POLITICAL MATTER •

“The question remains, why is the MPC attempting to address inflation by increasing the lending rate, thereby reducing the money supply when the cause of Nigeria’s inflation is not, in fact, an increase in the money supply but an increase in price levels?”

On the 25th and 26th of July, 2016, Nigeria’s Monetary Policy Committee (MPC) held its 4th meeting this year. The committee made the decision to increase the monetary policy rate (MPR), i.e. the lending rate at which the Central Bank lends money to Nigeria’s domestic banks, from 12% to 14%. Given that the MPC’s previous decision to change the bank rate from 11% to 12% was announced as recently as March 23, not only was this latest decision a tough one for the committee to make but it is a very interesting one that will have a significant impact on Nigeria’s financial and economic landscape.

Bearing in mind that the Nigerian economy is currently in a technical recession, one might expect the MPC to lean towards policies that will boost the economy and encourage loans to the real economy by keeping interest rates low.

With some of its members including the Governor of the Central Bank, the four Bank Deputy Governors, and two members of the Bank’s Board of Directors, the decisions made by the Monetary Policy Committee cannot be taken lightly. The committee has responsibility within the Central Bank of Nigeria (CBN) for formulating monetary and credit policy. The MPC maintains Nigeria’s external reserves to safeguard the international value of the legal currency; with the ultimate intention of promoting price stability and a sound and efficient financial system. The MPC is, further, intended to act as banker and financial adviser to the country’s federal government; and be a lender of last resort to banks.

Put simply, the announcement that emerged on the 27^th of July that the monetary policy rate was now at 14% means that the commercial banks are lending money from the CBN at a higher rate. This higher rate will, most likely, be transferred on to those who borrow from commercial banks. One effect is that if people are borrowing at a higher rate of interest, more expensive debts might hinder growth.

As of June this year, an inflation rate of 16.5% means that an investor must earn a minimum 16.5% return on his or her investment to achieve any real growth. Anything below 16.5% means that inflation will have eroded any positive growth.

Bearing in mind that the Nigerian economy is currently in a technical recession, one might expect the MPC to lean towards policies that will boost the economy and encourage loans to the real economy by keeping interest rates low. However, it actually isn’t that simple because the question of rates in Nigeria is a more structural one.

The CBN is currently faced with a dilemma. On the one hand, there is the argument that monetary policy should be eased to boost flagging economic growth. This would involve reduced interest rates so that the real economy can borrow for less. Borrowing that will then be invested in the economy through increased spending. On the other hand, however, inflation is currently on a high – going from 12.8% in March, (at the time, a four-year high), to a now eleven year high of 16.5% as of June.

From single digits of 9.6% in January to high double digits in June, in the space of 6 months, inflation has grown by over 7%.

Tied to a sharp jump in power and energy prices, and a much weaker exchange rate, which in turn, reduces the value the consumer gets from the naira, high inflation seems the most likely target of the MPC’s recent decision to increase the lending rate. By increasing interest rates and, thereby, reducing the flow of money into the system as many will find it too expensive to take on debt by borrowing, the overarching result might be to stem the rise in inflation.

Although this works out in theory, in practice – and due to the peculiarity of the Nigerian market – the situation is a slightly different one. Nigeria saw inflation surge for the 5th consecutive time this year. From single digits of 9.6% in January to high double digits in June, in the space of 6 months, inflation has grown by over 7%. Inflation can be either the result of an increase in the money supply or an increase in price levels. The inflation that Nigeria is currently experiencing is not driven by a higher money supply but rather by higher price levels. So when we hear about inflation in Nigeria, we are hearing about a rise in prices compared to some established benchmark.

Recently, the CBN introduced a flexible foreign exchange regime (the “float”) and this saw N1.2 trillion leave the system as the CBN addressed a backlog of dollar demand. In other words, the CBN bought naira in exchange for supplying dollars to those demanding foreign currency. This means that there is less supply in money. On the other hand, a 45% rise in electricity prices and a 70% jump in the petrol price, coupled with a weak exchange rate has led to significantly higher price levels. The question remains, why is the MPC attempting to address inflation by increasing the lending rate, thereby reducing the money supply when the cause of Nigeria’s inflation is not, in fact, an increase in the money supply but an increase in price levels?

This is perhaps a question only the MPC is in a position to answer, but it is worth remembering that the MPC emphasised its commitment to act as a complimentary force to fiscal policy in its aim to boosting economic activity. For growth to be real, the impact of inflation must be eliminated. As of June this year, an inflation rate of 16.5% means that an investor must earn a minimum 16.5% return on his or her investment to achieve any real growth. Anything below 16.5% means that inflation will have eroded any positive growth.

The monetary policy committee has over the past year made decisions to adjust interest rates in both directions from 13% to 11% to 12% to 14%.

And still, it is struggling to meet its desired impact. There is clearly a need for monetary policy to be more effectively combined with the country’s fiscal policy in order to achieve sustained economic growth. Without this, it would appear that the MPC is going into a gun fight with a knife.

Oluwatosin Olaseinde is a Nigerian. She is a chartered accountant with 7 years’ experience across audit and corporate finance and research.