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RISING INFLATION, FISCAL LAXITY: WHAT WILL CBN'S MPC DECIDE TOMORROW?

By NBF News
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Members of the Monetary Policy Committee (MPC) would find it difficult to decide which way the pendulum should swing when they ponder tweaking benchmark rate and other variables. This is because, while inflation is threatening to break further away from government target of a single digit, the Federal Government on the other hand has continued with fiscal laxity as is evident in the little savings from benign crude oil prices in past few months.

Past monetary tightening have failed to subdue inflation and maintain stability in foreign exchange market, so the question is what would the committee do?

When the Central Bank of Nigeria (CBN)'s MPC rises from its statutory meeting tomorrow, it would attempt to proffer answers for the nagging questions raised by inflation, government spending, and the deceleration in economic growth, among others.

Based on the dicey situation on ground, analysts' opinion varies on what possible action the committee would take tomorrow.

While Samir Gadio, an analyst with Standard Bank, London, believes that the committee would leave rates unchanged in spite of the fact that risks to policy rates are shifting to the downside, Jide Solanke, an analyst with FSDH said that the MPC would reduce policy rate.

'Although the risks to policy rates are somewhat shifting to the downside, we still expect the CBN to keep the Monetary Policy Rate (MPR) unchanged at 12 per cent and maintain the Standing Deposit Facility (SDF) and Standing Lending Facility (SLF) rates at 10 per cent (MPR-200 bps) and 14 per cent (MPR+200 basis points (bps)), respectively.

'We also suspect that the CBN will hold the cash reserve requirement (CRR) ratio at eight per cent. The neutral interest rate decision would be consistent with the MPC's stance over its past four meetings (21/22 May, 19/20 March, 30/31 January and 21 November) and probably represent the most appropriate response to the mixed metrics prevailing in the domestic and international economy at present,' said Gadio.

Gadio said fiscal laxity remains a cause for concern, saying despite some restraint at the Federal Government level, as illustrated by the flat recurrent expenditure target in the 2012 budget, the overall federally consolidated fiscal stance remains exceptionally loose.

'As an oil-producing economy, Nigeria should have accumulated substantial fiscal savings in recent years, but the continued monetisation and sharing of Excess Crude Account (ECA) proceeds among the three tiers of government has prevented any positive turnaround in this area,' he said.

Perhaps the good news is that the state governors have finally agreed to launch a mini version of the Sovereign Wealth Fund (SWF) with an initial funding of $1 billion, but insist on retaining the inefficient ECA framework. Gadio said that in this case, the new SWF would become almost irrelevant as a codified mechanism to save oil proceeds.

Other worries associated with fiscal spending is the cost associated with the fuel subsidy which analysts say has become unbearable over time (N2.19 trillion in 2011) and the provision in the 2012 fiscal framework has already been largely spent (N451 billion out of N888 billion) to repay last year's arrears.

While the lower oil price in 2012 and increase in the capped petrol price to N97 per litre should reduce the cost of the subsidy going forward, there are already talks about the possibility of a supplementary budget to cover an expected shortfall. This does not bode well for the country's fiscal position, especially given a probable moderate drop in oil revenue in coming months.

Overall, the sizeable fiscal expansion witnessed since late 2009 and its impact on systemic liquidity, mainly via Federation Account Allocation Committee (FAAC) disbursements - arguably support the need for a prolonged tight monetary environment.

Based on prevailing circumstances, Gadio said, even if the committee wanted to tighten monetary conditions, the CBN would not necessarily have recourse to the MPR as the central bank could intensify its open market operations (OMO) to mop up fiscal (and foreign capital) inflows and keep liquidity in check. But the last OMO took place in early June, which suggests the CBN does not see the existing liquidity environment as posing a systemic threat and has pursued a less restrictive monetary stance lately.

