Nigeria’s Monetary Policy- fiddling while Rome burns

 

In dynamic and developed economies, trying to understand where the economy is headed can often feel like a gaze through the crystal ball. Due to the complex nature of these Advanced Economies, many of them make decisions based on economic data. This reactive mode is tantamount to looking in the rearview mirror to set the course ahead. By depending on lagging economic data, central banks are usually well behind the curve, with constant need to play catchup to be in step with where the economy has already gone. This is usually understandable for the large and complex economies, and steering these economies is no easy feat under any conditions. Thankfully, their policy transmission mechanisms are quite robust and the outcomes of the deployed policy levers can usually be second-guessed with relative ease.

 

For a developing economy like Nigeria, without the luxury of an effective transmission mechanism, reactive policy actions are usually too far behind the curve, and their impact much slower to reflect in the targeted parameters, and the transmission, often incomplete. Nigeria’s Monetary Policy Committee (MPC), saddled with the responsibility of maintaining price stability, both domestically and externally, as measured by inflation and exchange rate respectively, now finds itself confronted by the self-inflicted paradox of having to tighten during an economic slowdown.

 

In the communique released after last week’s MPC meeting, the committee on one hand stated that the exchange rate barely moved during the period under review, thus, reiterating its commitment to maintaining a stable exchange rate, and on the other hand noted that “the excess liquidity in the banking system was contributing to the current pressure in the foreign exchange market with a strong pass-through to consumer prices”. These two conflicting statements, like many other decisions taken by the MPC in recent times, left me bemused. Has it finally dawned on the apex bank that goods and services are mostly priced on the back of the autonomous market’s rate, notwithstanding where the FX was sourced? If that is the case, what is then the effective exchange rate?

 

At the point of injecting liquidity into the banking system, was the committee unaware that previous similar attempts never translated into lending to the real sector? How come the implication of the causal relationship between excess liquidity in the banking system and the pressure on the autonomous market’s exchange rate was not put into consideration before the fact, or was the committee oblivious of this empirically established relationship? I also find it curious that the MPC would expect increased lending to the real sector at a point when incidence of non-performing loans was on the rise, and many of the sectors were already in recession. If one is to foray into uncharted territories, isn’t it commonsensical to do so when the tide is in one’s favor? I’m also at a loss to why monetary policy will be deployed to tackle structural inefficiencies.

 

In my opinion, the major debate worth having, and the decision worth taking at the last MPC meeting was on the foreign exchange determination framework, but unfortunately, this was only mentioned passingly. At the heart of many of the issues currently plaguing the economy is the lack of adequate FX to meet genuine productive demand. Oil at the current price will not provide the needed FX supply, and it will be foolhardy to expect an influx of foreign investors when their translation risk is not defined at the point of entry.

 

The exchange rate bugbear cannot be wished away, it has to be addressed, and in good time. It is common knowledge that the private sector is heavily exposed to the foreign exchange risk, including the banks, and if this risk is allowed to crystalize, it portends unimaginable danger to the stability of the financial ecosystem. The nature of the current risk cannot be solved by deploying naira assets as was done during the 2011 financial crisis; moreover, the apex bank’s balance sheet is now considerably weaker, with minimal room for any tactical manoeuvre. The time to act is now.

 

 Olugbenga A. Olufeagba