Making sense of historical monetary policy decisions
In the last six years, Monetary Policy Committee (MPC) decisions have included easing the monetary policy rate (MPR) just once, November 2015, and the cash reserve requirement (CRR) has been eased just twice, July and November 2015. In contrast, the MPR has been tightened ten times, including twice during the recession in 2016, and the CRR has also been tightened ten times, including once in 2016.
It is very puzzling that MPC finds extraneous reasons, typically about banks or foreign exchange supply, to tighten monetary policy, even when the economy is contracting and can do with some liquidity boost. We demonstrate that MPC decisions have been disconnected from economic realities, and urgent steps must be taken to ensure a reconnect. The economy is bigger and more important than the banks, but MPC statements continue to dwell on banks’ conditions, rather than on economic conditions, indicative of lapses in banking supervision.
To make sense of the historical monetary policy decisions, we compare the patterns in policy decisions across the Soludo, Lamido, and Emefiele regimes. This uncovers significant and instructive insights across the regimes.
Soludo era
Charles Chukwuma Soludo met the MPR at 15 percent, raised it on five occasions and eased it on five occasions over his tenure to leave it at 8 percent when he left. He met the CRR at 9.5 percent, raised it to 10 percent the month he took over, but also withdrew 60 billion public sector deposits from the banks in the same month, and subsequently preferred the later approach to CRR, which he effectively abandoned, making more withdrawals in November of that year. He cut policy rate from 15 percent to 8 percent, and cut CRR from 9.5 to 1 percent over his five-year term.
The strategy of withdrawing public sector deposits to mop up excess liquidity targeted the specific banks with excess liquidity problems, without putting any burden of increased CRR on banks that did not have the problem. Once the excess liquidity had been effectively mopped up, he was able to ease rates sustainably without any backlash, and market rates eased considerably for nearly one and a half years after he left, before his successor changed the strategy in September 2010.
Lamido era
Sanusi Lamido Sanusi met the MPR at 8 percent, eased it to 6 percent at his first MPC meeting in July 2009, the only time he eased, then raised it to 6.25 percent fourteen months later in September 2010, and then raised at each of the six meetings in 2011 to 12 percent by October, holding it at that level until he left. He met CRR at 1 percent, never eased it, but raised it on four occasions to 12 percent over an 18- month period from January 2011 to July 2012, he left it at that level on private deposits but raised the CRR on public sector deposits to 50 percent in July 2013, and 75 percent in September 2013, then raised the one on private deposits to 15 percent in November 2013, leaving the one on public sector deposits at 75 percent. Lamido raised the MPR from 6 percent to 12 percent, and raised the CRR from 1 percent to 15/75 percent in his time. He eased MPR once and raised it seven times. He never eased CRR, but raised it seven times.
Lamido shied away from confronting the individual banks with excess liquidity problem, preferring to hike both policy rate and CRR to ridiculous levels until he left. Banks without excess liquidity were forced to swallow the same CRR pills that should have been prescribed only for banks with excess liquidity.
Soludo’s style of mopping up public deposits from specific banks with excess liquidity is indeed equivalent to a selective cash reserve requirement regime in which the hammer falls only on the banks that are likely to destabilize the system with excess liquidity. Some variants of that approach are now needed to demolish the ostensible MPR and CRR burdens that Lamido had unnecessarily heaped on the economy, which his successor is aggravating, and pave way for an orderly transition to a low MPR/CRR regime that is required to underpin a regime of low market interest rates and stronger liquidity support for real economic growth.
•Emefiele era
Godwin Emefiele met MPR at 12 percent when he took over in June 2014, raised it to 14 percent in November of that year, eased it to 11 percent a year later, the only time he eased it, before raising it to 12 percent in March 2016, and raised it further to 14 percent in July 2015. He met a CRR regime of 15 percent on private deposits and 75 percent on public sector deposits, raised the one on private sector deposits to 20 percent in November 2014, maintaining 75 percent on public sector deposits, until he unified the two at 31 percent in May 2015, then cut it to twenty five percent in July 2015, and cut it further to 20 percent in November 2015, before raising it to 22.5 percent in March 2016. He has thus hiked policy rate thrice and eased it once, and hiked CRR thrice and eased it twice, to leave both levers tighter than he met them.
Like Lamido, Emefiele has continued to shy away from confronting the individual banks with excess liquidity problem, preferring to hike both policy rate and CRR to ridiculous levels. Banks without excess liquidity are still being forced to swallow the same CRR pills that should be prescribed only for banks with excess liquidity. Thus, while monetary policy conundrums, maintaining tight policy stance in the face of weak growth and employment realities, emerged in the Lamido era, it has been continued and slightly aggravated in the Emefiele era. Nigeria must seek an orderly return to the pre-Lamido era of low MPR/CRR combined with selective liquidity interventions.
•Tightening monetary policy stance in a recession is very puzzling
While the Central Bank of Nigeria {CBN) Act created the Monetary Policy Committee (MPC) with a dual mandate as follows, ‘facilitate the attainment of the objective of price stability and to support the economic policy of the Federal Government’, the MPC tends to wrongly claim the first of the two mandates as its primary mandate.
There is a need for the MPC to pay more attention to the second mandate, especially now that the Federal Government is embarking on an Economic Growth and Recovery Plan. To support economic growth and recovery, the MPC must ease its policy stance by cutting monetary policy rate in an orderly manner to such a low level that will provide much needed liquidity support for investment and sustained growth.
Money is different from credit. Monetary ease is different from ease of credit. Monetary policy is first about money before it is about credit. Easy money will help economic recovery even if it does not translate to easy credit. Nigeria’s foreign investment policy must be recalibrated away from preoccupation with volatile and easily reversible portfolio inflows towards harder to reverse diaspora and foreign direct investment inflows.
