The Battle Against Inflation – Is the CBN using the right tools? By NICK AGULE — National Accord Newspaper

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March 30, 2024

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Nick Agule

Twitter: @NickAgule

Email: nick.agule@yahoo.co.uk

Facebook: Nick Agule, FCA

30.03.2024

Introduction

The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) held its 294th meeting on the 25th and 26th of March 2024. At the end of the meeting, the MPC diagnosed the causative factors of inflation in Nigeria in these words:

“Key drivers of inflationary pressure remain the strong exchange rate pass-through to domestic prices; rising cost of transportation; high cost of energy and other production inputs; lingering insecurity, especially in food producing areas; and legacy infrastructure deficits.”

From the above, Nigeria’s inflation is in the main cost-push and not demand-pull. Interest rate increases are more effective if inflation is demand-pull because consumers are expected to choose savings (to take advantage of high interest rates) over consumption, so demand is curtailed, and inflation is tamed. But increasing interest rates in a cost-push inflation rather exacerbates the situation as producers transfer (pass-through) the higher borrowing costs to consumers through price hikes!

In the light of the causative factors of inflation as enumerated by the MPC above, members came to this decision point:

“…either progressing with its tightening cycle or hold, to observe the impact of the previous rate hike and adjustment of the Cash Reserve Requirement”.

But inexplicably, and for reasons not made clear, the members despite the data above decided to continue with tightening therefore increased the Monetary Policy Rate (MPR) by 200 basis points (2%) with an increase from 22.75% to 24.75%. Between 27th February 2024 to 26th March 2024 (a period of 1 month), the MPR has increased by 600 basis points (6%) from 18.75% to 24.75%.

Examining the impact of this huge jump in MPR on inflation rate throws up the following data:

For the 7 months (July 2023 – January 2024) preceding the February 2024 MPC meeting, MPR remained the same at 18.75%. During this period headline inflation rose from 24.08% to 29.9% an increase of 5.84% which averaged 0.83% per month.

After the MPC hiked rates by 400 basis points (4%) in February 2024 from 18.75% to 22.75%, headline inflation roared from 29.9% to 31.72% an increase of 1.8% in just 1 month!

It clear from the above data that inflation in Nigeria is having a direct variation with MPR whereas the objective of the MPC is for inflation to have an inverse variation with MPR. This is why it is unclear why the MPC decided to hike MPR instead of the more cautious approach to wait and see what the fuller impact of the hike in the February meeting will be.

Given the scenarios above, it would appear that the MPC is hiking MPR not necessarily targeting inflation but targeting exchange rates and Foreign Portfolio Investment (FPI). It would therefore be in order to examine these 2 objectives.

Foreign Portfolio Investment (FPI)

There is a point that if interest rates are raised above inflation rates (to achieve positive real interest rates), it will attract FPI. But there are questions with this approach:

If the MPC is concerned about money supply in the Nigerian economy and have taken policy measures to mop up liquidity – increase MPR, increase CRR, sell treasury bills etc – why is the CBN now targeting FPI which will consequentially increase liquidity? Of what value is the CBN mopping up deposits in Nigerian banks to the CBN vaults then targeting deposits from FPIs? (CRR is cash reserve ratio which is currently set at 45% meaning if a bank takes 1bn in deposits they must transfer 450m to the CBN thus limiting the bank’s ability to create credit thus curtails money supply).

Where will the monies brought in by the FPIs at such high interest rates be invested to generate enough returns to service the investments and still break-even?

While it seems the CBN is concerned with naira money supply (thus tightening by mopping up deposits in Nigerian banks), the CBN seems to be wooing those who will supply foreign money to the economy. It appears therefore that the CBN is targeting foreign exchange rate more than inflation with this chase for FPI because the more foreign exchange (FX) e.g. dollars brought in, the better the value of the naira. So let us look at the exchange rate.

Exchange Rate

The CBN is concerned with exchange rate stability, and they should because it is one of their core mandates. But stability does not necessarily mean a strong naira. The naira can be weak and still be stable. What investors dislike is wide variations (instability) in the value of a currency. Even if a currency is weak but stable, investors can plan on it and will work with it. The rate of exchange between the USD/GBP was at a time 2/1 but these days it’s 1.25/1 but the Bank of England is not breaking the bank of foreign reserves to defend the GBP! Rather there is high stability because this 1.25/1 rate has hovered around this mark for nearly 10 years without wide variations. This is the objective of a central bank!

