The Monetary Policy Committee (MPC) of the Central bank of Nigeria (CBN) met on the 25th and 26th March 2019, against the backup of developments in the global and domestic environments in the first quarter of 2019. A major decision taken by MPC was to adjust downward the Monetary Policy Rate (MPR) by 50 basis points from 14.00 to 13.50 per cent.
The MPR has been held up at 14 per cent since July 2016. MPR is the benchmark for bank's lending rate to funds borrowers. Thus, a reduction in MPR should imply a reduction in bank lending rate. Lowering cost of borrowing encourages businesses to increase investment spending. It also gives banks incentives to lend to businesses and households and allow them to spend more.
The purpose of the reduction MPR is to stimulate output growth and employment generation in the economy as enunciated in the Economic Recovery Growth Plan (ERGP). Lowering of MPR is a pro-growth approach and consistent with global trends. Ideally, a reduction in the bank's lending rate is expected to result in reduced cost of borrowing and increased access to more funding by the real sector.
A major concern is whether the effect of the rate cut would actually cascade down the economy and whether or not it will bring down inflation. This concern is predicated upon some implications as enunciated below.The weakness of monetary policy rule on transmission mechanism in Nigeria makes impunity and self-advantageous discretion by banks possible. They may still refuse or fail to lend at lower rate. Also, with persistent attractive yields on money market instruments banks may be reluctant to increase lending to the real sector as envisaged.
A reduction in MPR is an expansionary policy. When CBN loosens MPR the government may lose the battle on inflation. There is a general belief that election in Nigeria is characterized by a high volume of cash injection into the economy through the machinations of the politicians. Another action that may fuel inflation resulting from increased money supply is the new minimum wage recently approved. Embarking on an expansionary policy when factors increasing liquidity in the economy are active may worsen inflation.
The government is presently having huge fiscal deficit and the Honourable Minister of Finance has declared that government intends to fund the 2019 budget through borrowing to be sourced locally and internationally. Reduction in interest rate will cause it to borrow locally at cheaper rate from the Commercial Banks thus creating scarcity of funds for the real sector.
Government borrowing has always been known to crowd out private sector borrowing. The crowding out effect is such that government borrowing drives down or eliminates borrowing by the private sector and this may actually bring up cost of funds to the private sector and ultimately worsen inflation.
Rate cut may weaken foreign investor preference for Naira denominated fixed income assets, which in turn, may reduce foreign exchange supply in the market. The experience of Ghana is a case in point. The Ghanaian cedi is reported to have plummeted following policy cut rate by Bank of Ghana.
The currency has been reported to be feeble and passes as one of the worst performing currencies against the U. S. Dollar so far this year. In addition, the country's inflation rate also rose from nine per cent to 9.2 per cent as February this year. Nigeria's MPC at its meeting in July 2016 hiked MPR by 200 basis points from 12 per cent to 14 per cent.
The rationale advanced for the decision was to attract foreign portfolio investment into the country and strengthen the Naira. In spite of this, the average Naira exchange rate weakened further since 2016. Does a reduced MPR now not amount to a policy somersault?
For the Centre for Economic Policy Analysis and Research (CEPAR), based on the aforesaid, opines as follows:
- There are intended benefits in the decision to reduce MPR, but this should be approved with caution.
- The budget is in deficit and to be financed through borrowing. If funds are cheaper, government will be encouraged to borrow in the domestic market to finance budget deficit. This has tendency to crowd out private sector borrowing and ultimately worsen inflation through increased costs.
- Treasury Single Account in spite of its perceived gains, has made funds sterile thereby creating shortage in money supply. It takes away liquidity from the system thereby increasing cost of funds.
- Current efforts on infrastructure rejuvenation by the Federal government should be intensified. for sustainable output growth and employment generation.
- Government should cut down borrowing. High levels of debt, while manageable for shorter time periods, may eventually push up inflation rate and increase costs. Furthermore, reduction in government borrowing will stimulate private sector borrowing.
Prof. Nwokoma is the Director of CEPAR of the University of Lagos