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Combating inflation sparks divergent views

By Babajide Komolafe
It is now certain that increase in prices  goods and services inflation, is rising, and unfortunately quite earlier than anticipated by monetary authorities and even economic experts. But there is uncertainty and divergence of views on how to ensure that prices remain stable or experience minimal increase.

Before the National Bureau of Statistics (NBS) announced the official inflation figures last week, which reveal that prices of goods and services rose further by 12.5 per cent in April, there was general concern and worry that inflation rate, which dropped to 12.3 and 11.8 per cent in February and March respectively, would soon be on the upward trend.
“Inflation threat is real”, averred Bismark Rewane of Financial Derivative Company Limited.

“Inflation threat will be largely as a result of the expansionary 2010 budget signed into law and pre-election spending”, he stated while presenting Monthly Economic news and view at the Lagos Business School on May 5th.
Similarly, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) expressed strong concerns of threat of inflation in May 12th Meeting. It stated,

“The threat of inflationary pressure in the near-to-medium term remains real given the expansionary stance of the 2010 Federal Government budget and the anticipated increase in spending usually associated with the run-up to election across the country. In this regard, the MPC confirmed that it will continue to monitor price developments in the months ahead with a view to ensuring that the downside risk of inflation to growth is minimized.”

The CBN and economic experts however appears to be cut napping by the inflation figures released by the NBS for April. What they considered a threat that would materialize in the third quarter had become real even in April. And most worrisome is the fact that the rise in inflation rate according to the NBS is driven by increased prices of food items (food inflation).

The implication is that the rising inflation rate is beside the  anticipated increase in money supply due to  implementation of budget 2010, Asset Management Company, and pre-election year spending, all projected to impact on prices of goods and services from the third quarter.  By the time these factors come to bear on the economy, the inflation rate might cross the 15 per cent mark. To forestall this from becoming a reality requires urgent action from the monetary authorities, hence waiting till the July MPC meeting before the CBN takes measures in the regard might be too costly a luxury.

While economic experts agree on the need for urgent action to curb inflation, they however differ on the policy measures that should be adopted especially in view of the expansionary monetary policy stance of the apex bank aimed at stabilizing the financial sector in the wake of the global financial crisis and the banking sector reforms.
While Rewane recommends monetary tightening, Razia Khan of Standard Chartered Africa Research recommends appreciation of the naira.

“Now that the inflation threats have become more real, it is expected that the CBN will be contemplating tightening measures in a bid to anchoring inflation expectations before it spins out of control,” Rewane’s Financial Derivative Company Limited said in a bulleting released after the NBS released the new inflation figures.

What is likely according to the Company in the short term, is a review of existing monetary policy stance including:  Increasing the liquidity ratio currently 25%. Reviewing upwards the cash reserve ratio presently at 1%
Introduction of a new non interest bearing deposit for Money Deposit Banks leading to a mopping up of excess liquidity and containing inflationary pressure.

A change in the MPR is not feasible at this point because of its political implications and its impact on credit availability.

Khan however argue that, “Rather than react by increasing policy rates  the effect of which would be somewhat questionable  we believe there is room to allow for gradual Naira  appreciation to rein in any future price pressures.  Given that banks are in aggregate still flush with liquidity, the transmission mechanism of Naira (NGN) appreciation is likely to be more effective than conventional interest rate policy in containing future inflation.”

In a statement titled, “Central Bank of Nigeria-tightening ahead?, she posited, “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, increases 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 Naira appreciation might forestall threatened price pressures.

To date, foreign exchange reserves have been largely static around USD 40billion, despite the rise in both oil output and price.  A number of explanations are given  Joint Venture payments by Nigeria National Petroleum Corporation (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 Foreign exchange reserves to rise in time, facilitating foreign exchange sales. Rather than aim just for FX stability, the CBN might find itself allowing the Naira to appreciate as the preferred means of tightening policy. “


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