Excerpts from the November 2014 CBN MPC

As usual with the release of the personal statements of members, Professor Abdul-Ganiyu Garba delivered another rousing piece which I believe you would find educative. At the end of its two day monetary policy committee meeting in November, the CBN abandoned its previous USDNGN peg and signalled commencement of fresh round of tightening. The committee: Adjusted the mid-point of the official USDNGN exchange rate to N168/$ (from N155/$) and widened the band around the peg by 200bps to +/- 5% with no MPC member in dissent. In addition, the MPC Hiked the monetary policy rate (MPR) and private sector cash reserve ratio (CRR) by 100bps and 500bps to 13% and 20% respectively whilst retaining public CRR at 75% and symmetric +/-200bps corridor around MPR by unanimous vote of all 11 members.



May 2013 offered emerging nations a foretaste of what they will face in a post-quantitative easing era. The “Bernanke effect” – the effects of Bernanke’s perceived miscommunication of his forward guidance about the timing of US tapering in May 2013 unsettled global financial markets. The miscommunication unsettled investor’s confidence who responded with a global selloff in most stock markets. In emerging markets, the problem was worse in intensity and scope: it affected yields on government securities, exchange rates and commodity prices in addition to stock prices and market capitalization. Most emerging markets opened themselves to strong contagion effects in the way they went about attracting portfolio flows to build reserves, stimulate asset price recovery in the stock markets and stabilize or engineer appreciation in their domestic currencies

For emerging markets clearly, May 2013 was a game changer whether they realized it or not. It signaled the beginning of the end of the honeymoon with investors who responded to the high country risk premiums offered by emerging markets. The portfolio flows funded public deficits and asset price bubbles hence, giving the illusions of recoveries in capital markets that had been decimated by the flight of 2008-2009.

The events of May 2013 signaled a coming turbulence. Therefore, while the turbulence appears more intense now hence, more obvious, the tide turned not in October-November 2014 but in May 2013. In the aftermath of May 2013, the long run trend of the Nigerian Stock Exchange (NSE) in terms of indexes and market capitalization has been downward. In addition, the exchange rate spread steadily widened. Between May 2013 and November 2014, the global political and economic environment became more risky and uncertain.

In addition to the growing global security challenges and the strategic political-economic conflicts between Russia and the West, the growing disconnect between the United States and Europe in terms of paths of their economies and monetary policy stance has been systematically unsettling key financial and commodity markets to the dis-advantage of vulnerable emerging markets. It is important to understand the secular nature of the current problems to inform a correct analysis of strategic and policy options.

Lessons of history – Mexican currency crisis of 1993-94, the Asian crisis of 1997-98 and the Russian currency crisis of 1998 – offer clear lessons about the likely path and consequences of unwise and untimely monetary response to speculative attack. In the case of Nigeria with multiple and segmented markets, a widening spread was inevitable given the events in the aftermath of May 2013. The spread between BDC and RDAS/WDAS rose from an average of ₦2.05 between January and April 2013 to ₦6.64 between May and December 2014 and November 24, the spread was ₦25 (about 16% of the RDAS exchange rate). It is obvious that the size of the spread was a strong incentive for arbitrage, rule-violations in forex use, currency substitution and for short positions against the Naira. The loss of about 40% in the price of crude oil simply made a problem that has been building since May 2013 more visible. In my view, the falling price of crude oil was simply a trigger. It is important to see beyond the trigger factors to the structural vulnerabilities, market functioning problems and failures to rein-in fiscal deficits, public debt and dissavings that are the real problems.

We have emphasized repeatedly that it is important to see beyond the short term to develop a medium and long term forward looking perspective and to build long term resilience. The Gulf Cooperation countries are estimated to have saved about 2.5 trillion US$ in foreign reserves during the longest oil boom in human history. In addition, they seemed to have invested wisely through their Sovereign Wealth Funds to develop their economies and secure the medium to long term interests of their commonwealths. Their case seems to offer positive lessons.


My concern at this November 2014 MPC is short, medium and long termed. In the short term I am convinced that the MPC must direct the economy away from the paths of Mexico (1993-4), Asian Tigers (1997-8) and Russia (1998). We cannot afford a “confidence cycle” that destroys the capacity of the monetary authorities to influence the path of the economy. Medium to long term, we have to address the key vulnerabilities in economic policies (monetary and fiscal), market functioning and disconnect between financial and real sectors. If we think through carefully and analyze the path of the economy from 2004 (pre-banking consolidation) to date, it will become obvious that a short-sighted perspective is dangerous. My vote at this last MPC meeting of 2014 addresses short term, medium and long term paths of the economy. It takes due account of current realities and expectations that are influencing the pricing of Nigeria’s country risks by speculators (revealed by the spread between Euro Bonds and FGN Bonds) and of the pricing of the Naira in the Inter-Bank market and other markets. It is clear that the market has increasing moved well outside the band announced in 2011 after the events of May 2013.

