The one fact that is beyond dispute about the meeting, last week, of the Central Bank of Nigeria’s (CBN) rate-setting committee (the MPC) is that its main decision took everyone by surprise. No less startling were the Monetary Policy Committee’s thinking (that bank liquidity had become a major vulnerability), and its preferred tool for redressing this (imposition of a 50% cash reserve requirement for public sector deposits).
We do not (yet) have the numbers associated with the MPC’s decision and choice of policy tool, but it is safe from this vantage to suppose that the picture of the economy confronting members of the policy committee was rather stark. Or, how else could anyone have canvassed such a severe constriction of monetary policy conditions, at a time when the official spin on the economy is that it could not be in better fettle? Is there space for the charge that on the evidence of a clear dissonance between the MPC’s decision and its take on the economy, we are back to the design of monetary policy in back rooms filled with smoke and mirrors?
Over the last three years, the MPC’s decision-making process, and its communication policy have helped increase the economy’s “signal-to-noise ratio”. When we speak of inflation expectations being properly anchored, it is largely because the market and the CBN have reached an agreement on the key economic indices to watch out for, and the levers to pull in the bid for stable domestic prices. Unexpected occurrences, as with the recent MPC decision threaten this balance.
Indeed, for all the post-MPC meeting gloom (largely in the banking sector, I should admit), the communique was full of adulatory phrases. According to it, “The Committee was satisfied with the prevailing macroeconomic stability achieved during the period, including the single digit inflation, stable banking system, exchange rate stability, favourable output growth, capital market recovery, and growth in external reserves, thus sustaining internal balance and external viability”.
It also noted that the National Bureau of Statistics’ current estimate of output growth projects overall, GDP growth for this year at 6.91%, up from 6.58% last year. All the major variables passed muster. The “non-oil sector remained the major driver of growth recording 7.91% in contrast to the growth rate of -0.68% for the oil sector during the second quarter of 2013”. And even where MPC members ought to have been concerned (growing evidence of demand pressure in the exchange rate markets), the committee “observed that the experience in Nigeria was not unique, as the spike in the US yields negatively impacted financial markets globally”.
In the end, there were three allusions (scattered all over the communiqué) on the nature of the problem to which members of the MPC adverted their considerable resources. First was the reference to “excess structural liquidity in the banking system”, and its potential for “increased pressure on the exchange rate”. Next was the bit about how “the build-up in excess liquidity in the banking system” was driving up the “cost of liquidity management”. Apparently, the CBN’s balance sheet was beginning to sag under pressure from its open market operations in the market. Third was the palpable gripe over the “perverse incentive structure under which banks source huge amounts of public sector deposits and lend same to the government (through securities) and the CBN (via OMO bills) at high rates of interest”.
My first worry with all these talk about “liquidity” and the new threat it poses to system coherence is that with liquidity at the disturbing levels indicated by the MPC, domestic prices should not be rising at the benign rates we have seen over the last three months. (Recall that in this period, relative to last year’s count, the consumer price inflation is at unprecedented lows). But, then, perhaps asset prices are the ones being inflated away in this new bubble. And not just any asset class, but government securities, primarily.
However, even if we concede this argument, then the CBN has addressed symptoms and not the underlying ailment. Government’s huge and growing appetite for debt is the reason why the yields on government securities are as high as they are. Indeed, the whole point of the “crowding out effect” of government borrowing on the domestic credit creation process is that higher returns on government debt (it is risk-free, to start with) attract domestic savings away from other sectors of the economy.
Matched by a corresponding growth in net capital formation, such debt could, in the end, be self-compensating. But a government that is not reforming (and so needs to pay for the cost of the reforms), and is not investing in new public infrastructure (the private sector has been assigned this responsibility, because “we cannot expect government to do everything for us”), does great damage to any economy.
The CBN ought to remember this at its next MPC meeting, when, as we approach the 2015 elections, government may have lost all control of its purse strings.