Nigeria: MPC Rate Cut and Need for Complementary Fiscal Measures

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15 April 2019

In its second bi-monthly meeting held on March 25 and 26 this year, the Monetary Policy Committee of the Central Bank of Nigeria delivered a pleasant surprise in the form of a minor cut to the Monetary Policy Rate from 14 per cent to 13.5 per cent. It was the first time the MPR would be tinkered with since July 2016. The MPC points to the relative stability in the key macroeconomic variables as well as the need to signal a new direction that is pro-growth as justification for the 50 basis-point reduction. Specifically, the Committee was emboldened by the continued moderation in inflationary pressure and the stability in the foreign exchange market. Although still in breach of the CBN's upper band target of 9 per cent, headline inflation slowed to 11.31 percent in February 2019 from a peak of 18.72 in January 2017 according to the National Bureau of Statistics. On the external front, the MPC equally found solace in the moderate improvement in crude oil prices and stable accretion to external reserves especially against the backdrop of current developments in the oil futures market which indicate that oil prices will remain considerably above the federal government's 2019 budget benchmark. Equally heartwarming for the monetary authority is the trend of declining long term yields in the United States of America in the wake of the Federal Reserve's shift to a more dovish stance and the likelihood that capital flows in the medium term may be redirected to frontier and emerging markets including Nigeria.

Without any doubt, this move by the MPC bodes well for the Nigerian economy which requires a great deal of real-sector traction to achieve full recovery and inclusive growth. Typically, as the MPR-which is the rate at which banks borrow money from the CBN- is reduced, the banks in turn are expected to pass on the benefits to customers by reducing interest rates on loans. Admittedly, a 50 basis-point reduction may not be significant to translate to lower lending rates in the near term, explaining in part why financial markets' reaction to the surprise rate cut seemed subdued. The equities market, for instance, closed in the red with the All Share Index shedding 0.67 per cent on Wednesday being the first trading day following the announcement of the rate cut and only managed to eke out a gain of 0.01 per cent at the close of trading the following day. Nevertheless, the MPC decision has opened the door, which seemed shut for about 33 months, to subsequent rate cuts in the medium term. Going forward, against the backdrop of benign inflation, an accommodative monetary policy will provide room for increased channeling of credit to the real sector thereby reducing the cost of funds for many small and medium enterprises. The capital market stands to benefit from a low interest rate environment given that some of the increased liquidity will likely flow into the equities market. It will also be positive for the government's fiscal position arising from cheaper bonds' issuance considering that part of this year's budget deficit will be financed through borrowing from the domestic capital market.

It goes without saying that a dovish monetary policy stance is only enabled by low inflation and on this score the fiscal authorities equally have a role to play. This is consistent with the fiscal theory of price level (FTPL) which postulates that the price level is primarily determined by government debt and fiscal policy with monetary policy playing an indirect role contrary to the monetarist view that considers money supply as the primary determinant of inflation. The monthly Consumer Price Index reports by the NBS which identify structural factors as the primary drivers of inflation in Nigeria would appear to lend credence to this theory. This fact is also acknowledged by the MPC which had noted in its latest communiqué that the upside risks to inflation are chiefly due to factors 'outside the ambit of monetary policy'. Some of these factors highlighted by the Committee include the 'high cost of energy, infrastructure constraints, insecurity in some parts of the country and anticipated increase in liquidity from the late implementation of the 2018 budget'. Hence, it is vital not to downplay the influence of fiscal policy on price level and within the framework of the FTPL harp on the need for greater fiscal-monetary co-ordination in order to tackle inflation and foster inclusive growth.

It is for this reason that the federal government is called upon to sustain its current effort aimed at stimulating output growth by executing the policies contained in the Economic Recovery and Growth Plan including through addressing the problem of weak power infrastructure as well as tackling the menace of smuggling and dumping of goods into the country in a bid to accelerate domestic production and create employment opportunities. As noted by the MPC, part of the complementary measures expected of the government also include the speedy passage of the other aspects of the Petroleum Industry Bill to fast track the development of the value chain in the sector as well as the implementation of the new national minimum wage. Nonetheless, it must be pointed out that if a new minimum wage can only be implemented by increasing taxes such as the Value Added Tax, then it simply amounts to digging a hole to fill a new one as the associated spike in the cost of goods and services will erode the purchasing power of any upward adjustment to the wage floor. Therefore, any increase in VAT can be productive only if it is part of a broad fiscal strategy of rebalancing the tax mix in favour of consumption tax which will entail also lowering the company income tax. Doing otherwise in an economy that is still grappling with double-digit inflation, weak growth and high unemployment rate will cause more distortions and jeopardize on-going efforts at restoring sustainable economic growth.

The CBN projects GDP growth rate of 2.74 per cent for Nigeria in 2019, higher than the 2.0 per cent and 2.2 per cent recent projections by the IMF and the World Bank respectively. Given that the economy expanded by 1.9 per cent in 2018, the CBN's optimistic projection can only materialize following the effective implementation of the capital component of the budget with emphasis on the employment elastic sectors of the economy. Regrettably, implementation of annual budgets particularly the capital aspect has over the years been challenged by absence of timely passage as well as lack of matching funds while recurrent as well as statutory obligations like loan repayments always get fully implemented. To this end, no stone should be left unturned in getting the fiscal plan ready for implementation as the quick passage of the 2019 budget would reduce uncertainties in the business environment and boost investors' confidence. In particular, the cooperation of the National Assembly is required regarding the speedy approval of any government borrowing programme linked to funding the capital component of the budget. Further, the Finance ministry should ensure that funds are released on time and together with the ministry of Budget and National Planning put in place appropriate mechanisms for budget monitoring and evaluation. As the MPC rightly noted, the government can also help reduce the non-performing loans portfolio of the banking industry and stabilise the banking system by expediting action in settling all outstanding contractor-related arrears. Now that the apex bank appears to have signalled its readiness to change the monetary policy stance from tightening to calibrated easing in support of output growth and employment generation, it behoves the fiscal authorities to extend the much-desired handshake through well-targeted complementary measures.

Uwaleke, is a Professor of Finance and Capital Market and the Head of Banking and Finance department at the Nasarawa State University Keffi

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