I vote for moving the mid-point of the band and the width of the band. My vote is informed by a clear analysis of the paths of the economy in the short to medium terms and the urgency of eliminating an “arbitrage spread” that is fuelling the speculative attack on the Naira, currency substitution and sharp practices. I am convinced that moving the mid-point and the width of the band is just a first step towards correcting the weak mechanism design that inevitably segments the forex market creating an “arbitrage spread”. Market segmentation and arbitrage spread make arbitrage, currency substitution, sharp practices and short positions rational. Auction theory is clear that in repeated auctions such as RDAS/WDAS, the likelihood of collusion is very strong. Indeed, at least three Nigerian studies have provided strong evidence of collusive behaviours in Nigerian foreign exchange auction markets.

A silver lining for policy implementation is that collusion in the Nigerian forex auction market is easy to detect. A closing of the spread between the highest and the lowest bids that opens an “arbitrage spread” is a strong signal of the high likelihood of collusive behavior. Rational bidders who are driven purely by profit are best served by widening spreads even when a widening spread could destroy the currency. It is important therefore, to ensure that the auction systems in the financial markets are no longer rigged against the goals of monetary policy or the commonwealth. The Monetary Policy Implementation process would support policy effectiveness if it gives priority to quick detection and punishment of collusive behaviours. This will help to sustain the closing of the “arbitrage spread”.

At the September meeting, I voted for tightening because I was convinced that it was necessary to sterilize the “inverted intermediation liquidity” that was sitting idle in the SDF window daily. I was also convinced that tightening was necessary to sterilize the expected “AMCON injection” of N876 billion into the banking system in October when it redeemed maturing Series V zero coupon AMCON Bond. I was convinced that such an injection will inevitably add to the size of the inverted intermediation liquidity and provide more ammunition for currency substitution, short positions hence, pressure on the Naira. The data confirmed my expectations. It is therefore clear to me that sterilizing inverted intermediation liquidity must be a fundamental principle of monetary policy. This is because inverted intermediation liquidity is a “costly noise” in the monetary policy process. Minimizing inverted intermediation liquidity is therefore, necessary to minimize

(1) its collateral damages on market functioning and macroeconomic stability and

(2) to improve the effectiveness of monetary policy.

I vote therefore, for increasing the private sector CRR from 15% to 20%. This significantly minimizes the collateral damages of inverted intermediation liquidity. Analysis of previous CRR increases has shown them to be very effective in stemming artificial pressures on the Naira but with a lag. The lag effect is actually the implementation lag. The old argument was that because of reserve averaging, it was necessary to effect the CRR deductions at the end of the cycle. Policy effectiveness demands a zero implementation lag this time. In addition, closer supervision is necessary to minimize the effectiveness of “policy neutralizing moves”.

I voted to maintain MPR at 12%. I understand the argument about compensating for country risks to attract portfolio flows. However, I am not convinced by the argument. I am more convinced by the medium to long term argument. In any case, the effects of MPR increases are asymmetrical because of the asymmetries in the money market: wholesale borrowers with high interest rate elasticities are unlikely to be affected while retail sector borrowers with low interest rate elasticities are most likely to be adversely affected. This would heighten the risk of NPLs.

I have consistently expressed my preference for asymmetric corridors around the MPR. My argument consistently has been that it is necessary to improve the functioning of the interbank market. I also believe that economic agents respond to incentives. Therefore, improving market functioning by a creative use of incentives is far more critical to the effectiveness of monetary policies. Given that it is well established that financial markets malfunction when incentives are distorted to favour the greedy and powerful whose allegiance is to a corrupted idea of self-worth, much efforts must be devoted to improving market functioning. At this last MPC of 2014, I maintain the vote for an asymmetric corridor of -5 and +2 around the MPR.

The real challenge for economic management (monetary, fiscal and political economy) in 2015 and the medium term remains that of steering the economy seamlessly through the coming turbulence when the US Fed begins to increase rates and Europe and Japan remain weak. I therefore, feel compelled again to draw attention to

(1) The fact that monetary policy is not a panacea (a cure all);

(2) The urgency of a rule-based and performance oriented forward looking fiscal strategy and budgeting system and

(3) The urgency of eliminating all forms of distortions embedded the fiscal system and monetary policy that undermine market functioning.

The economic circumstance of Nigeria today is best viewed as an opportunity for policy makers on the monetary and fiscal sides to work together to build medium to long term resilience of the economy through creative approaches to vulnerabilities, systemic coordination, commitment problems and market functioning problems.

culled from the CBN website


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