By Kelechi Mgboji
Aggressive monetary policy tightening by the Central Bank of Nigeria (CBN), which saw the withdrawal of over N3 trillion from the financial system in the last six months, keeps agitating the minds of economic experts.
The question is, can the policy save the crashing naira against the backdrop of fast depleting foreign reserves?
First, the Credit Reserve Requirement (CRR) on public deposits was hiked to 75 per cent from 50 per cent late last year.
In March 2014, the CBN Monetary Policy Committee (MPC) raised the CRR on private sector deposits by 300 basis points to 15 per cent. But it retained Monetary Policy Rate (MPR) at 12 per cent.
Sarah Aladem, Acting CBN Governor
Acting CBN Governor, Sarah Alade, said it was the consensus of MPC members to continue to tighten monetary policy to consolidate recent gains where the naira was believed to have maintained relative stability.
“Recent resurgence of core inflation in spite of the downward trend in headline inflation reinforces this position.
“Thus, prudent monetary stance would also facilitate better reserve and exchange rate management in an environment where Fed tapering increases pressure on emerging economies financial markets,” she explained.
But analysts fault the excessive defence of the naira, saying the CBN is merely postponing the inevitable.
In an interview with TheNiche, Lagos Chamber of Commerce and Industry (LCCI) Director General, Muda Yusuf, warned that there is a limit to which the CBN can continue to defend the naira with foreign reserves.
He flayed monetary policy tightening which, in his view, is counter-productive because it affects credit flows, interest rate (the cost of credit) and businesses.
Although the CBN is using the policy to fight inflation, Yusuf added, the government has to choose between combating inflation and stimulating the economy with cheap credit to create jobs.
His words: “What is important now is to create jobs. The advanced economies are talking about how to stimulate economy, create jobs, and not how to tighten liquidity flows. They are crashing interest rate in some cases to as low as 3 per cent, in order to make sure that businesses have cheaper funds to create jobs.
“The government cannot give jobs, but small businesses can. So stimulating the economy is more urgent this time than stability of prices.”
Razia Khan of Standard Chartered Bank (SCB) agreed that further tightening provides short term stability but falls short of dealing with the bigger issues.
Khan, the Regional Head of Research (Africa Global Research) at SCB, said given current conditions – quantitative easing (QE) tapering of the United States Federal Reserve, looming bigger policy changes, shortfall in oil earnings, narrowing current account surplus, and the 2015 elections – each round of tightening is likely to be less effective in attracting new inflows.
In his view, “the spread between the interbank and RDAS FX (Retail Dutch Auction System Foreign Exchange) rates is likely to remain in place. In all likelihood, pressure on FX (foreign exchange) reserves, now less than $38 billion, will persist. This is the consequence of structural factors.”
“With continued depletion of FX reserves, speculation that the CBN’s official band will have to give way eventually is only likely to increase.”
Few believe, Khan stressed, that tightening alone will close the spread between the interbank and RDAS markets, or that near-term conditions will allow for naira appreciation on the interbank market with the exchange rate of dollar to naira retracing below 160.
To avert more pressure on foreign exchange (forex) reserves, Khan argued, there has to be a gradual rise in the dollar-naira rate at official auctions, with the CBN in control of the process the whole way through, but the spread between the official rate and interbank forex rates gradually narrowing.
“This remains necessary if Nigeria is to stabilise its FX reserves, which in turn is key to Nigeria’s ability to commit to price stability.”
A research posted online by economic experts at Meristem Securities Limited pointed out the impact the development may have on the economy.
According to them, a hike in CRR on private deposits to 15 per cent will further squeeze other banks shielded from previous decision (hike in CRR on public deposit to 75 per cent) due to their low exposure to public sector deposits.
They said considering the effect of the decision of the MPC on the performance of banks and the fact that most deposit money banks (DMBs) anticipate further tightening, they do not expect a major decline in their earnings, though investors’ initial reaction to the announcement may be negative.
Yields on fixed income instruments may trend up, the analysts added, as banks may need to re-assess portfolios in fixed income instruments and sell down their holdings to free up cash to meet the 15 per cent reserve requirement.
They expressed concern that continued outflow of funds may be witnessed as MPR is kept at 12 per cent, but were upbeat that increasing CRR on private deposits to 15 per cent may help ease pressure on the naira.
This may mop up excess liquidity if banks are speculating on forex.
In any case, the MPC welcomed the growth expectations but expressed concern that the industrial sector continues to lag behind.
It noted that growth remains consistently in favour of the agricultural sector, cited the continued achievement of relative exchange rate stability, and single digit inflation in 2014, given that the risks ahead will require extra-ordinary measures.
It viewed some of the developments as positive optimism by the market relative to other emerging market economies.
“While tension in Ukraine over Russia’s claims to Crimea remains serious, direct trade and financial links between Nigeria and the duo are largely limited,” Alade explained.
The MPC noted that the recent pressure in the forex market is in response to key developments in the U.S. over the unwinding by the Federal Reserve of its assets purchase programme.
Pressure on external reserves is deemed to be consistent with the seasonal annual payment of dividends to foreign investors.
On inflation, forecasts indicate that food inflation may not grow beyond current levels, especially with bumper harvests expected in 2014. However, core inflation may rise.