The monetary policy dilemma
The Central Bank of Nigeria (CBN)’s Monetary Policy Committee (MPC) will meet for the fifth time this year next Monday 19th and Tuesday 20th. The meeting will end a day before the Federal Open Market Committee (FOMC) of the US meet on the 21st, when many believed it is the only credible opportunity left for the FOMC to raise rate before the end of the year.
Now, and in the previous four times the MPC had met this year, it is doing so in the light of deteriorating economic conditions, rising inflation, rising non performing loans (NPLs) in the banking industry, and downward pressure on the Naira. Whereas growth was in the region of 2 percent at the start of this year, the economy has since entered recession at the end of Q2, and the economic outlook for the remainder of the year is very weak. At the start of the year, inflation started to spike. From 9.62 percent in January, it has reached over 17 percent in the month of July, an 11 year high. However, price increases are stabilising: the inflation figures released for the month of July showed that the increase in the rate of inflation was 0.6 percent, compared to 0.92 percent for the month of June. NPLs in the banking industry are rising at the back of deteriorating economic conditions, depreciation of the Naira, shortage of foreign exchange for the importation of inputs, and increases in interest rates. And finally, there is also continued downward pressure on the Naira. While it has stabilised at over N300 to the dollar in recent weeks, there is a lingering trepidation that we should expect the Naira to depreciate further.
But I think what will be uppermost in the discussion at the MPC meeting is how to conduct monetary policy in the light of the Naira float. The MPC is meeting for the second time after the floating of the Naira, which the CBN undertook on the 23rd of June. However, this time provides an ample time – three months data – to consider the dynamics of the value of the Naira since the float, especially since it has relaxed initial variation limits that were in place at the start. The meeting also provides an opportunity to assess the growing, albeit slowly, foreign portfolio flows, and how the recent approach to formalise a sizeable amount of diaspora remittances that come into Nigeria through the informal channel might help improve the liquidity in the interbank market and also affect the conduct of monetary policies.
These measures and the assessment are important to appropriately determine how the market for the Naira, against major international currencies, is shaping up. The shortcomings that we see today in the market, especially the shortage of liquidity, are to be expected in a new and growing market. Nigeria has never floated the Naira before, and now that we have done the right thing, it requires patience for the market to develop, mature and be predictable. Over many years, we have sought to manage our exchange rates and retain control of monetary policy even in the face of free movement of capital into Nigeria, often described as the impossible trinity. I can imagine how the CBN had struggled with this inconsistent approach to monetary policy, and I believe our trade with the world suffered as a result. In those previous eras, it is no wonder that the moment oil prices start to decline; the first casualty is the free movement of capital. We saw this in 2009 / 2010, and recently in 2015.
I admit that there is still some semblance of capital controls, but it is because the market is being developed, and liquidity has not reached appreciable levels. Also, though the floating of the Naira provides the breathing space for proper conduct of monetary policy, there is no doubt there exist a link between this conduct and that of the monetary policy activities in advanced economies, especially the US. Emerging markets, including China and India, have raised concerns about this in the past, and I am sure that the CBN also takes this into consideration. Indeed, some economists, such as Helene Rey of London Business School, have advocated some measures of capital controls, given the implications of the US interest rate policies on other economies.
Nonetheless, there is a greater control of monetary today than earlier in the year. With that control, the CBN and its MPC will definitely view their role slightly differently and critically examine how monetary policy will affect the rate at which the Naira will exchange for the dollar, amongst other policy objectives, especially the stability of prices.
Indeed, what Nigeria is experiencing today is not new. Rudiger Donrnbusch, in 1976, had explained why exchange rates were volatile after floating. At the time Dornbusch wrote his paper in the Journal of Political Economy, many of the advanced economies today have just transited from a pegged regime to a floating regime. It unleashed a period of great uncertainty, a replica of what we see in Nigeria today. It is the attempt to guard against this volatility that had prevented many African economies, largely relying on commodity exports, from floating their currencies in the first place.
In conclusion therefore, though we shall see the implications of the thoughts of the MPC and the larger Central Bank on the decisions they make on the benchmark interest rate, and the other measures of monetary policies, the floating of the Naira can only teach us one thing: how does the CBN now take control of monetary policy, improve liquidly in the foreign exchange market and improve Nigeria’s trade dynamics in the long term, while maintaining price stability. But as I have argued in the past, monetary policy is not sufficient to turn the tide, but the fact that the required monetary policy framework is now in place, gives the required space to now focus on fiscal policies that can help promote our international trade conditions. I thank you.
Ogho Okiti