By NBF News
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Last Tuesday's 100 basis points raise of Monetary Policy Rate by the Monetary Policy Committee from 6.5 per cent since January 25 to 7.5 per cent was one strategic step most observers had predicted would happen.

That was because prior to last week's MPC decision, developments in both the banking industry and the economy as a whole have all pointed to the need for urgent policy intervention to save the nation's economy from further hemorrhage in the face of heavy fiscal injection by the political class.

Moreover with the April general election beginning next Saturday, the economy appears to be at the receiving end as politicians struggle to match one another naira for naira and dollar for dollar in their desperate bid to win votes from the distraught electorate.

But in the midst of their unguarded profligacy, no one seems to have considered the impact the hot money would have on the economy and wellbeing of citizens.

However the Central Bank of Nigeria (CBN) by its action seemed to have proved some analysts who had earlier predicted that the rate would rise last week right when it actually raised the Monetary Policy Rate (MPR) again by 100 basis points from 6.5 per cent to 7.5 per cent to make it the highest single increase in recent time.

Announcing the decisions reached at the end of its Monetary Policy Committee (MPC) meeting in Abuja, the CBN Governor, Mallam Sanusi Lamido Sanusi, stated that the latest hike in the MPR was aimed at moderating domestic prices occasioned by rising inflation in the country as a result of high government spending.

The implication of this development observers have argued was that cost of funds will now soar higher than before as banks are bound to hike their interest rates on loans, while paying more on savings and deposits, a situation that has turned off many entrepreneurs from approaching the banks for funds even although Sanusi had assured that banks would lend this time round.

Other highlights of MPC decisions last week include the retention of the Cash Reserve Requirement (CRR) Ratio at 2 per cent as well as retention of the Liquidity Ratio (LR) at 30 per cent. It also extends the inter-bank guarantee on foreign credit transaction by three months, from June 30 to September 30, 2011.

With regard to external reserves, Sanusi stated that the nation's reserves increased by $2.82 billion from $32.34 billion recorded as at the end of December 2010 to $35.16 billion as at March 16, 2011.

Funding of the foreign exchange market through the Wholesale Dutch Auction System, which saw the apex bank supplying $5.145 billion from January through March 16, 2011, however fell short of demand which stood at $6.815 billion. He lamented that $1.34 billion was expended on the importation of petroleum product, saying that this is having adverse effects on the economy.

He emphasized that further tightening of the monetary policy was necessary, adding that whatever actions taken now should not be seen as disincentive to high growth impulses. It would be recalled that the apex bank, in its bid to cage the high inflation rate occasioned by election spending and the injection of funds into the economy by Assets Management Corporation of Nigeria (AMCON), had, on January 25, raised the MPR by 25 basis points from 6.25 per cent to 6.50 per cent.

Justifying the increase then, Sanusi had expressed concern over the high level of inflation ollowing government's spending in the build-up to the next month's general elections, saying that the action had negatively affected the economy. According to him, the apex bank, in the interest of the economy, has taken a  pre-emptive monetary policy measures to control soaring inflationary trend.

He observed that the risk of inflation was on the upward swing as a result of the liquidity injections from government spending in the run up to the April general elections in the country. The MPC's effort later paid off as the latest figure from the National Bureau of Statistics (NBS) shows that February headline inflation was down to11.1 per cent from 12.1 per cent recorded in January. The CBN had noted that interbank rates had fluctuated at various segments since the beginning of the year.

Analysts with Afrinvest (West Africa) Ltd., a security and investment banking group, had last Friday predicted the upward adjustment of the MPR, hinging their reason on the salutary effect of the January 25 hike on inflation. The flip side of the NBS data showed that, in the new Composite Consumer Price Index (CPI) series, food inflation trended upward from 10.3 per cent year-on-year to 12.2 per cent and increased by 2.9 per cent month-on-month as a result of prices of key food items moderating following the reductions seen over the festive season. On the other hand, core inflation decreased to 10.6 per cent from 12.1 per cent in January.

The announcement of the passage of a far more expansionary fiscal budget for 2011, appears to have been the determining factor, with the MPC voting unanimously to tighten rates.  The magnitude of fiscal expenditure, pretty much unchanged from last year's dramatically elevated levels, certainly required an offsetting policy response. Inflation risks in Nigeria are already high and moving higher.  Imported fuel is a contributor, and recent pressure on the NGN provided plenty of reason to be concerned. 

