If the newspapers are to be believed, the naira lost 2.8% of its value against the dollar (at the parallel market) in the seven days to Thursday last week. This was barely two days after the meeting of the Central Bank of Nigeria's (CBN) policy committee put up its benchmark rate by 1.50 percentage points. For much of my adult life, I have seen efforts at implementing orthodox economic solutions to Nigeria's myriad problems met by the charge of the country's exceptional status. "Nigeria defies economic logic" is the shorthand for this perspective. Rarely ever is the nature of this difference elaborated in any useful detail. It is just enough to know and admit that policies that work elsewhere have no resonance here. Apparently, we defy the laws of economics because of our unusually basal nature - too selfish, greedy, acquisitive, and thus prone to profiteering, hoarding, and allied acts of economic sabotage.
The recent travails of the naira only appear to strengthen this argument. Or how else do you explain the fact that "elsewhere" central banks raise interest rates and their respective currencies strengthen, while our central bank does exactly the same thing, and the naira plumbs new depths?
A large part of the explanation for this lies in the details. The whole point of putting up the central bank's benchmark rate is its subsequent effects. What the CBN describes as the monetary policy rate (MPR) is the rate at which commercial banks borrow from and lend to the central bank. In this role, it sets a floor to what banks charge when these transactions happen between themselves - i.e. interbank. And on the rates across their counters. When this base rate goes up, lending rates rise. And with fractional banking all about the volume of credit banks create on their deposits, this ought to reduce the amount of money available to borrowers. Higher rates on deposits also ensue. Again attracting funds out of circulation and into banks' vaults.
It is this process, also known as the monetary transmission mechanism, that strengthens the currency whose central bank puts rates up. Interfere with this process, and this causal relationship breaks down calamitously. Make it impossible for banks to collect deposits for one, and the usefulness of higher interest rates for dampening domestic demand is blunted.
How does the CBN score on this measure?
The cash reserve requirement is a tool with which central banks control money supply by affecting commercial banks' ability to lend. Usually expressed as a ratio of bank deposits, the reserve requirement forces banks to keep some of the deposits they raise with the central bank. Until recently, this ratio stood at 22.5% for commercial banks operating in the country. Put differently, for every naira commercial banks hold as deposits, they are obliged to salt 22.5 kobo away with the central bank. Now, banks pay depositors interest on these deposits, but earn little to nothing on the reserve component. The higher the cash reserve ratio, therefore, the harder banks have to work to turn an honest profit. In other words, higher cash reserve ratios de-incentivise deposit-taking. Over the last few years, the central bank has enforced on banks cash reserve requirements far higher than the regulatory level. Not many treasurers seem to understand the basis for the debits. Added to the volatility such arbitrariness imposes, the reserve deposits have gone one way only - lower deposit levels do not see returns to the banks of reserves taken earlier.
As if this was not enough, commercial banks who ordinarily resorted to interbank transactions to smooth demand-supply imbalances in their money market operations have found this route closed off to them. The central bank's imposition of a ceiling on interbank placements means that banks with a cash surplus (from being able to better raise deposits, for example) can no longer make this available to cash-strapped banks (for a fee) above a certain transaction level.
At its meeting last week, the CBN's policy committee reinforced this policy preference for lower bank deposits by fixing the cash reserve ratio at a "minimum of 32.5%". Most commentators missed the "minimum" qualifier in this policy change. Technically, the new cash reserve rate is anything the central bank says it is. On the face of it, this new formulation lends some respectability to the asymmetric cash reserve measures that have been in place up to now. All of which would have been okay, were the whole point of central banking not about the forward guidance that allows the markets move in its preferred direction. Unsure what their cash reserve obligations could be under the new scheme, banks will, sadly simply eschew deposits completely. Or resort to financial legerdemain (to conceal deposits from the central bank) whose net result will be to distort allocative mechanisms in the financial services space.
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This squares the cycle of our economy's exceptional circumstances. For so long as the increase in the central bank's benchmark rate fails to drive a build up of bank deposits, it will have next to no effect on domestic demand. And, thus, no effect on rising prices. Or the naira's exchange rate. In this rendering, the venality that we put forward as evidence of Nigerians' difference is nothing more than the "animal spirit" advertised in the orthodox literature. Nor is it explained outside of the infamous "invisible hand" that allocates resources in market economies. Like economic entities worldwide, Nigerians respond to stimuli from their operating environments.
What stands us apart is the calibre and extent (abysmal) of our policy making and the stimuli resulting from this.
Uddin Ifeanyi, journalist manqué and retired civil servant, can be reached @IfeanyiUddin.
