The increase in the Monetary Policy Rate (MPR) by the Central Bank of Nigeria (CBN) is aimed at achieving price stability through curbing inflation. But manufacturers will have to contend with the attendant high cost of production due to increased lending rates, which will then be passed on to consumers by raising prices, COLLINS NWEZE writes.
In recent months, the Central Bank of Nigeria (CBN) has taken some policy decisions aimed at tightening liquidity and achieving price stability. Over a week ago, the Monetary Policy Rate (MPR), rate at which banks borrow from the CBN was raised by 275 basis points (bps) to 12 per cent at extraordinary Monetary Policy Committee meeting. The increase, was sixth in a series by the apex bank this year.
The Cash Reserve Ratio (CRR), a proportion of banks deposit liabilities with the CBN, was doubled from four per cent. Also, reserve averaging method for computing CRR was suspended in favour of daily maintenance even as banks net open positions was reduced to one per cent of shareholder funds, from five per cent.
The apex bank, however, kept its 200 basis point corridor around the benchmark rate; its recommended deposit rate is 10 per cent and lending rate, 14 per cent.
Currently, average lending rate for prime customers, which is expected to go up is 17.79 per cent per annum, while that of those who are not prime customer is 20.40 per cent. But when other costs are added, the average lending rates for prime customers will hover between 25 and 27 per cent, while those who are not prime customers will be over 30 per cent. Also, interest rate on savings account, which is currently 2.27 per cent per annum is expected to rise to about 3.5 per cent. Interbank rates rates at which banks borrow from one another to cover their positions has since risen. Commenting on the monetary tightening, Managing Director, Financial Derivatives Company Limited, Mr. Bismarck Rewane, described it as a big pill to swallow.
Noting that the development has very wide implications, he said it would have been easier for the MPC to adjust the exchange rate. This will tighten liquidity so much and make banks to liquefy their Asset Management Corporation of Nigeria (AMCON) bonds. The cost would be passed on to corporate borrowers, who will also pass it on to consumers by raising the prices of their jobs.
These measures can also be of benefit to the naira, but it could be distruptive to corporate borrowers. I am not sure that the naira can be protected, but lets see what happens to the forex market in the future, he said.
The CBN Governor, Sanusi Lamido Sanusi said the actions were informed by the decision to control excess liquidity in the system and sustain inflation at single digit.
While some market participants had expected the apex bank to announce a devaluation of the naira at the special meeting, the decisiveness of the policy moves, and the dramatic tightening they represent, leaves little doubt about the apex banks overall policy intent.
Experts perspectives
Head, Market Risk, Greenwich Trust Limited Babatunde Obaniyi, said by raising the MPR, the CBN may be able to curb inflation. He said there was high demand pressure on the naira, which can only be controlled by mopping liquidity in the system.
Obaniyi said payment of the minimum wage would add to excess liquidity in the system, adding that the best option is to raise the MPR.
He said the apex bank has moved decisively to underscore its price stability credentials. According to the firm, in response to increased global uncertainty, capital outflows, and speculation over waning official commitment to foreign exchange stability, the CBN tightened policy much more than expected at an extraordinary MPC meeting, which was called in response to new all-time lows in the naira.
An analyst at Standard Bank, Razia Khan, explained the implication of these adjustments. He said it is the increased cost of funds that deters borrowing for reckless purposes, but which also shortchanges the real sector that engages on productive activities. By raising the base rate at which banks borrow from the CBN, the banks have no choice but to raise interest rates, thereby increasing the cost of loans. It also implies that funds available for lending by banks would reduce since a larger cash proportion is expected to be held with the CBN.
Analysts at Renaissance Capital insist that the rate, which was raised last month from 8.50 to 9.25 per cent, has failed to reduce the volume of money in circulation, thereby putting pressure on the naira against other global currencies, especially, the dollar.
A financial analyst, also predicted a hike in MPR. He said the exchange rate is bad as oil price is going down at a time the United States and Europe are economically challenged. We are in a box and need a bit of brainwave. The Federal Government has to step in as cost is likely to go up. I think labour will oppose removal of subsidy because government is not cutting its costs, he said.
He said the reduction in the price of oil means that Nigeria will earn less dollars, adding that the banking watchdog may not be able to meet the dollar demand meant for the importation of petrol and other consumables.
The Monetary Policy Committee is about liquidity and price stability. It is difficult to have price stability when three months to the end of the year, removal of oil subsidy looms, knowing that it will have a negative impact on inflation, he said, arguing that such an act will affect prices of products, goods and services.
