On the 2nd of June, the Central Bank of Nigeria (CBN) increased the Monetary Policy Rate (MPR) by 25 basis points to 10.25 from 10.0 per cent. This would be the third time the apex bank will be increasing the MPR since it was introduced December 2006
It would be recalled that the MPR replaced the Minimum Rediscount Rate (MRR), as the bench mark for interest rate in the economy.

Charles Soludo, Central Bank Governor

While the MRR represents the minimum interest rate banks can borrow from the CBN, the MPR is a short- term interest rate at which banks can predictably borrow from the apex bank. Thus, the MPR serves as an indication for other interest rates be it deposit or lending rate in the economy

The MPR was introduced at 10.0 per cent with spread of 600 basis points around the rate, i.e. 300 basis points above and 300 basis points below. This translates into an upper limit of 13 per cent and a lower limit of 7 per cent.

The first movement in the MPR was announced on June 5, 2007, a 200 basis point reduction from 10.0 per cent to 8.0 per cent as well as a reduction in the  width of the interest rate corridor from plus or minus 300 to plus or minus 250 basis points. But that was the last reduction as subsequent movements were increases. The first increase was a 100 basis point upward review to 9.0 per cent in October 2007, the second increase was a 50 basis points upward review to 9.5 per cent in December 2007. Later on, at the beginning of 2008, the MPR was further increased by 50 basis points to 10.0 per cent.

Also pertinent is the fact that the increases in the MPR were occasioned by one major factor, which is the need to forestall upward movement in  the inflation rate.

For example, in the communiqué that announced the first increase in October 2007, the CBN stated: “The MPC noted that year-on-year headline inflation would continue to remain single-digit in the rest of 2007, but at the upper region of the single digit range. Overall, a combination of stable food prices and a restrictive monetary policy stance is expected to help sustain the headline inflation within single digit.

The Committee also noted the challenges arising from rising autonomous private inflows and the attendant risk of further appreciation of the naira/dollar exchange rate. In addition, the Committee also noted the high possibility of substantial fiscal injections in the fourth quarter, arising from the supplementary budget at the federal and state levels.

Similarly, in announcing the increases in December 2007, April 2008 and June 2008, the CBN stated, “The Monetary Policy Committee (MPC) noted that the overall macroeconomic picture in 2007 has reflected improved stability; just as the prospects for the first quarter 2008 appear good. The bank’s projections show that the year-on-year (headline) inflation could remain single-digit in the first quarter of 2008, provided CBN continues to take proactive steps to manage the liquidity surfeit.

There remains a strong upside risk to inflation in the near-term due to expected large capital inflows and significant fiscal injections. In anticipation of the imminent fiscal surge and continuing capital inflows; and in order to drive core inflation down to single-digit as well as to sustain headline inflation along its present path, the Committee decided to take the following proactive actions.

“The MPC noted that the staff estimates indicate that inflation could remain within single-digit through the third quarter of the year if necessary actions are taken. In this regard, the Committee emphasized that the release of grains from the strategic grains reserve together with restrictive monetary policy would be important elements in keeping inflation under control in the months ahead. In the light of the uncertainties mentioned above, the Committee decided to: Raise the MPR by 50 basis points from 9.5 per cent to 10.0 per cent.

“The Committee noted that the Federal Government budget as approved, and the distribution of part of excess crude oil proceeds, would lead to high liquidity injection in the next two quarters of the year. It also noted that the actual and potential impact on liquidity of recent fiscal disbursements from the excess crude oil account and other disbursements scheduled for June 2008, would be considerable.

"The MPC observed that monetary policy has to be forward looking. The policy, therefore, has to ensure that concerns about price stability and real activity levels are recognised and actions taken to address them. In view of the sharp growth of credit to the private sector by 96 per cent and of M2 by 62 per cent on a year-on-year basis by March 2008, and as fiscal expansion is all time high, threats of resurgence of inflation are very high. In addition, there is the threat of imported inflation owing to global rise in prices.

In the light of the foregoing, the Committee decided to: Continue and even strengthen the use of instruments such as open market operations (OMO) and special sale of foreign exchange; Signal the tightening of the stance of monetary policy by: Raising the MPR by 25 basis points from 10.0 per cent to 10.25 per cent, and increasing the CRR by 100 basis points from 3.0 per cent to 4.0 per cent with effect from June 9, 2008.”