Gadio said that the inflation rate looked as if it could worsen, saying that it might climb further to between 13.7 and 13.8 per cent around July and August. Annual inflation reached 12.9 per cent year-on-year (y/y) in June, from 12.7 per cent y/y in May and 12.9 per cent y/y in April, printing below expectations (around 13.5 per cent y/y for last month).

'Based on this outcome, our recalibrated model indicates that inflation will peak at 13.7 per cent-13.8 per cent y/y in July-Aug, from a previous target of 14.4 per cent-14.5 per cent y/y, and subsequently ease to 11.2 per cent y/y in December. The more subdued June inflation figure and improved CPI outlook (versus earlier forecasts) will probably reinforce the neutral interest stance at next week's MPC. In any case, a hike would not have materialised even if inflation reached 13.5 per cent y/y in June since this path was already largely priced in by the market and the CBN', said Gadio.

But Solanke said that the MPC would likely reduce bench mark rate. The analyst said that the MPC would consider the state of the global and domestic economy in order to determine the appropriate policy responses that would impact on the Nigerian financial market within the next two months.

'Reviewing the macroeconomic developments around the globe and Nigeria in particular in the last few months and the short to medium term outlook, the MPC in our opinion, may have no other choice than to change its monetary policy stance in favour of monetary easing in the next meeting.

This is with the intention to boost economic activities and stimulate the current weak purchasing power arising from the high unemployment rate of 23.90 per cent in the country, and the recent economic policies of the government,' said Solanke.

Solanke argued that although the Nigerian economy has been recording robust growth rates in the last few years, a critical look at the figures published by the National Bureau of Statistics (NBS) showed that the Nigerian economy, as measured by the real Gross Domestic Product (GDP) growth rate, has been decelerating since the beginning of 2011. The GDP growth rate in first quarter of 2011 was 7.13 per cent, lower than 7.36 per cent in first quarter of 2010; 7.61 per cent in second quarter of 2011, lower than 7.69 per cent in second quarter of 2010; 7.3 per cent in third quarter 2011, lower than 7.86 per cent in the third quarter of 2010; 7.68 per cent in the fourth quarter of 2011, lower than 8.36 per cent in fourth quarter of 2010 and finally 6.17 per cent in first quarter of 2012, lower than 7.13 per cent in the first quarter of 2011.

The growth rate in first quarter of 2012 is the lowest in the last nine quarters and it is worrisome because agriculture which accounted for an average of 40 per cent of the real GDP in the last 9 quarters, recorded the lowest growth rate of 4.15 per cent as against 5.54 per cent in Q1, 2011 and 5.43 per cent in the first quarter of 2010. Its contribution to real GDP in the first quarter of 2012 was also the lowest in the last nine quarters. If the current trend continues, the Nigerian economy may soon go into a recession.

Solanke said that what the monetary policy required under the current situation is a relaxed monetary policy stance. The International Monetary Fund (IMF) and other related major international institutions have warned of weak global economic growth in 2012, and suggested monetary easing in the face of the current threat to global growth outlook.

Monetary economist's approach to curtailing rising inflation rate is to raise interest rate with the view of persuading consumers to delay current consumptions and increase savings and investments in marketable securities, which would ultimately reduce the amount of money buying few goods. The need to also maintain a real positive return on fixed income securities in Nigeria may also justify raising rates. Solanke argues that a review of inflation rate development between January 2011 and June 2012 shows that inflation rate did not respond to MPR hike.

Inflation rate was at 12.10 per cent in January 2011 when MPR was increased from 6.25 per cent to 6.50 per cent. As at June 2012, inflation rate had increased further to 12.9 per cent when MPR has almost doubled at 12 per cent.

'In our view, rising inflation in Nigeria can be linked to shortage of outputs, rising cost of necessary inputs in production process, weak infrastructure, increase in electricity tariff, increase in import duties on imported cereals and the impact of the partial subsidy removal of fuel. We think tight monetary policy, particularly raising rates, under the current situation, has not been able to bring down inflation rate because the cause is beyond what monetary policy can handle, therefore the need for a change in policy stance,'  said Solanke.