or of Gross National Income (20.21 per cent in 2018, and lower than in Algeria, 38 per cent; Angola, 27 per cent; or Botswana, 38 per cent), gross national savings in Nigeria is far lower than levels needed by an economy with as severe a need for investment in infrastructure as ours.
This brings us to questions about the absorptive capacity of the economy for more borrowing. The Buhari government has been something of a trial of the domestic economy’s capacity to effectively spend money. And it has piled on credit. Look to the first quarter output numbers for how effective this policy has been. Despite the country’s large debt profile, the oil and gas sector remains a big driver of economic output. Until government demonstrates that it can more efficiently use domestic resources, ought we to continue policies that evacuate the citizens’ pockets in order to keep a profligate government supplied?