Abuja, Nigeria. March 19, 2012 - As the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) meets for the second time in 2012 on March 19th and 20th, the committee’s decision on interest rate will have to reflect and indeed consider some of the recent challenges facing the Nigerian economy, especially in light of slowing economic growth and rising poverty.  While the headline inflation rate is expected to rise from the current level of 12.6 percent, the Monetary Policy Rate (MPR) is at present 12 percent and the projection is that the rate may be left unchanged.

It has been maintained by some analysts that despite challenges of inflationary pressures, the CBN was raising interest rate at a pace that negatively affects economic growth. The recent call by the International Monetary Fund (IMF) that it is time the CBN eases monetary policy may have indirectly validate the view of analysts who hitherto believe that the CBN should trade-off a little more inflation for economic growth. According to recent data by the National Bureau of Statistics (NBS), the economy grew less in 2011 compared to 2010 even as the NBS also estimated that 61 percent of Nigerians are living below the poverty line and unemployment rate at 23.9 percent.  Specifically, the Nigerian economy grew 7.68 percent in Q4 2011, lower than 8.60 percent in the corresponding period of 2010 and the contraction, according to the NBS, is due to global effects and shut-down in oil production in the period. For the whole of 2011, the economy grew 7.36 percent as against 7.98 percent in 2010. Although this growth rate is considered impressive when compared with other emerging and developing economies, rising poverty and unemployment remains an issue. Therefore, against the expected rise in the inflation rate, the committee may leave the official interest rate unchanged at 12 percent in order to give room for economic growth prospects.  

Although oil production, which declined to 2.4mbpd in Q4 2011 from 2.6mbpd in the corresponding period of 2010, partly contributed to the contraction in economic growth, the high interest rate environment may have also contributed to the not too impressive performance of critical sectors such as agriculture and manufacturing.  Figure 1 shows the average sectoral lending rates, the treasury bills rate and the deposit rates and indicates that the 91-Day treasury bills rate is 14.8 percent, meaning that the government is borrowing much cheaper compared to the rate at which banks are lending to the different sectors of the economy. The implication of this is that a high MPR particularly crowds out private sector firms and Small and Medium Enterprises (SMEs) since the banks find it more attractive to hold government treasury bills. Therefore, the CBN’s monetary policy framework should be designed to stimulate growth in private sector credit and not increase the attractiveness of holding public debt.

 

Figure 1: Sectoral Lending Rates, Treasury Bills Rate and Deposit Rates

 

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    Source: Central Bank of Nigeria

Although the risk of a government credit default is low when compared to the private sector, the current lending rates to the private sector are still considered high. Specifically, average lending rates to the manufacturing and agriculture sectors are 23.18 percent and 22.03 percent respectively, for oil and gas is 23.40 percent and general commerce 24.15 percent. While these lending rates do not encourage demand for, and eventual flow of credit to the productive sectors, the low deposit rates (average savings deposit at 1.93 percent, time deposit 9.4 percent and demand deposit 0.63 percent) do not boost savings mobilisation, which also facilitate economic growth.  This implies financial disintermediation since there is inadequate mobilisation of saving due to low deposits rates on one hand, and on the other hand, high lending rates that discourage the growth of the private sector, particularly SMEs. The take-off of the cashless policy in Lagos state which is the financial hub of the country, may have unintended short-term negative effect on savings mobilisation due to operational challenges on one hand and the issue of security associated with electronic and internet banking on the other. However, the CBN has increased the withdrawal and deposit limits while also reducing the charges payable, and this will help reduce the short-term negative effects of the policy. Figure 2 shows that Nigeria’s quarterly GDP growth rates for 2011, apart from Q2, were lower than 2010, resulting in a lower overall growth of 7.36 percent for 2011 compared with 7.82 percent for 2010.

 

Figure 2: Nigeria’s Quarterly Real GDP Growth

 

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Source: National Bureau of Statistics

Nevertheless, despite the low probability of government credit default, it is important to note that public financial management reform is needed in Nigeria in order to improve budgeting transparency and effectiveness, and to reduce expenditure and revenue volatility. Also, the government’s creditworthiness is based on external perceptions, that is, in international credit markets, so the management of the oil resources is very critical. Therefore, it is essential that that public financial management reforms in Nigeria occur sooner rather than later as high public corruption and weak public financial management may eventually damage the government’s creditworthiness.  The implication is that there are underlying risks to holding high levels of public debt and risks to lending to the government should not be discounted.