With the corridor around the MPR unchanged at +/-200Bps, the rate on the standing deposit facility now moves up to 5.5 per cent.  The rate on the CBN's standing lending facility is 9.5 per cent – higher, but of course still less than the prevailing inflation trend. 

Understandably, we are now likely to see a move up in bond yields - almost across the curve - reflecting the tightening stance of the CBN.  The key question will be how much further tightening we should anticipate.  In part this will depend on whether positive real FGN bond yields can be achieved, but also on NGN stability and whether further tightening might be required to support the exchange rate.  The flood of spending ahead of elections has certainly been a factor in the strength of demand for foreign exchange, and the extent of tightening that will be required going forward very much depends on how successfully the authorities manage to drain excess liquidity. 

The extension of interbank guarantees for the banking system, for another three months, speaks much of the authorities' policy dilemma.  While narrow money growth is now more robust, driven by government spending, this has not yet translated into the kind of loan extension strength the CBN would probably want to see.  There is an inflation risk stemming from the pressure of excess liquidity on the currency, but it is not yet clear that this risk extends to anything like excessive bank lending.  While financial sector resolution has come a long way, it will still be a while before the M&A process is complete.  Nonetheless, following the AMCON purchase of NPLS from the banking sector, we would expect healthier rates of loan growth in the months ahead, albeit still way below the peaks of the bubble that characterized pre-crisis lending activity.

 Our view has long been that we will see the MPR end the year at 8% – we now seem to be getting to 8per cent sooner than expected.  For now, we do not expect sustained tightening beyond that level, but much depends on how easily demand for foreign exchange is stabilized.  Bond yields should correct, but this is not expected to pose a significant risk to the banking system.  If anything, higher yields may be needed to restore calm to the forex market.

However, according to Mr Opeyemi Agbaje, a legal practitioner and financial consultant, the increase in CBN benchmark rate was expected considering what is happening in the economy. He explained that the option left for the CBN was either to devalue or raise interest rate to tame inflation. Agbaje who described inflation as a major problem the monetary authorities have had to contend with at the moment noted that with rising commodity prices across the world, coupled with the fact that the nation's foreign reserves have fast being depleted, the apex bank would have no option than to devalue to keep the economy going.

He contended that reducing money supply would be a viable option to control rising demand for foreign currencies and also tame inflation.

On the impact of the MPR hike on the nation's real sector, Agbaje said he does not expect operators in the real sector to be happy about the development, but that in the interest of the larger economy they may need to accept it in good faith now to avoid a situation where inflation rate will grow to about 15 per cent or more and create more problems for the economy. He argued that at any point above the current level the effect of inflation will escalate manufacturers' production cost as well as drain consumer demand which he said will not be in the interest of the real sector.

Going forward, Agbaje said he expects to see further devaluation of the naira by the Central Bank of Nigeria perhaps immediately after April election. He also predicted that government would still be compelled by exigencies of the domestic and global economy to deregulate prices of petroleum prodcuts in the country by the second half of 2011, considering that these issues have been held up for long due to the impending elections.

According to him the onus now lies on the CBN to clarify the issues it would want to put in the front burner among the three key parameters of inflation, interest rate and exchange rate. It appears he said, that the CBN has already given up on inflation but would need to clarify its priority areas after the election stressing that however that if the CBN was able to fix the issue of the 8 rescued banks, the economy would record some level of vibrancy in the flow of credit to the economy. But Dr Jonah Ezeikpe, a former bank chief executive and financial consultant noted that last week's interest rate hike has both short and long term implication for the economy.

In the short run, he expects to see increase in prime lending rate by banks which are likely to add margins on the CBN regulated rates to cover their cost of funds and other incidental costs of business. But a lot he argued that bank's prime lending rate to customers would depend on the perceived risk rating of borrowers. From all indications, he contended interest rate on loans will go up in line with the CBN review, while demand for credit and investment are likely to go down as these will also moderate prices.

While arguing that these economic phenomena may actually not happen in the Nigeria economy due to its unique characteristics, he pointed out that much of the borrowing from the nation's banking system are not really for investment and production but mainly for capital flight by politicians and other classes of people who are into series of shady business.

