Breaking News
Translate

CBN to appreciate Naira to forestall looming inflationary risks

By Babajide  Komolafe
Head of Macroeconomics  and Regional Research,     Africa, Standard Chartered Bank, Mrs Razia Khan has predicted the Central Bank of Nigeria (CBN) will have to appreciate the naira to forestall looming risks of higher inflation growth in the second half of the year.

sanusi

“Given the obvious problems with the transmission mechanism of interest rate policy, we continue to believe that the authorities will have a preference for tightening through the exchange rate.  Any naira appreciation might forestall threatened price pressures”, she said in a report last week.

Continuing, she said, “To date, Foreign exchange reserves have been largely static around USD 40bn, despite the rise in both oil output and price.  A number of explanations are given _ Joint Venture payments by NNPC, more frequent disbursements from the Excess Crude Account etc.  But given the continued favourable outlook for oil prices and production levels, we would expect FX reserves to rise in time, facilitating FX sales.

Rather than aim just for Foreign exchange stability, the CBN might find itself allowing the NGN to appreciate as the preferred means of tightening policy.  Indeed with 17 months of import cover already in place, there is little reason why this cannot begin soon.  There would be little risk of a steep bond market correction if tightening is conducted through this means, and in the context of policy visibility, it may even prove to be the more popular policy.”

Corroborating Khan’s prediction, a former Director of the CBN, who spoke on condition of anonymity  said, “Considering the favorable outlook for oil prices and the improved production level with sanity in the Niger Delta, we must try to firm up Naira to encourage the production ends take advantage of cheap imports with a strong regulation of importation of finished products but adequate imports of raw materials for production-The likes of importing concentrates to produce juice must stop because if agric is improving we must have a factory that will take the agric output for adding value rather than rotting away in the farms.

Consequently, as election money is coming, CBN must have arsenal of instruments to mop it up and make Naira scarce and exchange rate appreciating for the growth and lowering of inflation. High inflation rate will continue if Naira depreciates because this has a direct feed into inflation for an import dependent economy. We should note what Ghana has done to improve their economy through the exchange rate route; although Nigeria is a big economy-it is still relevant

The Monetary Policy Committee (MPC) of the CBN had raise alarm over increasing threat of rising inflation. The Committee in the communiqué issued at the end of its meeting noted that in the next quarter monetary expansion may be driven by increased government spending, the purchase of toxic assets by the AMCON (Asset Management Company) and recapitalization of distressed banks.  These expansions may translate into the risk of higher inflation, asset price bubbles or pressure on exchange rate and foreign reserves.  The next MPC in July will assess these risks and take appropriate actions.”

Assessing the policy options available to the apex bank to combat these risks, Khan noted that  an interest rate policy via adjustment of the Monetary Policy Rate would not be effective due to  “obvious problems with the transmission  mechanism of interest rate policy.”

She said, “The Central Bank of Nigeria kept its Monetary Policy Rate on hold at 6% and the corridor around the MPR unchanged at its meeting yesterday, largely as the market had expected.  However, the rhetoric on inflation was distinctly more hawkish, with the CBN warning that while inflation risks were limited in the near term, (and therefore any reversal of the accommodative monetary policy stance at this time would be ‘premature’), by the next quarter it could be all change.

Monetary expansion might then be driven by increased government spending ahead of elections, the purchase of non-performing assets by the AMC (expected to be operational by July), as well as the recapitalisation of distressed banks.  The concern is that all of these factors might exacerbate liquidity sufficiently to pose some risk to both inflation and FX stability.  The next MPC meeting, scheduled for early July, will ‘assess these risks’ and ‘take appropriate action’.

“Also noteworthy was the extension of guarantees on interbank placements to mid-2011, from the previous expiry date of end_2010.  The move serves as a timely reminder that although progress has been made with various aspects of the banking sector reforms, the process is not yet complete. Creditors and investors may still require additional confidence-boosting measures in order to justify exposure to the rescued banks.  Moreover, with credit growth still disappointing – retail lending rates have only just started to fall, and moderately at that – there are strong arguments in favour of keeping interest rates low.

“So what is a central bank to do when faced with the dilemma of a potential rise in inflation risks amidst sluggish credit growth, and a banking sector evidently still in need of support?  Given the obvious difficulties with the transmission mechanism of monetary policy for the moment, an outright adjustment to the MPR, or the corridor around it, looks increasingly less certain.  Banks are generally flush with liquidity.  There is minimal borrowing from the CBN window.  It is not clear that a hike in the repo rate would effectively achieve a material tightening.  Similarly, an increase in the rate on the CBN’s Standing Deposit Facility, say from 1 to 2%, may not be hugely effective in curbing excess liquidity. It would also send the wrong message to banks that are being encouraged to expand asset growth.

“Given the obvious problems with the transmission mechanism of interest rate policy, we continue to believe that the authorities will have a preference for tightening through the exchange rate.  Any NGN appreciation might forestall threatened price pressures.

To date, FX reserves have been largely static around USD 40bn, despite the rise in both oil output and price.  A number of explanations are given – JV payments by NNPC, more frequent disbursements from the Excess Crude Account etc.

But given the continued favourable outlook for oil prices and production levels, we would expect FX reserves to rise in time, facilitating FX sales. Rather than aim just for FX stability, the CBN might find itself allowing the NGN to appreciate as the preferred means of tightening policy.

Indeed with 17 months of import cover already in place, there is little reason why this cannot begin soon.  There would be little risk of a steep bond market correction if tightening is conducted through this means, and in the context of policy visibility, it may even prove to be the more popular policy.”


Disclaimer

Comments expressed here do not reflect the opinions of vanguard newspapers or any employee thereof.