Concerns about monetary policy considerations
•Economic recovery should currently be the overriding consideration for monetary policy, and the MPC should set a threshold for GDP growth, below which it cannot tighten.
•Inflation should currently not be a consideration for monetary policy decision because it is cost-pushed, and would taper off by itself. Cost push inflation are transitory. It is the demand-pulled inflation that are persistent. As such, it is only demand-pulled inflation that call for policy tightening. The MPC has acknowledged the benign outlook of inflation in the medium term, this should provide a basis for doing more for the economic recovery objective.
•Ensuring that the policy rate is positive in real terms to attract savings should never be a consideration for setting monetary policy rate (MPR) because the MPR is an overnight rate that should define the intercept of the upward sloping yield curve. It is some of the longer maturity interest rates along the yield curve that should be higher than the expected inflation rate to deliver positive real interest rates to savers, but short maturity rates like the MPR should not be expected to be higher than the expected inflation rates. Other countries’ experiences currently show that it is not even necessary for the policy rate to be positive in nominal terms, much less positive in real terms.
•FPI inflows should not be a consideration for monetary policy. MPC should leave private banks, bond and equity traders to attract FPI and concentrate on using MPR to regulate liquidity and provide support for growth.
Concerns about MPR
•MPC needs to ease the MPR considerably but in an orderly manner to pave way for the low interest rate environment required for rapid economic recovery and growth.
ii. MPC should adopt an economic growth threshold for hiking rates.
MPR Benchmarks
•The Monetary Policy Rate is negative in Sweden, and Switzerland. ii. It is zero in European Monetary Union (EMU) and Japan.
•It is close to zero in the UK, US, Denmark and other developed markets.
•It is considerably higher than zero in BRICS (Brazil, 14%, Russia, 10%, India, 6.25%, China,
4.25%, South Africa, 7%) and MINT (Malaysia, 3%, Indonesia, 6.5%, Nigeria, 14% Turkey,
7.5%). Nigeria and Brazil have the highest policy rates across the developed countries, BRICS and MINT.
•Inflation rate is twice or thrice as large as the policy rate in many developed markets, but well below the policy rate across BRICS and MINT.
Concerns about CRR
•There is also an urgent need to ease CRR and keep it low.
•CRR was a mere 1% in Nigeria in 2009, before the MPC began to raise it since September
2010. It should be reiterated that prior to 2010, excess liquidity concerns were addressed by withdrawing Federal Government funds from the banks with such excess liquidity. Such interventions were bank-specific, and therefore more efficient than the practice of asking all banks to observe the same CRR, even when some of the banks have no excess liquidity. CRR should only be selectively observed by the individual banks with excess liquidity.
•It results from conflicts from laxity in banking supervision/prudential regulation: One of the reasons given by the MPC for not easing its monetary stance was that, ‘in the past, the MPC had cut rates to achieve the above objectives; but found that rather than deploy the available liquidity to provide credit to agriculture and manufacturing sectors, the rate cuts provided opportunities for lending to traders who deployed the same liquidity in putting pressure on the foreign exchange market which had limited supply, thus pushing up the exchange rate.’2
First, this highlights tensions between monetary policy and micro/macro-prudential policies: the MPC is not easing policy because banks’ choices in response to policy easing may destabilize the economy. This MPC statement also confirms lapses in micro/macro-prudential policies: there are no supervisory/regulatory arrangements in place to ensure that banks’ responses to policy easing will not destabilize the forex market.
Nigeria thus faces a situation in which the MPC will be unable to fulfil the second part of its dual mandate so long as banking supervision/regulatory arrangements remain lax. Stronger supervisory regimes in the central bank in the past would promptly mop up excess liquidity in the specific banks that have it, either by issuing stabilization securities or moving Federal Government deposits out of such banks into the central bank coffers, and go on to ease monetary policies for the sake of overall economic growth and stability. Banking supervision should not weaken to the point that the central bank gives excuses on behalf the banks it is supposed to supervise.
Second, the last part of the above quote, ‘the rate cuts provided opportunities for lending to traders who deployed the same liquidity in putting pressure on the foreign exchange market which had limited supply, thus pushing up the exchange rate’, also highlight tensions between monetary policy and foreign exchange policies: the CBN’s policy of demand protection and price control is inferior to the alternative of confronting the limits on the supply of foreign exchange.
• Monetary and micro/macro-prudential policies must be realigned
The CBN Act of 2007 rightly created the Monetary Policy Committee (MPC) in Section 12 and the Financial Services Regulatory Committee (FSRCC) in Section 43 to address different aspects of macroeconomic policy concerns. While the MPC has actively and transparently engaged its monetary policy mandate through six meetings a year, the FSRCC has been dormant and opaque, with the consequence that its errors of omission in the micro/macro-prudential policy space have spilled over into the monetary policy space and are now creating tensions in the pursuit of the growth and recovery objectives of monetary policy.
Both committees are chaired by the Governor of the Central Bank, but while the MPC includes all the four Deputy Governors of the CBN and two other Members of the CBN Board, the FSRCC includes only the CBN Governor.
While the membership of the MPC gives no room for any other institution to be represented apart from the CBN, the FSRCC membership includes representations from five other institutions, viz: Nigerian Deposit Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), National Insurance Commission (NAICOM), Corporate Affairs Commission (CAC) and the Federal Ministry of Finance (FMF). The MPC includes three individuals to be appointed by the President, and two individuals to be appointed by the CBN Governor, who are selected for their expertise in economic analysis, the FSRCC does not include any individual appointee.
Ayo Teriba
