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Ineffectuality of CBN's lower Monetary Policy Rate 14 Jan 2016

At its November 23 – 24, 2015 meeting, the Monetary Policy Committee of Central Bank of Nigeria, dropped its anchor interest rate by 200 basis points. The MPC decision set the Monetary Policy Rate at 11 per cent. This was the first adjustment in the MPR since November 2014, and the first drop in the benchmark rate in six years.
    
Stakeholders in the real sectors, including the magniloquent Manufacturers Association of Nigeria, have over the past years advocated reduction in the MPR to drive down the prohibitive interest rates charged by the commercial banks. Unfortunately, however, the cut in the MPR was decided at a time it was less likely to remove the ball and chain that high cost of lending had posed to industrial expansion and lending to SMEs. A combination of external and domestic issues are set to blunt the interest rate reduction.
     
Three weeks after the downward review of the MPR, the Federal Open Market Committee, the policy-setting organ of the US Federal Reserve, raised the federal funds rate – its anchor interest rate – by 25 basis points. It is the irony of the globalised financial market that a quarter percentage point rate hike by the Fed would derail the effect of 2 percent point reduction of anchor interest rate in Nigeria. The outsized influence of the US in the global asset market ensures its decisions are capable of altering the course and effectiveness of macroeconomic policy in the emerging and frontier markets. The Fed is not expected to be aggressive in this tightening cycle, but as it unsteadily raises interest rate over the coming months and years, a reversal of financial flows to the less developed markets of the world are expected, thereby imposing precarious monetary conditions.
    
In that sense, the negative effect of the rate increase in the US would serve as a counterweight to the rate cut by the MPC. This being the case, domestic credit market conditions are unlikely to improve significantly.
    
If, indeed, the MPC expected a different outcome, then its decision was ill-timed. The CBN's loosening cycle should have kicked in at least one MPC meeting before November. That would have allowed its decision to independently act on the market for more than two months before the Fed's decision. To the extent that external risk is weighted in the MPC decision-making, one might say the MPC made a decision that, predictably, would be blunted.
    
Incidentally, policy analysts now see interest rate divergence as a major global risk in 2016. As the US ends its extraordinary loose monetary policy of the last years, Europe and Japan have continued with policies that keep interest rates at the zero lower bound. Steady GDP growth in the US since February 2014 has been a contrast to much of the remaining advanced economies, where growth remains sapped by weaknesses of the post-2008 – 2009 Global Financial Crisis: sovereign credit crisis in Europe, persisting commodity price rout, and slower China growth.
    
This divergence will intensify in 2016 as the US continues to hike interest rate. To counter the effect on their economies, emerging and frontier market central banks would have to pursue expansionary policies to dampen financial pressures, arising in part from portfolio departures from their markets.
    
However, the CBN faces strong constraints in moving in the opposite direction of the US interest rate. Not least because of the inflationary implication. Nigeria's inflation rate, at 9.4% in November, is in a touching distance of the much-feared double digit. The more steady the rate hike by the Fed gets, the more apparent would be the powerlessness of the MPC to act in the way to counter the risk with the needed level of aggressive rate cuts. The inflationary outlook will strongly constrain the MPC's power to act.
    
Apart from this external constraint, the CBN has self-imposed limits on the effectiveness of its decision for a lower MPR and reduction in the Cash Reserve Ratio. While credit demand growth is anticipated because of the lower interest rate, with the reduction of the CRR from 25 per cent to 20 per cent freeing additional liquidity of about N900 billion to the banks for onward lending, the CBN has predetermined the allocation of the additional liquidity. Its good intention of enhancing credit penetration in “employment generation activities” nevertheless imposes restrictions on the banks in efficiently allocating their credit assets. The CBN has under its belt a long history of ineffectiveness with similar prescriptions for credit allocation.
    
Should the banks even try to comply, they would have elevated credit risk staring them in the face. A lending boom to sectors with peccable credit profiles – agriculture, infrastructure and solid minerals – would blow back. The growing credit impairment of the banks would only accelerate, and if not countered, it could plunge the financial market into instability.
    
According to the Minister of Power, Works and Housing, Babatunde Fashola, this administration inherited over N1.87 trillion debt in the old Ministry of Works. While road infrastructure contracts are notorious for being inflated, this high-level of indebtedness, and the high number of abandoned projects that dot the nation's landscape, reflect negative commercial performance in the infrastructure space. The negative performance is reinforced by ineffective fiscal operation by the past administrations. What's more; the solid minerals sector is unproven with commercial funding. The current policy support for the transformation of the sector from artisanal mining to industrial operations remains aspirational after ten years of the sector reform began.
    
Also, the fiscal operations of the Federal Government in 2016 will impede supply of credit to the private sector. The financing of the N2.2 trillion fiscal deficit in the budget announced by President Muhammadu Buhari is a potential rut in the transmission of CBN's stimulus monetary policy, as the risk analysis of the banks would favour investment in government bonds.  
    
In spite of the concerns on the feasibility of the deficit, it is expected that the government would be successful in raising the debt financing. This outlook is supported by the low threshold of Nigeria's debt-to-GDP ratio – which is expected to reach only 14% with the 2016 deficit financing, and the robust economic fundamentals that are only little tapped. Most projections also support the $38 a barrel budget benchmark price for crude oil in 2016, although the Brent Crude had fallen below $35 per barrel when President Buhari read the budget before the joint session of the National Assembly on December 22. The credit worthiness of the government has also been bolstered by the establishment of a N113 billion sinking fund towards the retirement of maturing loans.
    
Given the attractive yields offered by the FGN bonds, public sector debt will continue to crowd out private sector credit. In 2016, the credit risk appetite of the banks would favour federal government debts. This has been the case in the last few years that issuances of the FGN Bond series gathered pace. While the private sector might want to borrow more to fund projects, the safe haven of government debt, its high yield, and the ease of booking and managing it, would be irresistible for the banks.
    
What options are left for the MPC in transmitting credit to the private sector to aid production and employment generation? Perhaps the development finance institutions. Their role is more in tandem with the objective of development financing that the CBN Governor Godwin Emefiele said he would prioritise when he was appointed. While the DFI might be deficient in risk management and, generally, in their pool of talents, the CBN can easily influence the ramping up of these capacities. It would also have to closely monitor that the funding is not diverted.
    
How the CBN is able to navigate the external and domestic factors in stimulating the productive economy would be critical for the structural transformation that the decline of oil price has made even more crucial for Nigeria. The apex bank had been little successful with this objective at 'normal' times. 2016 would even be more challenging for its realisation.