Why should the Central Bank of Nigeria’s (CBN) rate-setting committee not raise the policy rate at its meeting this week? The CBN’s Monetary Policy Committee (MPC) meets (today and tomorrow) against a very mixed (dare I say, fraught) economic backdrop. Arguably, from a certain vantage, tailwinds look strong. Inflation, for one, is trending down and in to psychologically long-desired territory; the headline number lost 60 basis points on the May 2013 count (9%), to close June at 8.4%. External reserves, at close to US$50bn look to be in decent kilter. What is there to worry about, then?
Okay, so key political actors continue to conduct themselves in a way that promises to over-heat the system? However, except in the extent to which the fall-outs from the increasingly catty politicking adversely affect domestic prices (for instance, when the anticipated election-related spending finally takes off) none of this is yet the CBN’s business.
Look beneath these rosy numbers, though, and dust clouds are clearly evident. Although oil prices have remained elevated over the current election cycle (over US$100 for the local blend), our reserves have been lower, and the currency a lot weaker than it should be at this time. Domestic debt is unsustainably high (given current earnings), the foreign component is rising, and there is next to no net capital formation anywhere.
Lower inflation rates notwithstanding, the consensus is that structural rigidities in the local economy mean that we are not a single digit economy. Lower- to mid-teens? Yes. However, to sustain single digit rates, we will need to implement deeper reforms reaching across the economy for far longer. How then to explain the falling consumer price index? Simple. Because the economy is weakening. Rising unemployment means that final domestic demand is softer now than it was last year, and falling. Downbeat earnings reports (except in banking) tell a similar story. Across industries, companies are reporting both lower sales volumes and revenues.
External reserves? This closed Thursday at US$46.93bn. So, in truth, this index is a lot closer to US$40bn than it is to the US$50bn that we have been advertising of late. Remember also that the former sum is not an accounting balance. It is instead, a 30-day moving average. In all likelihood, therefore, the actual balance on that account could be far lower than this. US$43bn maybe? And all of this, primarily because in the six months to end-June, the CBN has had to intervene more in support of the naira at the official foreign exchange markets than it has done in any other six months period since 2011.
Understandably, we all panicked when Ben S. Bernanke’s May 18 statement turned on the vacuum cleaner that threatened to suck capital flows out of emerging market economies. And ever since, we have looked askance at the threat to the domestic exchange rate (and by extension to the CBN’s price stability remit) of a sustained reversal in capital flows into this economy. Friday, last week, (in conversation with one of the country’s leading economist) I was charged with “phrasing the challenge facing the economy (and hence its managers) wrongly — in terms of the recent movements in foreign portfolio inflows (FPI)”.
According to him, with, or without, the FPI vulnerability, a conflation of events (beginning from the middle of the second quarter of this year) always meant that the naira was going to come under downward pressure. For him, raising rates at this point was not evidence of a serious signaling effort, but betokened a new madness. He proposed instead, a twin track approach to dealing with the economy in its present state.
The first leg of this leverages the new “peace” in the markets (brought about by the more supportive environment created by the US Federal Reserve Chairman’s 16th Humphrey-Hawkins report to congress), and does any of three things. Widen the band, within which the naira trades, while holding the mid-point as is; keep the band, and move the mid-point; or widen the band and move the mid-point. He was unsure why policy should be inordinately concerned with insulating the markets from volatility when funds managers never tire of advertising the many algorithms with which they successfully manage volatility across economies and assets classes.
By year-end, when the markets would have fully digested the effects of the first creeping devaluation of the naira, and when slower economic activity will make this bearable, we may then move up the policy rates. His point? Current conditions have made the opportunity cost of our reserves too expensive to fritter away.