So, the question is, who stands to benefit from a strong naira which appears to be the holy grail of the CBN now. The only people who benefit from a strong naira are importers! So, the question is, should the CBN be encouraging importation by making the naira strong? And given that this defence of the naira is coming at the expense of our foreign reserves, is it worth it? A weak and stable naira will discourage imports and encourage exports because Nigerian goods and services will become cheaper and more attractive to foreign buyers. As more foreign buyers become interested in Nigerian goods and services, our local industry will begin to boom to meet up with the demand (local and foreign) for our products! It only takes the fiscal authorities to create the enabling environment to make this happen!

The CBN therefore should be setting monetary policy to encourage local industry, but interest rate hike does damage to this! It is therefore inexplicable that the CBN is hiking interest rate to strengthen the value of the naira to make importers happy! There is an elevated need to change direction here!

Recommendations:

The CBN should stop further MPR hikes. When MPR did not change for 7 months, inflation only increased by 24% an average of 3.4% per month. When rates were hiked in February 2024, inflation increased by 6% in 1 month! This is evidential that interest rate rise is hurting inflation more than helping it. It is time to apply the breaks and watch what happens in the next few months.

The CBN needs to come to the trade-off. What is best for the Nigerian economy?

High interest rate, high inflation, low output, and high unemployment? Or
Low interest rate, high inflation, high output, and low unemployment?

With fiscal authorities coming to the table, option ‘b’ will do Nigeria far better.

And the CBN can achieve option ‘b’ without FPI by lowering in a measured way the CCR and MPR so that Nigerian banks can lend to the real sectors of the economy to boost output and create jobs. There is no point keeping Nigerian banks’ deposits in CBN’s vaults while courting FPI.

The CBN should apply a corridor between lending and deposits by deposit money banks. A 500 basis points corridor for example will mean if a bank takes in savings at 5% interest, they cannot lend at more than 10%! The current practice where banks take in deposits at below 5% but lend at over 30% is counterproductive and only generates more profits for shareholders at the expense of the larger economy!

The CBN should engage in Quantitative Easing (QE) by printing money but SOLELY for capital projects. For example, if the CBN prints money for agricultural revolution (mechanisation, landclearing, improved seedlings, fertiliser plants, irrigation, processing facilities, marketing and retail outlets, storage facilities, roads/rail infrastructure to ease transportation etc.) Nigeria will emerge by achieving not only food security, but food will become a major export earner even more than crude oil and millions of high-quality jobs will be created in the process. There are nations banning the use of hydrocarbons, but no nation can ban the use of food! Agriculture provides the biggest comparative advantage to Nigeria because of our rich fertile soil, conducive climate, waterbodies for irrigation and huge human capital availability.

The CBN must aggressively pursue the unbanked and bring them into the banking net. The FinTechs are doing a lot here and need the support of the CBN. Because monetary policy in a cash economy loses its effectiveness and steam because the cash outside the banking system which is part of money supply is not easily mopped up with tightening.

The CBN should slow down on chasing hot money and the fiscal authorities need to encourage direct investments like the telecoms where the MTNs and co brought in their money not to invest in government securities to earn high interest rates but committed the monies to building telecoms infrastructure across the nation to earn profits in return. The same strategy should be adopted to build our power, agriculture, refineries, steel, rail, roads, ports etc. infrastructure. Once these infrastructures are in place, serious manufacturing and production activities will begin and the journey to Nigeria’s trillion-dollar economy will have fully started.

Rather than chasing dollar hot money by raising interest rates thus strangulating local industry, the Nigerian government should stop the stealing of our crude oil and there will be much more dollar inflow than what FPI will bring in. It is said within government circles that about 1 million barrels of crude oil are stolen daily. At the current price of $85 this will generate over $2.5 billion dollars monthly inflow. The Nigerian government has capacity to stop this criminality.

Economic policy coordination is a sine qua non to jumpstart the economy because monetary and fiscal policies are like 2 lungs in a body, they must breathe in and out together for the body to survive. It is therefore excellent news and highly commendable that President Tinubu has created the Presidential Economic Coordination Council headed by himself and the Economic Management Team Emergency Taskforce heading by the Minister of Finance and Coordinating Minister of the Economy. These structures should hit the ground running to get our economy out of the woods.

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