The monetary policy committee will also be considering the effects of the approved 2012 budget by the national assembly on monetary policy, especially in the medium term. The revision of the budget due to the inability of the government to achieve 100 percent deregulation of the downstream petroleum sector, resulted in the provision of N888 billion for subsidy. Overall, the approved aggregate expenditure of N4.877 trillion is 4.9 percent higher than the amended budget of N4.648 trillion while approved capital and recurrent expenditures are N1.52 trillion and N2.43 trillion respectively. However, the approximately 5 percent increase in the total expenditure did not result in increase in the projected fiscal deficit as the approved deficit level of N1.1 trillion is 8.3 percent lower than the N1.2 trillion in the amended budget.  The reason for this is the upward revision of the oil price benchmark from $70pb to $72pb which will provide the government with more revenue to execute the planned expenditures. Nevertheless, there remains risk to the fiscal deficit exceeding projections for the following reasons; first, the actual difference (in realised revenues) between the old and revised benchmark price is not substantial, second, the downside risks to oil revenues remain shut-in production, stalled growth in the oil sector due to uncertainty surrounding the Petroleum Industry Bill and volatile world oil markets.


Highlights of the 2012 Budget  
    

The budget as approved by the national assembly has a number of implications for monetary policy which the MPC will be considering. The reduction in projected deficit will reduce the pressure on monetary policy but the increase in the oil benchmark price and subsequent increase in total expenditure means fiscal expansion and this will have implications for monetary policy. Also, the retained assumption of inflation rate of 9.5 percent and exchange rate of N155/$ despite the budgetary expansion will be difficult to achieve due to a number of reasons. First, inflation will be higher due to the mark up in food and retail prices as a result of the higher fuel price. Second, there may be another phase of partial deregulation later in the year as the government attempts to move towards full deregulation of the downstream oil sector. Third, expansionary fiscal policy implies that the naira will be under pressure in the near future and the assumption of N155/$1 is unrealistic and the CBN must be pragmatic in assessing threats to price and exchange rate stability from fiscal expansion, fuel price increases and revenue/expenditure volatility. Another issue is that oil production shut-down is one of the reasons why growth slacked in Q4 2011 and should further disruptions happen, the assumed oil production benchmark of 2.48mbpd may be difficult to achieve and could have effects on projected revenue. Therefore, if projected revenue decline due to inability to meet the oil production benchmark, fiscal deficit may increase as the government will have to borrow to fund its planned expenditures. However, the approval of N48.67 billion to the Niger Delta Development Commission (NDDC) and about N2.22 billion to the Niger Delta Ministry, if implemented may help calm nerves and reduce the likelihood of violence.

On the global scene, oil prices reached a 3-year high level of $127 per barrel while the year-to-date average remains above $100 per barrel. This has positive implications for Nigeria in terms of oil revenue (the downside is the renewed threats to oil production due to recent militant insurgency in the Niger Delta) and external reserves accumulation which increased by 5.5 percent from December 2011 to $34.7 billion in January 2012. However, rising oil prices also have implications for importation of petroleum products and this may shoot up the subsidy budget and could lead to a supplementary budget. In other words, because Nigeria rely on importation of refined crude oil, the surge in global prices means that Nigeria will be importing the products at high cost. Also, should the naira depreciate beyond the assumed level of N155/$, it means that importation of crude will be more expensive in naira terms, thereby putting pressure on the fiscal deficit.

There has been moderation in demand for exchange rate as the sale of foreign exchange was down by about 11.6 percent since the start of the year and this has helped stabilize the naira around N156/$ in the official window. These positive conditions (high oil prices, increase in external reserves, and relative stability in the exchange rate due to reduced demand pressure for foreign exchange) are likely to be taken into consideration by the MPC members and may influence their voting pattern.  Global economic performance remains dismal with the European Union unemployment rate at record high of 10.7 percent and China lowering its GDP target to 7.5 percent from 8.0 percent for 2012. The weak US economy has also led to China reducing its share of US dollar denominated reserves to 54 percent in 2011 from 65 percent in 2010.

Overall, there is a cautious mood in the policy arena, in the aftermath of the January fuel subsidy crisis. The MPC members will tap into this mood by not causing further panic in the economy. However, risks remain to the government’s budget especially in meeting revenue targets, the fiscal deficit, and keeping subsidy payments within a manageable level. There are also wider risks to macroeconomic stability if prices and exchange rate remain unstable in the near future. Nonetheless, the full take-off of the Sovereign Wealth Fund will help moderate the adverse macroeconomic impact of revenue volatility while the fiscal deficit effect will be mitigated or be benign. In summary, the MPC members may vote to keep the monetary policy rate unchanged at 12 percent despite the inevitable rise in inflation rate. The slowdown in domestic economic growth in 2011 compared to 2010, continued uncertainty in global economy and the advice by the IMF for monetary policy ease, may be the key factors that could determine the voting pattern of the members.

 

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