Alarm bells set off as CBN goes aggressive in monetary tightening 

ONOME AMUGE 

As the Central Bank of Nigeria’s (CBN) recent monetary policy announcements reverberate through the financial sector, a chorus of cautionary voices from economic pundits fills the air. Analysts and experts alike are assessing the implications of these policy decisions, weighing their potential impact on the economy.

The monetary policy rate, which is used to control the supply of money in the economy, has now been raised by 400 basis points, reaching a historical high of 22.75 percent from 18.75 percent. In addition, the CBN also increased the Cash Reserve Ratio (CSR) to a staggering 45 percent, and widened the asymmetric corridor to an unprecedented level of +200/-700. 

In a momentous decision, the Monetary Policy Committee (MPC), headed by Yemi Cardoso, the CBN governor, voted to raise the monetary policy rate to a historical high, and the second increase since the election of President Bola Tinubu in 2023, and it signals a significant shift in monetary policy.

With Nigeria’s inflation rate hitting a staggering 29.9 percent in January 2024, the MPC’s decision to raise the MPR was considered a prudent one, aimed at stabilising prices and taming inflation. Cardoso explained that several factors were contributing to the high inflation rate, including a growing fiscal deficit, rising energy costs, and ongoing insecurity. He noted that, if left unchecked, inflation could become more persistent and difficult to control in the medium term.

He noted that the MPC considered various policy scenarios, including holding or hiking the MPR, and ultimately decided that a hike was necessary to ensure price stability.

The monetary policy rate is a powerful tool used by central banks to shape economic activity. It is the interest rate at which commercial banks borrow money from the central bank, and it plays a significant role in influencing the money supply, interest rates, and other key economic indicators. By raising the MPR, the CBN hopes to influence these factors and help restore confidence in the Nigerian economy. It is also expected to help restore investor confidence in the Nigerian economy, which has been negatively impacted by high inflation and a weakened naira.

Uche Uwaleke, a finance and capital market professor at the Nasarawa State University, Keffi, denounced the CBN’s rate hike as an ‘overkill’. 

Discussing the MPR jerk up in a television interview, Uwaleke said, “You can liken it to a situation in which a patient that is being treated for an ailment and is expected to take three pills a day- one  in the morning, one in the afternoon and one in the night, and then the patient decides to take all of them at once in a bid to cure the ailment. What would you expect? That kind of  approach may even end up hurting the patient. So, that’s the kind of  situation we find ourselves in.”

According to Uwaleke, given the current high inflation rate, it was expected that the MPC would hike the monetary policy rate. However, he added that the decision to raise the MPR by 400 basis points was unexpected and would have a significant impact on the economy. 

Uwaleke, who is also the president of the Association of Capital Market Academics of Nigeria (ACMAN), noted that monetary policy has multiple channels through which it can impact the economy, including the interest rate channel, credit channel, exchange rate channel, and asset price channel. He stated that this understanding is critical when formulating monetary policy, as it helps to ensure that policy decisions are made with all relevant factors in mind.

While acknowledging that the CBN has multiple tools to tighten monetary policy, he argued that the combination of a 400 basis point increase in the MPR and a 12.5 percentage point increase in the cash reserve requirement was excessive and could have been achieved through a combination of other measures.

Uwaleke noted that monetary policy is not meant to work in isolation, and should be implemented in conjunction with other policy measures, such as fiscal policy, while expressing concern that the 400 basis point increase in the MPR would have negative implications for fiscal policy, pointing out that beyond its impact on the cost of credit, the MPR hike would also affect the economy in other ways. 

He stated further that the ability of businesses to access credit would be negatively impacted, which in turn could affect productive activity and employment, adding that the hike could also lead to an increase in loan defaults, which would affect the asset quality of banks.

Uwaleke highlighted that the decision to raise the MPR could also slow down GDP growth, citing anecdotal evidence from the previous quarters. He noted that the lack of an MPR hike in the third and fourth quarters of 2023 may have contributed to the slight increase in GDP growth during that period. However, he acknowledged that there is a trade-off between inflation and GDP growth, and that the CBN needs to find the right balance.

He recommended that the MPC should have opted for a more moderate approach, increasing the MPR by no more than 200 basis points. He stated that this would have allowed the committee to observe how the economy responded to the policy change before making further adjustments when they meet in March.

Paul Alaje, the chief economist and partner at SPM Professional, expressed a negative view of the latest monetary policy rate, warning that it could have negative multiplier effects on the economy. 

In light of the potential impacts of the latest monetary policy on businesses, Alaje advised firms that rely on bank loans to prepare for the possibility of higher interest rates in the short term. He warned that these higher interest rates could drive up costs for businesses, and these costs could ultimately be passed on to consumers in the form of higher prices.

Alaje further pointed out that the rate hike could have an adverse impact on employment. He explained that the increased cost of borrowing would lead to a reduction in spending by businesses, and this could result in job losses.

The economist expressed scepticism that the rate hike would have a significant impact on inflation in the short term. He noted that the current inflation was driven by cost-push factors, which are unlikely to be affected by higher interest rates. He also suggested that government spending on capital projects could offset some of the negative effects of the rate hike on GDP growth.

“If FAAC inflows and spendings do not impact the economy as expected, its combined impact with this adjustment in rates may lead to financial distress in the system, given the reality of the current economic quagmire. We have made our choices. However, economic choices have consequences,” Alaje added.

