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ANALYSIS: Monetary policy in another chase after inflation

By Babajide Komolafe
As the Monetary Policy Committee of the Central Bank of Nigeria (CBN) begins  its maiden meeting for  2011  today, concerns about inflation, which is the rate of increase of prices of  goods and services, is expected to dominate the agenda of the meeting as it did for most part of last year.

Financial experts who spoke to Vanguard on the direction of monetary policy in 2011 predicted that taming the inflation rate, to ensure stable prices, and hence policy measures to curb money supply, would be the major task for the Committee this year.

“I think monetary policy this year will be dominated still by fears of inflation and money supply issues,” said Mr. Victor Ogiemwonyin, Chief Executive, Partnership Investment and Finance Company.

In the first nine months of  2010, monetary policy was dominated by need to stabilise the financial system vis-a-vis the impact of the global financial crises and the intervention measures adopted in 2009. As a result, the CBN rolled out measures to stimulate flow of money into the system by setting up special funds for on-lending to the real sector at concessionary interest rate.

It also made it cheap for banks to borrow from it by allowing the monetary policy rate (MPR), its benchmark interest rate, to remain stable at 6.0 per cent. In addition to this, the apex bank extended the guarantee on interbank loans initially till December 31st 2010 and later to June 30th 2011.

However, following signs that the financial sector has achieved some stability, and increased expectation of huge inflow of money into the economy due to election expenses and the Asset Management Corporation of Nigeria (AMCON), the CBN changed the focus of monetary policy to fighting inflation. Hence, at the MPC meeting of September 29, it rolled out measures to curb money supply, and made it costly to borrow by raising the MPR to 6.25 per cent.

“Having considered the above factors, the Committee considered it imperative to commence policy actions aimed at moderating the inflationary pressures in the economy, particularly given the outlook for government spending in an election year and the liquidity implications of the purchase of non_performing loans (NPLs) by AMCON,” the Committee said in a communiqué issued at the end of the meeting.

According to experts, the tendency for inflation to rise is very real in 2011 being an election year; hence the tight monetary policy measures introduced in the last quarter of last year would be maintained or even reinforced.

“The elections and recent Federal Government disbursements will greatly influence the inflation direction. Expanding credit to Governments at federal and state levels will combine with expected credit easing to further heat up the economy,”  observed Ogiemwonyin.

The real challenge, according to Mr. Opeyemi Agbaje, Chief Executive of Resources and Trust Company,  will be reducing inflation below 10 per cent and in the medium term, below 5 per cent.”  “This is unlikely now given current fiscal posture. The fiscal approach (high spending and falling reserves) also endangers the exchange rate, which may depreciate imminently except reserves accumulation resumes again,” he averred.

On her part, Razia Khan of Standard Chartered Bank, said that the apex bank would have to further raise the monetary policy rate to curb money supply but when it should do so is another issue. She also identified increased government spending, AMCON purchase of bad debts and further decline in external reserves as the factors that make further tightening of money policy necessary. “With ongoing AMCON activity, purchasing non-performing loans from the banking sector, there will be a further need to tighten liquidity.

Any sign that foreign exchange reserves remain pressured would justify an earlier tightening, in our view,” she said.

While sharing the view that monetary tightening to curb money supply is inevitable in 2011, an economic expert and former top official of the CBN, who pleaded anonymity, however, stressed the importance of timing to ensure the tightening does not undermine on_going economic recovery.

“It is expected that in 2011, monetary authority will begin to unwind the quantitative easing policies. The concern therefore is how to design a strategy that does not on one hand raise interest rates prematurely, thereby prematurely nipping the economic recovery in the bud, while on the other hand does not keep rates too low for too long, thereby leading to a surge in inflation or inflation expectations. What is needed is an effective policy to prevent the unprecedented monetary stimulus from becoming destabilizing influence on price stability,” the official said.

The issue of timing indeed would play a critical role in determining when CBN would introduce measures to further tighten monetary policy this year. The economic recovery is still fragile and the stability of the financial sector is still tender.  Even among the ten members of the MPC, there is division on the issue of timing.  But at its last meeting in 2010, those who believe it is not time for further tightening carried the day with six members voting for delay of further tightening while four voted for immediate further tightening.

However, if data presented at the MPC meeting today indicate sharp increase in money supply as expected due to the recently concluded primaries of the political parties and the AMCON purchase of bad debts,  those who believe further  tightening should be immediate might carry the day.

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