EMEKA OKOROANYANWU
The Monetary Policy Committee (MPC) chaired by the Central Bank of Nigeria (CBN) Governor, Godwin Emefiele in a surprise move last week, reduced the monetary policy rate (MPR) by 100 basis points from 12.50 per cent to 11.50 per cent.
It also adjusted the asymmetric corridor from +100/-700 basis points around the MPR while retaining the Cash Reserve Ratio (CRR) at 27.5 per cent and the Liquidity Ration at 30 per cent.
After adjusting the policy rate only three times in it previous 25 meetings, the committee has now reduced the MPR twice in 7 months in 2020 in response to current growth concerns. The adjustment means that the CBN will now borrow from banks at MPR minus 700bps (3.5%) and lend to them at MPR + 100 bps (12.5%).
The reduction in MPR, analysts say is likely a signal of the apex bank’s intention to sustain a regime of reduced interest rates and push further down the cost of funds in the money market. The bank had two weeks ago in line with this thinking, reduced interest on savings deposit to 1.25 per cent. The cut may also signal a rash of other policies by the apex bank aimed at shoring up credit to the real sector of the economy.
For instance, when the CBN cut MPR in March 2019 several accommodative administrative measures including the introduction of the LDR policy, the review of standing deposit facility guidelines, and the exclusion of non-bank institutions and individuals from OMO market were unfurled.
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For banks, the decision to reduce the MPR would further moderate cost of funds while simultaneous reductions in interest on loans and asset yields are likely to offset the pass-through from the reduced cost of funds on NIMs.
The rate cut may also signal opportunities for reduction in lending rates and, consequently, support spending, even as banks are likely to remain guarded regarding credit creation in the near term due to broad macroeconomic concerns and fear of higher impairments charges.
The MPC’s decision signals its intention to maintain low yields in the fixed income market as the CBN may look to implement this through a combination of administrative measures and strategic liquidity management in the near term.
While announcing the cut in MPR, Emefiele said reduction would put pressure on the deposit money banks to lower cost of credit. But analysts are not together in this assertion. Uche Uwaleke, a Professor of Capital Market, said he expected status quo to be maintained against the backdrop of rising inflation and pressure in the foreign market.
“By lowering the MPR by 100 basis points, the real rate of return has been dragged further into the negative territory, which is likely to affect capital inflows adversely. In reducing the MPR, the MPC must have been emboldened by the recent marginal accretion to reserves as well as the approaching harvest season which is expected to rein-in food inflation.
“But the reality is that with foreign investors exiting the country following COVID-19, except crude oil price recovers substantially, I see further pressure in the foreign exchange market,” Uwaleke said.
He noted that the gap between the AFEX rate and the parallel market had begun to widen due to increasing demand on the back of resumption in international flights, saying that inflation rate would worsen due to cost-push factors such as increase in Value Added Tax as well as hike in electricity tariffs and pump price of fuel.
“From experience, a reduction in MPR has little or no impact on economic growth due to poor transmission mechanism. Deposit Money Banks hardly reciprocate this gesture through a commensurate reduction in interest rate due to several other costs borne by financial institutions arising from infrastructure deficit, especially power and insecurity.
“So, empirical studies in Nigeria have shown that a cut in MPR hardly translates to a reduction in lending rates. I recognise that a number of Central Banks have cut rates in response to the pandemic. But most of them have done so because inflation rate was within the target range. In the case of Nigeria where inflation rate of 13.2 per cent is well above the CBN’s upper band of nine per cent, cutting the MPR in a season of rising inflation and foreign exchange market pressure may not be a wise decision. The CBN has been supporting economic growth in the last few years using more of unconventional measures in line with its developmental function,” he said.
He said that MPC should have advised CBN to strengthen and scale up its interventions in the various sectors to stimulate the economy instead of rate cut.
Other analysts at Cordros Research said that lower rates were intended to compel banks to extend more credit to the real sector. They noted that banks’ concerns would still depend on asset quality and systemic risk.
“Though lower rates are intended to compel banks to extend more credit to the real sector, we note that banks’ concerns will still lie around asset quality and systemic risk. Consequently, we do not expect any significant growth in domestic credit or aggregate demand, especially given the historical ineffectiveness of the MPR in stimulating output and also the negative impact of the pandemic on household income. We also note that the CBN did not address the issue of the exchange rate and foreign exchange illiquidity, which in our view,are major hindrances to any meaningful economic recovery,” they said.
On market impact, the analysts said that the fixed income market would likely witness a downward adjustment in yields as a consequence, making the equities market even more attractive and worth a second look.