He said where the naira is facing a challenge; the best thing to do is to increase the cost of money. If you increase what it costs to buy foreign exchange (forex), then the naira will firm up. The CBN has to look at the cost of money again. He said when there is too much money in circulation; the CBN may do well to obstruct it a little.
Managing Director, Financial Nigeria International, Jide Akintunde, said the policy is an attempt to consolidate on the gains of the past monetary policy which had helped to bring inflation to single digit from around 23 per cent in 2004. He said the increase was normal for the economy and would help to control inflations but admitted that high rates of this nature affect productive activities needed for the growth of domestic market economy. Others insist the CBN is only carrying out its constitutional duties by upwardly adjusting the rates, but needs to be cautious about it.
CBNs measures to stabilise Naira
The CBN has said it will restrict the sale of dollars at its auctions to foreign companies taking the currency offshore, in a further measure to limit local foreign exchange demand and support the weakening naira. The regulator said foreign investors were guaranteed to repatriate their earnings and proceeds of investments offshore but they could only seek dollars for such purposes from the open market, limiting forex demand at its auction. All remittances in respect of dividends, capital and proceeds of investments shall be through the use of autonomous funds (interbank), CBN Director, Trade and Exchange, Batari Musa said in a circular to banks.
For the avoidance of doubts, foreign investors are guaranteed repatriation of their earnings and or proceeds of investments through the use of autonomous funds, he said. The CBN has in its continued effort to consolidate on the policy measures taken on foreign exchange utilisation, coupled with the need to streamline petroleum products importers, authorised dealers are to forward copies of the Form lsquo;M proceeds and other relevant documents to the CBN for consideration. Also, request for purchase of foreign exchange shall be made within 48 hours to the bidding or auction day, failing which the bid shall be considered for the next auction session.
The apex bank said that after negotiation of the transaction, and within 30 days of arrival of the cargo, authorised dealers shall provide the final shipping documents including product certification report issued by the Department of Petroleum Resources (DPR) among other measures.
In the face of the spectre of declining oil prices, declining foreign reserves, increased demand for foreign exchange, fiscal dominance and capital flow reversals, monetary policy must bear a larger burden of economic adjustment. The MPC has, therefore, to make difficult choices, each of which has clear costs and benefits.
Presure on Naira
The pressure on the local currency intensified after the CBN, on September 26, sold naira outside the weakest edge of its target.
Inflation rises to 10.3 per cent
Nigerias headline inflation rose to 10.3 per cent in September, beating the CBN single-digit target. The rise in inflation came to many as a surprise because of six official interest rate rises by the apex bank this year. The inflation was 9.3 per cent in August, snapping three straight months of declines, the National Bureau of Statistics (NBS) said.
Food prices, the largest contributor to the consumer index, rose by 9.5 per cent year-on-year in September after 8.7 per cent the previous month. The biggest contributors to the consumer inflation were the high prices of electricity and food items even as the rise in food prices was mainly due to the increasing costs of yam, cooking oil and fish, the NBS document said.
The CBN has been raising interest rates for more than a year to help curb high inflation and support the naira, which plunged to an all-time low this week. CBN hiked its benchmark interest rate by a much bigger-than-expected 275 basis points to 12 per cent and implemented several other tightening measures at an emergency meeting on October 10.
Same day, the naira recovered from the record low of 167.8 to the dollar, after the CBN sold around $1 billion into the market in the space of a week, traders said. But trading on the local currency remains volatile and further weakness would add to inflation pressures.
Implications to private sector, others
The President, National Association of Small Scale Industrialists (NASSI) said the result of these moves has raised the cost of getting loans from banks for commercial and manufacturing purposes. For the MPR, it means that if banks were before now, lending at N25 per cent per annum, then their lending rate will go up by at least two per cent. It also means that interest on saving will rise, making it more attractive for people to keep more money in the banks.
It is expected that interest on savings, which many banks used to pay about one per cent per annum, may move to between 1.5 per cent and two per cent. For Primary Mortgage Institutions (PMIs), the interest may move to between three and four per cent, depending on individuals bargain power, said Chukwumah Chukwu, Treasury Manager, UniTrust Savings amp; Loans Limited.
He explained that the cost of foodstuffs and other goods and services, which had gone up by at least 13 per cent in recent months, will climb even higher in the months ahead due to increase cost of funds to borrowers. The poverty level in the country will ascend within or above similar trajectory.