He stated ''I do not expect a decline in the volume of demand for foreign exchange particularly for people who are buying for capital flight. I say this because a greater percentage of foreign exchange bought from the CBN WDAS is not for real production but for capital flight and if must have significant change in the demand pattern, then we would need to fix the real sector of the economy''. For the above reason, the former bank chief said he does not envisage any significant growth in the performance of the real sector immediately after the election and perhaps up to the end of the first half of the year.

He warned however that government's penchant for using agriculture productivity and rising crude oil prices as basis for measuring economic growth was counterproductive considering that outcomes of these variables were usually unpredictable and cannot be controlled by nation's sovereign authority.

But despite the efforts so far exerted by the CBN in protecting the naira in the foreign exchange market, Ezikpe advised though the country does need outright devaluation of the naira at this point in time, the apex bank should stop defending the naira but should allow it to float to avoid further depletion of the nation's foreign reserves.

He argued that with the reserves already down while the Excess Crude Account has been wiped off, due to efforts to hedge the naira against other international currencies, a viable option to make the naira find its rhythm in the market place was to allow it to float without officially devaluing it. According to him, a more likely trend in the market place was the likelihood of rising import bills as politicians make last minute efforts to bring in goods to prosecute their elections in April. In addition, Nigerians are likely to witness more capital flight and persistent excess liquidity in the system which the CBN's current liquidity control measures may not be able to contain.

He explained however that much of the liquidity will be coming from political spending and not for productive enterprise. The increase in Monetary Policy Rate (MPR) by the Central Bank of Nigeria would really impact on Nigerian investors in various ways. This is because of the linkage that often exists between the money and capital markets in the economy. According to Chief Emmanuel Akamobi, Managing Director/CEO, Star Insurance Brokers limited, the development will have a negative impact on money market dealers but for investors in the capital market, there are indications that more investors will be chasing fewer stocks resulting in rise in price of quoted stocks.

He argued that the issue would be one of great benefit to stakeholders in the stock market that has remained dull for some times now. According to Peter Eluehike, Managing Director/CEO, Reading Investment limited, it will have a reversal effect on the sector because when there is investor patronage at the capital market, the money market receives less patronage and vice versa. According to him, despite the 100 bases points increase in MPR by the Central Bank of Nigeria (CBN), equities sustained their upward momentum as bargain hunters increased their investments on the bourse following the release of positive corporate results of some banking majors.

'Banking stocks (which strengthened by 2.04 per cent according the NSE Banking Index) remained the catalysts which informed across-the-board price rallies, as well as the increases in the market's total deals, transacted volumes and Naira votes by 24.50 per cent, 24.79 per cent and 31.75 per cent respectively. Consequently, the NSE ASI gained 118 basis points yesterday.

Meanwhile industrialists under the aegis of Nigerian Association of Chambers of Commerce, Industry, Mines and Agriculture (NACCIMA) and the Lagos Chamber of Commerce and Industry (LCCI) have faulted the decision of the Central Bank of Nigeria (CBN) to raise the Monetary Policy Rate (MPR) from 6.5 percent to 7.5 percent.

The two bodies while speaking through their respective Directors General (DG), Mr.Muda Yusuff and Mr. John Isemede argued that the development will spell doom for manufacturers who are already battling with a myriad of problems ranging from poor power supply and rising overhead costs as well as declining consumers demand. Specifically,Yusuff argued that the upward review of the MPR was indicative of growing concerns about liquidity in the economy particularly as the CBN was yet to fully resolve the recapitalization of the rescued banks.

'We have seen large injections from AMCON; there was the recent statutory releases to governments at all levels; the heightened momentum of electioneering campaigns has resulted in substantial spending by the political class.  These are some of the probable sources of liquidity growth,' he said. Besides, he said the MPR review would have some impact on interest rate; saying the move would raise inflationary expectations and fuel speculations in the foreign exchange market. 

Also, he noted that the concern is that; fiscal and monetary policies are moving in opposite directions while fiscal policies remain expansionary and monetary policy stance getting tighter.  These are some of the contradictions in the realm of economic policy management. With the new budget figures, there is a risk that the situation may get even worse'. The LCCI DG maintained.

On his part, Isemede explained that manufacturers can no longer compete because the cost of production will definitely go up as a result of the increase in MPR which will see them sourcing funds at a higher cost.

Again, he stressed that the development will lead to a situation where the cost of goods produced locally cannot compete with that of smuggled goods, adding that the situation will equally lead to a situation whereby people cannot deposit money in the banks as a result of low interest rates.