Thus, it can be seen that the main motive for increasing the MPR has been anticipated upward pressure on the inflation rate. This, according to the CBN, is occasioned by three factors namely: rise in food prices, unprecedented increase in credit to the private sector and lastly, huge fiscal injection into the economy. Of these three factors, the most severe is the huge fiscal injection into the economy via the monthly statutory allocation and monetisation of the excess crude oil revenue.

The CBN Governor, Professor Charles Soludo himself alluded to this fact during his dialogue with the organised private sector two weeks ago. While explaining the rationale for the latest increase in the MPR, he stated, “If you decide that you don’t want inflation to go beyond ten per cent and you also want economy to grow at ten per cent, it goes by simple arithmetic that the aggregate money supply should not grow by more than approximately 20 per cent. But if then on the government side, government is already pumping in much into the system that it accounts for increase in aggregate money supply for about 15 per cent.

The implication is that the private sector must be constrained not to grow more than the remaining five per cent. I am just saying it in a very simplistic manner it is a little bit more complicated than that. But it is just to drive home the point that when government spending, and I said this when I went to talk to the one of the committees of one of the arms of the National Assembly, I said, if you are concerned about interest rate, you should have started during the budgeting session. You should have started by controlling how much you are pumping into the system.

“Because the more (money) government pumps in, the less (money)  private sector has to spend for you to maintain a certain level of inflation. If you have both sectors, this one is pumping in unlimited amount, that one is pumping in unlimited amount, the only thing that can adjust is inflation. Because there is only so much that the system can absorb, there is only so much cassava that is available, there is only so much rice that is available, then you are pumping money here, you are pumping money there. If government spends so much credit, the private sector will naturally have to slow.

 "And what is the mechanism through which that happens? It is through the price which is interest rate. So when you are looking at government spending, when you are looking at the budget going up, it then immediately  gives you  a sense as to how interest rate will go. If government spending is expansionary, then the Central Bank as the monetary authority, will have to pursue a tight monetary policy, which will then be, we, trying to mop up liquidity that is being put into the system. Mopping up liquidity means interest rate will have to go up.”

The import of the above is aptly revealed in the fact that as at June 1999, fiscal injection into the economy through monthly statutory allocation was N30 billion. Presently, total fiscal injection through statutory allocation and excess crude reserve fund is more than N400 billion.  Hence, to ensure this does not lead to increased inflation, the apex bank had to implement tight monetary policy as it has been doing in recent times i.e increase the MPR, increase cash reserve ratio and roll out treasury bills to mop up liquidity. Yet, the ultimate effect of these is increase in interest rate.

 Interestingly, all the previous increases in MPR were not accompanied by increase in lending rate. The last increase, however, seems to be the last straw that broke the camel’s back, as banks responded by slightly adjusting their lending rates upward. Perhaps in anticipation of the upward review of the MPR, banks started increasing their lending rate in the last week of May. As noted by the Money Market Association of Nigeria in its May Monthly report, “Lending rates went up marginally in the month of May in the 24 Deposit Money Banks (DMBs), as average normal lending rate was 17.5539 per cent, marking 0.14 per cent increase against 17.5283 per cent recorded in April. While Prime lending rate also rose up to 17.4792 per cent, representing 0.08 per cent increase against 17.4643 per cent obtainable in April.

Further, in its outlook for June, the report warned, “Deposit and Lending rates will trend upward in the month of June, as Banks and Discount will pay more to mobilise funds.”

The implication of the above is that, if the major threat to inflation and which is why the apex bank is increasing the MPR, resulting to increase in interest rate, is huge fiscal injection into the economy, the economy might be gradually sliding to the era of high interest rate. That was the ugly era when lending rates hovered between 25 and 35 per cent.

This is because from all indications, the likelihood of a drastic reduction in the monthly fiscal injection is very low. In fact, with some advocating for the scrapping of the excess crude reserve account and the sharing of all the excess crude oil revenue, fiscal injection on a monthly basis might shoot up to unimaginable volume. With little or no possibility of drastic reduction in fiscal injections, the only way to avoid a gradual but steady rise in interest rate is for the CBN to devise another means of managing the liquidity injections that will not affect interest rate.

Unfortunately, the CBN governor did not give any indication of such alternative. He only explained to the concerned private sector operators why the apex bank had to increase MPR and by extension, interest rate. In his usual scholarly manner, he made the operators to realise that in as much as there is the threat of high inflation, the apex bank,  in order to reduce money in the system especially to the private sector, would have to raise the MPR and by extension, interest rate. This, of course in the light of increased oil earnings and willingness of the fiscal authorities to spend more and hence pump more money into the system, means the private sector should expect further increase in interest rate.

Source: Financial Vanguard