Zero Equilibrium CBN Monetary Policy Watch: A Review of the MPC's Decisions

– By Chinedu Okoye 

Foreword: 

The monetary policy committee at the Central Bank of Nigeria held its 302nd meeting Tuesday 22 September, with adjustments made to it's regulatory and reserve requirements that balances interests of different groups, satisfying calls for a cut, without betraying it's tight monetary policy stance.

The Nigerian Central Bank's MPC decision siggests a balancing of interests, but ultimately focuses more on restrictive policy. The MPC cut rates by 50bps cut, as opposed to ZE expectations of a 25bps cut –per our previous post: ZE Monetary Policy Watch: A Review and Outlook on September Global Central Bank Rate Decisions . But also in line with market experts expected 25bps - 50 bps cut.

A Dual Move with Muted Multiplier Effects:

This is viewed (by ZE) as a systematic dual move, that satisfying political and industry pressures on the surface, and restrciting money supply via the non-TSA CRR channel.

However, the cut in monetary policy rate may have no bearing – or lead to an increase – on effective borrowing costs as CRR on non-TSA accounts (of government agencies that generate revenue) was raised to 75%. The move to cut banking CRR and increase the Reserve ratio of on-TSA accounts (government institution deposits) is unlikely to move he curve as it is nothing but a systematic balancing of interests.

A systematic Balancing of interests:

Then Bank essentially attempted satisfying industry and political demnds, without compromising on its right monetary stance under covers of a reduced MPR and CRR. But the hike in CRR on non-TSA accounts to 75%, is deemed excessive and counterintuitive.

Because the government is the single largest earner and purchaser of goods and services in the economy, restricting bank's use of the heavy revenue inflows only to be packed as idle balances at the banks reserve account at the CBN, automatically reduces money supply.

The balancing act which was supposed to be a deep CRR cut to 45% is insufficient to move the needle as the money multiplier effect from 5% CRR reduction is muted out by the CRR on non-TSA accounts. More so, this overcompensation would worsen the crowding-out effects.

Intensification of the Crowding-out Effects:

The crowding out effects is excerbated as well. This is because the amount of deposit funds that is available for lending is 55 kobo on the Naira, whereas the banks are restricted to 25 kobo on the Naira for public sector and revenue generating agencies.

This shrinks the pool of funds available as the funds are not being utilized by the public or private sector, as these entities compete for loanable/investible funds in the same local credit or debt market. As they do so, the market has a tendency to favor non-cyclical and risk-free assets. 

A Possible Move from Crowding-Out to a Debt Overhang:

This move can create a domestic liquidity squeeze and/or increase in effective banking offer rates for borrowers. And this could lead to a more enhanced the crowding our effects than we've seen come into the fold in the past 18 months. The liquidity squeeze dampens demand at auctions, making NTBs more dependent on foreign portfolio Investors participation.

A lower effective demand from local Institutional investors could weigh in on government security yields, making it more expensive to service debt, and pushing interest rate to the private sector up as well. In this case both public and private investment lags, leading to declining consumer demand and output.

A Call for a Policy Review:

Should this hold for longer, chances are that the public sector experiences a debt overhang where debt servicing crowds out essential and growth-based budgetary expenditures, and that Increased portion of the budget (debt servicing obligations) crowds out private investment.

The Bank may have to review it's MPR and CRR in the coming months to avoid the level of monetary squeeze that could ensue from the move.

This is because, reducing rates and restricting money supply by raising non-TSA accounts CRR could translate to higher dependence on foreign participation at NTB and Longer-term government securities auctions.

FPI Dependence & Naira Vulnerability:

While credit to the private sector has expanded steadily in recent years, lending to the public sector has also increased, albeit in a more volatile and less predictable manner.

The imposition of a 75% CRR on non-TSA deposits – by way of reducing the pool of loanable funds available to banks – could stunt private sector credit growth, disrupt the disinflationary progress, while amplifying volatility in government borrowing.

This shift could deepen Nigeria’s reliance on foreign portfolio inflows to finance fiscal deficits. Such dependence exposes the Naira to heightened vulnerability should investor risk appetite for Nigerian government securities weaken.

ZE Remarks and Expectations on Inflation and the Naira Exchange Rate:

• The prospects of elevated inflation (as a result of the MPC decision(s)) will continue to erode already weaken real yields, weighing on the attractiveness of Nigerian assets for foreign portfolio investors (FPIs).

• To offset this, the CBN may be tempted, pressured or somewhat compelled to further ease bank funding conditions through additional reductions in the CRR  – of which I approve and advocate a 1000bps (10%) reduction – and its policy rate (MPR) – of which I am in disagreement.

• The disagreement of further reduction in monetary policy rates is cause; such monetary accommodation reduces [the effective NTB offer] real yields, and risks reversing the modest recent gains of the Naira, introducing renewed volatility in the NGN/USD exchange rate, and disrupting the disinflationary progress.

• We will closely monitor how the MPC’s latest policy decisions filter through to inflation, liquidity, and exchange rate dynamics over the coming month in the run-up to the 303rd MPC.

• Our baseline is for the Naira to gravitate back toward its mean trading band of N1550/$ – N1650/$, irrespective of whether more MPR cuts occur this year.

• This expectation is conditional on a limited (≤10%), or non-CRR reduction from current levels.

• Should the CRR not be lowered further toward 35% by year-end, then even with additional cuts to the MPR, the ongoing disinflationary trend would likely stall around January 2026.