According to him, the effects of the latest tightening on the real economy are likely to be fairly limited, raising the risk of further rate hikes if they are deemed necessary. The transmission effect of monetary policy is still problematic. For structural reasons, very little bank lending in the economy is channelled to the real sector. Weighing up the policy costs and benefits, the authorities will feel vindicated by their decisions, ultimately, price stability results in greater benefits to more Nigerians than lower interest rates and a more volatile foreign exchange rate, he said.
Global implications
While the CBN has long supported the exchange rate through regular dollar sales at its official Wholesale Dutch Auction System (WDAS) auctions, market nervousness over the sustainability of foreign exchange stability is rooted in several key factors. First, despite rising oil output, higher oil prices, and a comfortable current account surplus, Nigerias reserves have been under pressure, falling to a recent low of $30 billion from a peak of over $60 billion before the global crisis.
According to Khan, this was partly due to expansionary fiscal policy and excessive liquidity growth, which raised demand for forex, much of which had been largely met by the CBN until recently. In the last three trading sessions, the authorities have not fully met demand at the WDAS auctions. Dollar to naira has traded outside of its theoretical +/-3 per cent trading band around 150, prompting speculation of a policy shift. The authorities had already stated that they would not defend the naira at all costs, if fundamentals deteriorated as in 2008, fuelling higher demand for forex on the interbank market.
The increasingly uncertain global economic outlook, doubts about the sustainability of current oil prices despite a tight market, and Nigerias significant overdependence on oil for its foreign exchange earnings have also weighed on sentiment. These factors have added to fears that the authorities would be forced to take a more flexible approach to currency management in the event of a more severe global economic slowdown.
Budget 2012 assumptions
Budget 2012 assumptions show little evidence of fiscal consolidation. The MPC said the 2012 budget is more expansionary than that of this year. The 2012 budget assumes a budget deficit of 2.69 per cent of Gross Domestic Product (GDP), which is marginally smaller than the target for the 2011 budget, of 2.97 per cent. Moreover, the government plans to increase fiscal spending to N4.8 trillion in 2012, from the N4.4 trillion planned for 2011. This explains Sanusis view that the proposed 2012 budget suggests a loose fiscal policy. The proposed increase in fiscal expenditure presents an inflationary risk for 2012.
It is expected that private sector credit growth in Nigeria is unlikely to increase beyond the mid-teens, given the higher-interest-rate environment. Moreover, the appeal of local-currency debt for banks and investors is likely to increase, as real yields rise.
Way out
Faced with these developments, the authorities could have made one of two policy choices. According to the MPC statement, they might have succumbed to market pressure and announced a one-off devaluation of the naira. However, in their view, this would not have ended pressure on the currency and would have achieved little. The demand for foreign exchange would have increased further had they given the market a reason to doubt their future commitment to currency stability, risking an even greater drawdown of reserves. Moreover, there is little evidence that Nigerias import demand is sensitive to the exchange rate. Price stability would have been compromised, with little to show for it. In economic terms, this would not have represented a stable equilibrium, and the benefits of such action would have been questionable, Khan said.
She said instead, the preferred approach was to tighten significantly, underscoring the authorities commitment to price stability and dealing with the causes of excessive demand for foreign exchange in the official, interbank and parallel markets at their source. However, the expected payment of debt owed by the Nigeria National Petroleum Corporation (NNPC) to the Federation Account this quarter is likely to add further to near-term liquidity pressures.
In the near term, the knee-jerk market reaction to unexpectedly aggressive tightening is expected to drive a significant downward retracement in the dollar to naira foreign exchange rate.
Each one per cent increase in the CRR is estimated to remove at least N100 billion from the economy. The higher CRR of eight per cent should result in the immediate withdrawal of N400 billion from the banking system.
With banks paying a higher rate to borrow via the CBNs standing lending facility, overall tightening is significant. Until recently, there was little competition for funds in the banking system. The availability of official guarantees on interbank deposits in the aftermath of the banking-sector crisis shielded banks, especially weaker institutions, from competing for liability growth. In fact, low deposit rates, largely unresponsive to the resumption of CBN tightening in September 2010, had caused larger cash balances to remain outside the banking system. Apparently, this may change now, with more aggressive competition for liabilities raising banking-sector deposit rates far more than in the past.
Unlike in previous instances of CBN tightening earlier this year, the return on naira deposits, and the opportunity cost of holding foreign exchange, should finally respond to policy action. Even if earlier tightening had little impact on demand for forex, this will not necessarily hold true in the future. Should the authorities be dissatisfied with the results, more tightening, either through policy measures on higher MPR or more frequent Open Market Operations (OMOs) cannot be ruled out
Tags: Monetary
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