The increase in monetary policy rates
The Monetary Policy Committee (MPC) following its meeting held on Monday and Tuesday 21 and 22 March, 2016 hiked the Monetary Policy Rate (MPR); the benchmark interest rate which the monetary authorities would charge the banks that approach it in fulfillment of its lender of last resort function from 11 per cent to 12 per cent. What was a bit surprising regarding this decision is that this rate was only reduced at the November meeting of the MPC from 13 per cent at which it had been for long period of over four years. It was then rationalised that this reduction was in response to the need to reflate the economy to create an environment that would be conducive for launching a massive attack on the worrisome problem of growing and rising unemployment. It was also argued then that such a development is better aligned with the avowed determination of the fiscal authorities to stimulate the economy for job creation growth as could be gleaned from the content of the fiscal policy document of 2016 which included an unprecedented deficit of N2.2 trillion, the equivalent of 2.1 per cent of the GDP.
But it would appear that what has led to this reaction by MPC is the recent spike in the inflation rate which was reported by the National Bureau of Statistics to have reached 11.4 per cent in February rising from 9.6 per cent in January, 2016. Reasons advanced by the MPC for this decision included but not limited to the fuel scarcity, increase in energy tariffs, and slow growth of credit to the Private Sector and foreign exchange scarcity. There is of course also the issue of the uncertainty surrounding fiscal policies, security challenges in parts of the country which had impacted negatively on the ability to distribute agricultural produce across the country, low electricity supply, fuel shortages, an adverse external environment and overall slow growth of the economy which are mostly outside the purview of monetary authorities.
Monetary tightening is almost a reflexive reaction expected from the monetary authorities in the event of rising inflation. But to most informed observers of the economy, what has largely accounted for the recent hike in inflation is the uncertainty surrounding the availability of foreign exchange particularly the rate of exchange of the Naira as it crashed precipitously at the parallel market; which would then mean that the recent increase in the rate of inflation is in response to cost push factors instead of demand pull as it would seem to have been interpreted. And if that is a correct reading of the situation most commentators have wondered whether a hike on the MPR is the most suitable response in the circumstance.
The Cash Reserve Ratio (CRR) was also increased to 22.5 per cent up from 20 per cent which would result in the draining of liquidity from the banking system. In fact it was reported that interbank rate increased to 20 per cent just before the Easter recess as an estimated amount of N409.7 billion was reported to have been sterilised from the banking system as a result of this upward review on the reserve rate. But by the admission of MPC, the accommodative policy stance adopted since July, 2015 had not impacted the economy because the Deposit Money Banks could only access the surplus funds resulting from this measure based on their ability to identify viable projects for funding which has the potential of impacting positively on the unemployment situation. If that is the situation it begs the question whether it is also timely for the CRR to have been increased. The asymmetric corridor around the MPR was also reduced from +200/-700 to +200/-500 basis points to encourage the banks to deposit their excess liquidity with the Central Bank consistent with the liquidity mopping up thrust of monetary policy.
The likely consequences of this development is that there will be increase in lending rates across board which is not a good development for the Small and Medium Scale enterprises already reeling from many other challenges in the economy not the least of which is the ability to source affordable credit and foreign exchange as most of these category of businesses are hooked on importation to sustain their operations against the general scarcity of foreign exchange.
There is this little debate whether the MPR could be below the rate of inflation in an economy with the example of Turkey where Monetary Policy rate is 7.5 per cent which is lower than the prevailing inflation rate at 8.78 per cent. If the MPR is below the rate of inflation that is a situation of veritable subsidy to the DMBs and for obvious reasons such a stance could not be countenanced in a situation of credit tightening. This hike in the MPR is supposed to impact the Savings rate by increasing it to 3.6 per cent from the prevailing 3.3 per cent rate which still represents a negative return of -7.8 per cent which is often categorized as the payment of an inflation tax.
It is expected that this development would result to an increase on the yields on fixed income securities and might attract more investors including portfolio investors who might find them more attractive relative to the yields from money market instruments. But overall the Capital Market might be impacted negatively as there is flight from shares to safer bonds with now enhanced yields. It is also expected that the mopping up of liquidity from the system would ultimately impact on the demand for foreign exchange and help in the fight to stem the falling rate of exchange of the Naira. While we await the passage of Budget 2016 which we are informed was sent to the President without the breakdown which now presents a veritable cog in wheel, it is expected that the cash infusion expected from the reflationary budget would definitely exacerbate the liquidity situation in the economy negating the thrust of monetary policy as it attempts to keep a leash on rising liquidity within the system. The MPC has served notice that the monetary authorities are working on new modalities for the determination of exchange rate which we expect should accommodate the much talked about flexibility to increase the attractiveness of the economy to autonomous inflow of foreign exchange; And may be contribute inexorably to the much desired stability of exchange rates in the economy so that we commence the process of deescalating the dominance of foreign exchange concerns in the management of the economy.
Dr. Boniface Chizea wrote from Lagos
No Comments yet