The Lagos Chamber of Commerce and Industry (LCCI) also expressed reservations about the CBN’s decision to raise the MPR as a means of tackling rising inflation. The LCCI noted that while the aim of the MPR hike was to curb inflation, it could actually have a negative impact on businesses and the country’s overall economic growth.

Chinyere Almona, the LCCI’s director general, stated that addressing the current rise in inflation requires a holistic approach, with both fiscal and monetary policies working together.

According to the LCCI, the CBN’s repeated MPR hikes may not be effective in controlling inflation because they do not address the root causes of rising prices. Instead, the LCCI argued, policies should be targeted at the factors driving inflation, such as energy costs, exchange rates, and other supply chain disruptions.

“The Chamber’s view on the current fight against inflation is that the monetary and fiscal authorities should focus on the factors driving the inflation rates by tackling supply-side deficiencies instead of focusing too much attention on demand-side management.

“We urge the CBN to continue with its FOREX market reforms to a conclusive end, as the high exchange rate against the naira is a major culprit in the skyrocketing inflation rates.

“On the fiscal side, the government needs to subsidise some productive sectors like agriculture, transport, and healthcare while keeping a stern eye on enhancing the country’s security profile,” it stated.

In addition to its concerns about the MPR hikes, the LCCI identified several other areas where the government needs to intervene in order to address inflation and promote economic growth. These include reducing the duty rate for imported agricultural inputs, which would help local manufacturers reduce their production costs. The LCCI also called for investment in agro-industrial hubs to promote the production of agricultural goods, as well as easier access to credit for small and medium-sized enterprises (SMEs), which play an important role in driving economic growth.

The LCCI further stressed that the MPR hike would only exacerbate the challenges faced by SMEs, who are already struggling with high borrowing costs. The Chamber noted that most SMEs are unable to access loans at the CBN’s prevailing MPR, let alone the higher rates that will result from the hike. It therefore urged the government to consider offering concessionary rates below the MPR to support SMEs and encourage economic growth.

Nnaemeka Obiaraeri, chief executive officer of Taurus Capital, characterised the MPC’s decision to raise the MPR as “shocking” and expressed doubt that it would be effective in the medium to long term. According to Obiaraeri, banks will likely incorporate the MPR hike into their lending decisions, making it more difficult and expensive for borrowers to obtain loans. This could have a negative impact on businesses and the economy as a whole, Obiaraeri warned.

“This simply means if you already have a loan in the bank that is going at 25 or 30 percent, the bank will have to adjust the rate by about 600 basis points to accommodate the 400 basis points jerk up by the CBN. This is not good for productivity, this is not good for manufacturing and honest entrepreneurship in the economy. This is going to send shockwaves to honest enterprises and entrepreneurs,” he said.

Obiaraeri noted that the MPC’s decision would be more effective in an economy where most economic activity is captured in the formal sector and where supply and demand determine the price of goods and services. 

However, he pointed out that Nigeria’s economy is largely informal and that the supply of the US dollar, a key driver of inflation, is not determined by the forces of demand and supply. He argued that the MPC’s approach was therefore unlikely to achieve the desired results.

“Nigeria does not meet some of the assumptions that drive some of these economic theories that they are putting in place by the CBN. Basically what they have done is to put the MPR at the level that foreign portfolio investors that flow in dollars to buy the CBN treasury bills or listed securities and the likes,” he observed.

The investment banking executive predicted that the MPR hike would lead to a short-term influx of foreign investment, as investors would take advantage of the higher interest rates. This inflow of foreign capital, he noted, would help stabilise the exchange rate in the short term. However, he warned that this stabilisation would only last for a week or so, after which the investors would withdraw their capital and the exchange rate would likely depreciate again.

“What we need to do is to boost the supply side of the dollar. 90 percent of these problems are from the fiscal side,” he added.

The Centre for the Promotion of Private Enterprise (CPPE), a Nigerian think tank, also criticised the MPC’s decision to raise the MPR at such a high rate, warning that this would have a negative impact on the real sector of the economy. 

According to Muda Yusuf, CPPE’s chief executive officer, the MPC’s actions would have a negative impact on the ability of banks to play their role as financial intermediaries in the Nigerian economy. He explained that by increasing the MPR and CRR, the MPC was making it more expensive for banks to lend money and discouraging consumers from borrowing.

The organisation noted further that the MPC’s actions would significantly limit banks’ ability to support economic growth and investment, particularly in the real sector of the economy.

Yusuf acknowledged that the MPC’s decision was in line with the actions of central banks around the world, but argued that the CBN failed to consider the unique characteristics of the Nigerian economy. The CPPE argued that the primary drivers of inflation in Nigeria are on the supply side, such as rising energy and food prices, and that the CBN’s use of ‘ways and means’ financing has contributed to the country’s inflationary pressures.

The CPPE executive recalled that despite the repeated monetary tightening over the past two years, inflationary pressures have not eased. In fact, he noted, inflation has continued to rise. He argued that this indicates that the CBN’s approach is not effective in addressing the root causes of inflation in Nigeria.

“The transmission effects of monetary policy on the Nigeria economy are still very weak.   In the Nigerian context, price levels are not interest sensitive.  Supply side issues are much more profound drivers of inflation,” he stated.

In order to mitigate the negative effects of the MPC’s decision, Yusuf suggested that the CBN should accelerate the process of increasing the capitalisation of development finance institutions. This, he argued, would create a source of low-cost financing for small businesses and the real sector, which would help to offset the impact of the higher MPR on these sectors.