However, Ambrose Omordion, the Chief Operating Officer, InvestData Ltd., commended the apex bank for the interest rate cut. He said that it would encourage banks to lend to the real sector, adding that the economy would bounce back if well implemented. He said that many retail and institutional investors would increase their participation in the equities market due to anticipated low yield in the fixed income securities due to the rate cut.
But in adducing reasons for the decision to cut rates, Emefiele said “MPC was confronted by policy dilemma. Whereas MPC believes in the primacy of its price and monetary stability mandate, it nevertheless was confronted with what policy direction to focus on, given the contraction in output growth during the second quarter of 2020, which may lead to a recession, if the third quarter of 2020 output growth numbers further show a contraction. It is, therefore, of the view that, if a recession occurs in Q3, the Committee would be confronted with proposing policy options in a period of stagflation.
This, he said, was because, “with the recent removal of subsidy on fuel price, the increase in energy prices, and the adjustment of the exchange rate, inflationary pressure will no doubt persist unless MPC consider options that will deal with the pressure aggressively.”
He said the Committee was therefore of the view that, to abate the pressure, it had no choice but to pursue an expansionary monetary policy using development finance policy tools, targeted at raising output and aggregate supply to moderate the rate of inflation.
At present, he noted, fiscal policy is constrained and so cannot, on its own lift the economy out of contraction or recession given the paucity of funds arising from weak revenue base, current low crude oil prices, lack of fiscal buffers and high burden of debt services.
“Therefore, monetary policy must continue to provide massive support through its development finance activities to achieve growth in the Nigerian economy. This is the reason MPC will continue to play a dominant role in the achievement of the goals of the Economic Sustainability Program (ESP) through its interventionist role to navigate the country towards a direction that will boost output growth and moderate the level of inflation,” the Governor said.
Emefiele said given that the currency adjustment was a causal factor in determining the price of petroleum products and energy prices, the MPC, he note, believes that the CBN management must take bold actions to stabilise the exchange rate adding that management was further enjoined by the MPC to continue to provide funding to sectors that will resolve the supply constraints in petrol pricing, energy pricing and food availability. Emefiele said management was also directed to ensure that DMBs respond to the reduction in deposit rates by aggressively lowering cost of credit to borrowers.
As regards output growth, MPC, he said noted that air and road transportation; entertainment and accommodation; food services; and education subsectors were adversely affected by the lockdown. It therefore suggested that more efforts be put in place to continue to provide relief and funding to these subsectors to catalyse growth and improve the output numbers.
According to the Governor, in the view of the MPC, so far, evidence has not supported the rising inflation to monetary factors but rather, evidence suggests non- monetary factors (structural factors) as the overwhelming reasons accounting for the inflationary pressure.
Accordingly, the implication was that traditional monetary policy instruments are not helpful in addressing the type of inflationary pressure we are currently confronted with. What is useful, he said, is the kind of supply side measures currently being implemented.
MPC, he said, also expects that a downward adjustment in MPR may be necessary to further put pressure on deposit money banks to lower cost of credit in aid of growth. In the face of declining economic growth and rising inflation, the Committee faced a difficult set of policy choices, requiring trade- offs and sequencing. Following the above considerations, he said the Committee reviewed the choices before it, bearing in mind its primary mandate of price stability and the need to support the recovery of output growth.
Consequently, the Committee, he said, noted that the likely action aimed to addressing the rise in domestic prices would have been to tighten the stance of policy, as this will not only moderate the upward pressure on prices but will also attract fresh capital into the economy and improve the level of the external reserves. It however, noted that this decision may stifle the recovery of output growth and thus, drive the economy further into contraction.
He further said that on easing the stance of policy, the MPC was of the view that the action would provide cheaper credit to improve aggregate demand, stimulate production, reduce unemployment and support the recovery of output growth.
The Committee, he noted, observed that with inflation trending upwards, easing of the policy stance may exacerbate the current inflationary pressure through an increase in money supply. In addition, the MPC, he said, noted the tendency of an asymmetric response to downward price adjustments by ‘Other Depository Corporations’, thus undermining the overall beneficial impact of a reduction to the cost of capital. In the Committee’s view, a hold position will allow the economy to adjust to the ongoing stimulus measures put in place by the monetary and fiscal authorities to curb the downturn and allow more time for the MPC to assess their impact on the economy.
The Governor said that after the consideration of the three policy options, members were of the opinion that the option to loose will complement the apex bank’s commitment to sustain the trajectory of the economic recovery and reduce the negative impact of COVID-19. In addition, he said, the liquidity injections are expected to stimulate credit expansion to the critically impacted sectors of the economy and offer impetus for output growth and economic recovery.