Long Walk to Price Stability

James Emejo writes that the decision of the Central Bank of Nigeria to further hike the benchmark interest rate against analysts’ expectations, remains the most viable option at the moment amid murky local and global headwinds

After its meeting last week, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) decided to maintain its contractionary policy stance by raising e Monetary Policy Rate (MPR) otherwise known as interest rate by 50 basis points to 18 per cent from 17.5 per cent.

The raise came at a time the economy is bleeding – struggling with growth amidst high unemployment, rising inflation, and the already high cost of credit in the economy.

The MPC decision was also taken at a period when geopolitical headwinds particularly occasioned by the war between Russia and Ukraine, the banking failures in the US and Switzerland as well as COVID-19 issues in China continue to be major global concerns.

However, analysts had predicted that the apex bank would at least maintain the previous rate and not raise the policy stance further.

President Association of Capital Market Academics of Nigeria, Prof. Uche Uwaleke, said he expected MPC to maintain a hold position “considering the significant drop in currency in circulation occasioned by the recent currency redesign policy and the fact inflation rate decelerated month on month between January and February 2023.”

According to him, “The adverse impact of the recent cash scarcity on productive activities, as well as the conclusion of election season, should have justified a hold position.”

Inflation as Major Threat to Economy

However, according to the CBN Governor, Mr. Godwin Emefiele, who read the outcome of the MPC meeting, the naira redesign and cash withdrawal limit policies have resulted in a sizeable reduction in currency-outside-banks, indicating an expected improvement in the potency of monetary policy tools, this was not enough reason to lower interest rate in the face of existing and potential inflationary pressures which continued to threaten monetary policy.

The CBN governor insisted that the continued rise in headline inflation remained a significant problem confronting the economy, although other macroeconomic variables are moving in the right direction, despite observed headwinds.

He said: “The committee’s debate at this meeting, therefore, was whether to continue its rate hike to further dampen the rising inflation trajectory or hold to observe emerging development and allow for the impact of the last five rate hikes to permeate the economy. Loosening, in the view of members, would gravely undermine the gains achieved so far.

“The MPC observed the continued upward risk to price development around expectations on the removal of the petrol subsidy; rising prices of other energy sources; continuing exchange rate pressure; and uncertain climatic conditions.  These in the view of members, provide a compelling argument for an upward adjustment of the policy rate, albeit, less aggressively.”

No End in Sight for Loosening

After about five consecutive hiking of MPR by the central bank to rein in inflation, there are still no guarantees that a loosened stance will ensue soon. 

Emefiele explained that the apex bank would continue the existing tightening regime as headline inflation continues to rise and pose significant risks to the economy.

He also observed that the continued upward risk to price development around the expectation for the removal of fuel subsidy as well as rising prices of other energy sources, the continued exchange rate pressure, and uncertain climatic conditions had further justified the need to pursue a moderate contractionary monetary policy.

The MPC had expressed concern over the marginal increase in headline inflation (year-on-year) in February 2023 21.91 per cent from 21.82 per cent in January, representing a 0.09 percentage point increase.

This increase was attributed largely to a minimal rise in the food component to 24.35 per cent in February from 24.32 per cent in the preceding month, while the core component moderated to 18.84 per cent in February from 19.16 per cent in January.

The shocks to the food component were driven by the high cost of transportation of food items, lingering security challenges in major food-producing areas, and legacy infrastructural problems, which continue to hamper food supply logistics.

Inflation Deceleration Offers Hope 

 However, despite the current threats to financial stability, the fact that the inflation rate had slowed down considerably offers a glimmer of hope that monetary contraction may not persist for a longer period – and also showed that the monetary policy interventions in recent times had been potent.

Emefiele said: “I think we must appreciate the fact that between April 2022 and August 2022, we were seeing a very steep slope in the rate of increase in inflation rate in Nigeria and the rate of acceleration was quite steep. But from the May meeting when the global inflation pressures began to show real signs globally, we also started to raise MPR. All being in an attempt to tame the aggressive rise in inflation.

“What we saw is that because of the actions that we have taken, the rate of increase in price which is inflation has begun to decelerate. For instance, between April and August, the rate of increase in inflation was about five per cent. But between august and even now, the rate of increase in inflation is only about 1.4 per cent- because of the tightening measures that have been adopted by the CBN over this period.”

 High MPR Hasn’t Weighed on Inflation Significantly

According to Emefiele, it should have been expected that the tightening regime should have immediately caused headline inflation to decline.

But, to the contrary, “What you will find particularly in our environment is that as you’re tightening or before you start tightening, and you see inflation moving very aggressively and you begin a policy of tightening, what you want to do first, is to stem that rate of increase before you begin to see a reduction,” he said. 

Continuing, the CBN governor said, “Once you achieve the kind of moderation in the rate of increase of inflation, the next thing we’ll begin to see is that it should begin to go down as you continue your tightening policy and that is what we are doing.

“Whereas, you will see that the transmission mechanism in some economies is almost direct; as you are tightening, you are seeing inflation trending downwards immediately – however, the rate of response differs from one economy to another economy.”

Contractionary Policy Working

 If anything, the monetary authority said it was satisfied the tightening regime had started to reduce the rate of increase in prices, hoping that this would eventually lead to a decline in inflation moving forward.

But, the prospects for much lower inflation may not be immediate after all given that the current administration plans to end the fuel subsidy regime.

According to Emefiele, subsidy removal has its implication on prices, which is inflation. So, because monetary policy is not optimistic that prices will continue come down because of these measures, MPC feels that we need to continue to tighten and that’s what we did at this meeting.

 Quest for Real Monetary Rate

One of the main concerns of the central bank and which also influences the resolve to tighten MPR is the fact that currently, inflation is far above the MPR which has serious implications for investment inflows.

The CBN appreciates the fact that the margin between the monetary policy rate and inflation had remained wide which is a negative real rate – a huge disincentive to investment.

“And so, everything has to be put in place by monetary policy authorities to see that we will reduce that margin or that gap in negative real rate by ensuring that inflation comes down and whatever needs to be done to rein in inflation, we have to continue to do so,” Emefiele said.

He said, “So, that will continue to be the strategy but we’ll do it more moderately going forward because we’re conscious of the fact that when you over tighten just like we have seen in the US and in Switzerland that it could begin to have a contagion effect and negative impact on the banking system and financial system soundness indicators of financial system stability in an economy.

“Those are the kind of balance that we’re looking at MPC to see that whereas we want to continue to tighten to rein in inflation, we must do it in such a moderate manner that we try to achieve moderation in the inflation rate, but at the same time without creating financial system instability in our economy.”

“Unfortunately, that is where we are because of the uncharted territory that we have found ourselves arising from various geopolitical tensions that we have seen all over the world.”