Growth concerns and rising inflation in Nigeria #MPC

On the 25th and 26th of July, the Monetary Policy Committee held its 4th meeting this year.  The MPC is a committee that consists of - the Governor of the Central Bank of Nigeria who is the Chairman, the four Deputy Governors of the Bank, two members of the Board of Directors of the Bank, three members appointed by the President; and two members appointed by the Governor

The aim of the MPC is to have responsibility within the Bank for formulating monetary and credit policy. In other words, they maintain Nigeria’s external reserves to safeguard the international value of the legal currency. Promote price stability and a sound and efficient financial system in Nigeria. Act as banker and financial adviser to the Federal Government ; and act as lender of last resort to banks i.e being able to support the banks financially if the need be.

Now that we’ve gotten that out of the way; the MPC took a really interesting move yesterday. Why is this move interesting? because it was a tough decision and the impact could signal many things.

So, the MPC made a decision to increase the monetary policy rate (MPR) from 12% to 14%.  MPR is the lending rate at which the CBN lends money to domestic banks. So if the commercial banks are lending for more, the borrowers (from commercial banks) will most likely borrow for more. And if you borrow for more, a more expensive debt might hinder growth. Considering the economy is faced with a technical recession, one might lean towards policies that will boost the economy and loans to the real economy should play a role in boosting it, right? It actually isn’t as simple, as the issue with rates in Nigeria is more structural.

On the back of this decision, the CBN is faced with 2 dilemma.

On the one hand, is the argument that policy should be eased to boost flagging economic growth (reduce interest rates, so the real economy borrow for less which is then invested - the cheaper loan boosts investment into the economy). On the other hand, inflation is on a high, tied to the sharp jump in power and energy prices, and a much weaker exchange rate which in return, reduces the value consumer gets from the Naira. So address inflation by increasing the interest rates and reduce the flow of money in the system as debt will be expensive (but the liquidity in the system is relatively tight). This should reduce money supply which might in turn reduce inflation? Yes in theory but in practice and due to the peculiarity of our market, the situation differs.

We can see that from the decision the CBN took, it aims to address – inflation – which is one of the key tasks of the Monetary Policy Committee. Nigeria saw inflation surge for the 5th consecutive time this year. From single digit of 9.6% in January to high double digit of 16.5% in June. In the space of 6 months, inflation has grown by over 7%. Inflation can mean either an increase in the money supply or an increase in price levels. Generally, when we hear about inflation, we are hearing about a rise in prices compared to some benchmark. But the inflation that Nigeria is currently experiencing is not driven by a higher money supply but rather by higher price levels.

To put this in perspective, the CBN introduced a flexible FX regime (the “float”) recently and this saw N1.2 trillion leave the system as the CBN addressed a backlog of dollar demand I.e it bought the Naira in exchange to supply Dollars to the FOREX demanders. This means there is less money supply. And as for higher price level, this is driven by the 45% rise in electricity prices and 70% jump in petrol price and weak exchange rate.

The MPC emphasised its commitment to use tools to act as a complimentary force to fiscal policy in its aim to boosting economic activity. It was also mindful of the impact on rising inflation on real returns and economic growth. Let’s dwell on this a bit, there has been a period of slow economic growth driven by weak budget implementation. The budget was implemented really late. These are the kind of fiscal policies that can be combined with the monetary policies to yield impact. As for the real returns, for a growth to be real, the impact of inflation has to be eliminated. For example Nigeria’s inflation is 16.5% for the month of June, to earn any real growth in June one must earn a minimum of 16.5% on an investment. If not, the inflation will erode the positive growth.

The monetary policy committee has over the past 1 year made decisions to adjust the interest rate in both directions from 13% to 11% to 12% to 14%.

Yet, it is struggling to get the desired impact. Clearly, there is a need for all tools – fiscal and monetary policies - to be utilised efficiently to achieve growth. If not, this can be likened to going to a gun fight with a knife.