Reset, recalibrate, but please do not ease, yet!, By Uddin Ifeanyi

The CBN evidently has its work cut out for it. It makes sense, therefore that it should aim to realign its benchmark rate with the market. The big question, though, is whether by strengthening the MPR as its main policy lever, the apex bank would be able to improve monetary transmission through the Nigerian Overnight Financing Rate (NOFR) mechanism?

The gut reaction to the decision, last week, by the Central Bank of Nigeria’s (CBN) rate-setting committee to drop its benchmark rate by 350 basis points to 23 per cent, is to look at its effect on government borrowing. All things being equal, a lower monetary policy rate should let government issue treasury bills and other domestic debt more cheaply. While this does not change the weight of older debts, it raises the possibility of government issuing new debt at the cheaper rate to retire older more expensive borrowing. Even then, debt conversion will not materially alter the burdensome nature of our public debt on government’s finances.

It helps the conversation, then, that the CBN described its rate-cutting and the decision to narrow the corridor around its policy rate (to a 23.5 per cent rate at which banks can borrow from the central bank and a 20.0 per cent rate at which banks can park their surplus funds with the bank) as an operational recalibration, rather than an easing of domestic monetary policy conditions. With the opportunity cost of domestic banks’ funds at 20.0 per cent, government will still need to persuade banks to buy government securities.

For other reasons, fiscal policy will fail even more, were it to treat the lower policy rate as an invitation to borrow more money locally. The CBN points to election-related spending as an inflation risk. More public sector borrowing, especially if this passes through to consumption rather than investment in productive activities (which has been the case thus far), would drive yields on government borrowing back up, strengthen domestic price pressures and weaken the monetary policy framework.

Against the backdrop of the inflation numbers for August, the CBN’s decision to lower its benchmark rate is broadly consistent with the direction of the consumer price index. Inflation slowed last month: the headline number was 15.39 per cent year-over-year, month-on-month inflation fell to 0.71 per cent, and the core gauge reached 13.29 per cent, including a small monthly decline. But although, broad domestic price pressure is letting up, strong arguments remain against complacent policy making and the sense that the economy is into a conventional monetary easing cycle. Food inflation is currently at wallet-eroding highs, remaining in August above the headline print. Then, there is the tension between rural and urban inflation numbers.

…the extent to which it is able to operationalise both its search for MPR relevance and more effective monetary policy framework will depend on what happens to actual interbank, government securities, lending, and foreign exchange market rates. If rates in this market were to fall because players believe the new policy rate is a loosening of monetary conditions, then the CBN’s move becomes a de facto easing, even when the apex bank swears this was not its intention.

The CBN evidently has its work cut out for it. It makes sense, therefore that it should aim to realign its benchmark rate with the market. The big question, though, is whether by strengthening the MPR as its main policy lever, the apex bank would be able to improve monetary transmission through the Nigerian Overnight Financing Rate (NOFR) mechanism? As with the tortured attempts in the past by the bank to reset its policy infrastructure, success will depend on credible implementation. As it stands, the CBN’s decision to keep its reserve requirements high (45 per cent for deposit money banks and 75 per cent for non-Treasury Single Account public sector deposits) supports its claim that the underlying policy stance is restrictive.

However, the extent to which it is able to operationalise both its search for MPR relevance and more effective monetary policy framework will depend on what happens to actual interbank, government securities, lending, and foreign exchange market rates. If rates in this market were to fall because players believe the new policy rate is a loosening of monetary conditions, then the CBN’s move becomes a de facto easing, even when the apex bank swears this was not its intention.

A number of other economic indices make the CBN’s goals more realistic. A Q2 balance of payments surplus of US$3.51 billion, a current account in the black to the tune of US$7.54 billion, gross external reserves of US$55.25 billion (equal to about 11.3 months import cover), and a relatively steady exchange rate reduce the immediate risk that the CBN’s frameworks reset upsets domestic inflation expectations.

While I am willing to join the CBN in arguing that its attempt at recalibrating its policy tools is a technical repair to the domestic monetary policy transmission mechanism, it would matter very much, as part of this process, that the CBN should continue to regularly publish clear operational indicators…to show that it is indeed strengthening transmission without sacrificing monetary restraint.

The positive numbers go one step further, though: they raise the bar for goal achievement. Unlike in the recent past, the economy is growing, rather than shrinking (output growth in the second quarter of this year stood at 4.43 per cent, and the most recent purchasing managers index speaks to expanding economic activity) — although you would struggle to find confirmation of this off the streets. All useful contexts to refrain from using monetary policy to signal looser conditions before the country is able to anchor inflation expectations, achieve food price moderation, and exchange rate stability.

That the fiscal side of the economy’s management has a role to play in all this is apodeictic. How to get the tax-and-spend arm of government to understand this has thus far been way more difficult than getting the proverbial horse to slake its thirst by the brook. Food security, logistics, storage, transport, energy costs, and targeted protection for vulnerable households are crucial to getting the job of maintaining stable prices done. But none of these deliverables are a central bank task.

While I am willing to join the CBN in arguing that its attempt at recalibrating its policy tools is a technical repair to the domestic monetary policy transmission mechanism, it would matter very much, as part of this process, that the CBN should continue to regularly publish clear operational indicators (especially the NOFR, interbank rates, domestic liquidity conditions, lending rates, and expectations for inflation) to show that it is indeed strengthening transmission without sacrificing monetary restraint.

Uddin Ifeanyi, a journalist manqué and retired civil servant, can be reached @IfeanyiUddin.