Ahead of the commencement this morning of the meeting of the Central Bank of Nigeria’s (CBN) rate-setting committee, the relevant echo chambers resonated with calls for the apex bank to reduce its benchmark rate. Following the negative growth rates notched up by the economy in the first two quarters of the year, there is much recommending this perspective.
With government spending down on account of tighter oil earnings, much of domestic consumption spending has evaporated (government employees make up a large portion of paid workers in the country). Businesses, on the other hand are loth to push new investments as demand for their products/services shrink — most are bleeding red ink, anyway, from a combination of rising input costs (a rapidly depreciating naira), and falling demand.
How much sense does it make in this environment, therefore, for the central bank to tighten monetary conditions? This is more so when much of the current price increases in the domestic economy is the result of reforms undertaken by the incumbent administration. Whether it was the quasi-freeing of electricity tariffs, the deregulation of the pump-station price for petrol, or the liberalisation of the interbank foreign exchange market, the net effect of these alterations to the different product markets was a ratcheting up of prices of the prices of goods and services generally.
Tighter monetary conditions are thus useless tools in dealing with this type of inflation. They do have great use, though, where prices rise because consumption spending is up.
In this circumstance, our best bet is to let the structural changes that have driven up prices work their way through the system. Indeed, evidence abounds that this process is already afoot. Whereas the year-on-year increases in the consumer price index have remained sticky upwards, general price increases on a monthly basis have been gradually trending downwards since February (baring the uptick in May).
It is, thus, almost a safe bet that by the beginning of next year, the base effect should operate to drive prices down further. So there is a clear current case for not tightening monetary conditions further.
How strong is the call to loosen it, though?
One argument is that looser monetary conditions are necessary if the economy is to coax additional lending off banks. With government spending in the troughs and foreign capital playing coy, bank lending might just be the most readily available way to offer extra fillip to an economy treading deep waters.
Attractive though this proposition appears, it is in reality not an argument for lower rates. At best, it is a call for the CBN to take another look at how macro-prudential regulations might help boost bank lending. Eventually (by early next year), it would be more obvious that the macro-prudential challenge before the CBN is as much about reducing banks’ cash reserve requirement, in a way that grants them access to the funds currently sequestered away with the central bank, as it is about bringing down the capital adequacy ratio for the industry.
But having travelled down all of these avenues, is it possible to ignore the fact that even when bank lending rates were relatively lower, the industry was not creating loans in the bucketful? It has been argued, in explanation of this phenomenon, that structural impediments in the economy are a bigger let to credit growth than high lending rates. My favourite banking sector metric is the one that has the top 100 borrowers in Nigeria accounting for almost half of the industry’s loan book. This has, apparently, been the case for a long while now. So, even if we managed to persuade banks in the country to push out new loans today, it would inevitably be appropriated by a select few.
Then, there is the not so negligible matter of the naira. In our focus on the naira’s exchange rate, and its drivers, we have looked at why demand has remained elevated. Most analysts have argued that if you back out the discount on the naira’s value from the markets’ angst over the competence (or lack thereof) of the current managers of the economy, the naira (at US$1/N360) is considerably undervalued. Whatever the arithmetic, however, around the naira’s equilibrium price, it is hard to ignore the fact that much of the speculative demand for the naira might not be one-way bets on its future direction.
Instead, main street is simply concerned to hold its assets in more stable forms — gold, foreign currency-denominated assets, etc.
If this is true, then part of the work around the exchange rate would involve strengthening the naira as a store of value. It has been argued that the need to reflate the domestic economy out of recession means that inflation considerations will have to take backstage. Maybe. But government has limited autonomous fiscal space; and with the recent downgrade by Standards & Poor’s its plan to raise foreign borrowing would be more expensive.
Domestic borrowing, on the other hand is guaranteed to keep rates elevated anyway, irrespective of whatever the CBN decides today.