When the Central Bank of Nigeria (CBN) monetary policy committee (MPC) raised interest rates in 2016, their priority was fighting inflation.
Inflation has dropped consecutively for the last 15 months and based on this trend it is now plausible that Nigeria could see a single digit inflation rate by the 4th Quarter of 2018 based on observed disinflationary trend in the country for the first time since 2015.
Despite this monetary policy victory, the CBN has been unable to cut interest rates to spur a credit boom which could quicken the pace of Nigeria’s economic growth.
Many economists believed that as finally fell below the monetary policy rate (MPR) for the first time in two years, Central Bank will take the window of opportunity to ease the currently tight monetary conditions in the economy.
But the Monetary Policy Committee has chosen to hold the MPR, cash reserve ratio (CRR) and liquidity ratio at the same rate for the past 23 months.
Although the Central Bank would love to cut interest rates to boost credit activities, the threat that the Naira may come under attack thereby causing a currency devaluation is a risk too big for the MPC to assume this year. If Nigeria reduces interest rate, it could trigger a large amount of capital outflows in the country.
In 2017, foreign portfolio investment was as high as $12b according to the National Bureau of Statistics (NBS). The outflow en masse which typically follows a devaluation could cause an exchange rate crisis as the external reserves will come under tremendous strain.
With the Nigeria economy recovery still very fragile considering GDP growth of less than 2 percent in Q1 2018 and trade contracting in the quarter after expanding for the first time in Q4, 2017, following 6 quarters of negative growth prior, an exchange rate crisis could cause all the output gains to reverse and economic growth to return to zero or even negative.
Now in trying in boost economic growth by dropping interest rates, the Central Bank may end up causing an exchange rate crisis less than a year to Nigeria general elections. That’s a risk too expensive for the Central Bank Governor to take as the net outcome of this policy seems to be negative. Rising oil prices have helped to raise Nigeria’s external reserve to almost $50bn.
This puts the country at a better financial position to handle the Great Exit after either the devaluation, the interest rate drop or both occur. Sometimes the best thing to do when every action seems dangerous is to do nothing and that is the decision the Central Bank has taken in all the MPC meetings this year.
As the US Federal Reserve Bank continues to aggressively raise interest rates, the risk of large capital outflows moving from emerging markets back to America will continue to materialize. Emerging markets and frontier economies may be forced to adopt a contractionary Monetary policy to protect their currencies during this period. Although, it is unlikely that Nigeria will adopt a tighter monetary policy stance to protect the Naira, maintaining the current contractionary policy seems like the best decision today.
Emeka Ucheaga
