Excerpts from May 2015 MPC

6.0 GARBA, ABDUL-GANIYU

Background

The global economic outlook is tenuous. There is widespread nervousness about how the United States will normalize its expanded balance sheet which like that of many central banks has been bloated with toxic assets mopped up during the various phases of quantitative easing. There is also nervousness and uncertainties about the timing of the impending hikes in interest rates by the US Federal Reserve. These concerns added to the precarious state of Greece and the delinking of Eurozone and the United States monetary policies point to more difficult times ahead for most economies particularly, emerging economies. Many of these economies including Nigeria are still challenged by the negative commodity price shocks and by the reverse flows of portfolio investments. The macroeconomic data for the first quarter highlights the high sacrifice ratio of the high interest rate trap that many emerging nations including Nigeria have walked themselves into: declining GDP growth, high unemployment and rising inflation. Though, crude oil prices have risen by over 30% from the under $50 in January 2015, the nervousness about the global economy does not support confidence that the recovery would continue through to the end of the year. Other macroeconomic risks include the continuing pressure on the Naira and the fiscal vulnerabilities. Expectations about the future path of fiscal policy appear to be positive. If monetary-fiscal cooperation and coordination are prioritized and produce a comprehensive and consistent strategy, the effects on Nigerian financial markets including government securities and exchange rate may be positive. The Strategic Options I do not subscribe to the view that monetary policy is short termed and should focus on short term stability. The conventional wisdom is that economic agents are forward looking. It is obvious that key global and national players in the financial markets are highly sophisticated and strategic. It follows that if players are forward looking but monetary authorities are backward looking, the players will always be several steps ahead of policy makers. It is established that such dis-connects have negative effects on the effectiveness of policy. In addition, the action lags for necessary structural and institutional challenges will be longer than necessary. Such problems are not desirable for any economy in these tenuous times. There is sufficient evidence of such failures past and more recent history. The extent and scope of the failures that culminated into the global financial and economic crisis (the great recession) should make all policy makers who have responsibility for protecting their commonwealths to be proactive and continually alert to ensure that markets are working to be effectively allocative, aid discovery and stimulate creativity. I have no doubt that the primary strategic/policy challenge is to develop a comprehensive strategic framework that integrates economic policy, micro-prudential policy and macro-prudential policy compatible with macro objectives, financial system stability and effective market functioning. It is hard enough for monetary authorities to be effective in a global economy characterized and shaped by asymmetries, market power and strategic behaviours (legal and illegal) by dominant players as they struggle to sustain their advantages. One of the enduring lessons of the global financial crisis and its aftermath is that monetary authorities must be more proactive and act timely and decisively to prevent the prohibitive costs of illegal activities of financial institutions who in their determination to maximize profit opportunities undermine market functioning. The exposure of the Libor fixing scandal in 2012 revealed the roles key British and American global financial players played in fixing Libor rates between 2005 and 2009 to secure unfair advantages and to rig the money market. Later revelations have exposed the rigging of the global foreign exchange markets by six of the largest global players some of whom were involved in the sub-prime mortgage crisis and the Libor fixing scandal.

Building consensus on the need for a strategic shift to a forward looking and comprehensive framework is necessary if the CBN is ‘’to be proactive in providing a stable framework for the economic development of Nigeria’’ which is the mission statement of the bank. I am convinced that given the multiple principal objects of the CBN as provided for in Section 2 and the dual mandate of the MPC as provided for in Section 12 (1) of the CBN Act of 2007, a feasible framework for coordinating fiscal and monetary policy with macro and micro prudential policies is the top priority. Section 12 (1) provides that the MPC was established to facilitate the attainment of the objective price stability and to support the economic policy of the Federal Government’. I had no doubts whatsoever, that the top priority issue for the May 2015 MPC was improving on the monetary framework in ways that strengthen the transmission mechanism of monetary policy and also provides for a non-passive monetary policy stance.

The concern with liquidity is appropriate. However, given the tightening regime from September 2010, the sacrifice ratio of the ‘deflationary policies’, the exposures to portfolio flows and its consequences, the expansion in balance sheets of the Central Bank and Deposit Money Banks during and after the completion of AMCON ‘cleaning of bank balance sheets’ in 2010-2014, it was necessary to be clear about the real causes of the persistence of the problem of excess liquidity so that we could effectively control it without sacrificing growth and jobs or financial system stability. Otherwise, MPC meetings will consistently be either about tightening or passivity. I have consistently alluded to a high interest rate trap that MPC has to deal with in contrast to the low interest rate trap that many global central banks that deployed aggressive quantitative easing to stimulate their economies have to deal with.

Decision

I vote to maintain the discriminatory CRR: 75% on public deposit and 25% on private sector deposit (an increase of 500 basis points). When I voted in favour of discriminatory CRR in July 2013 it was not a frivolous decision. I feel obliged to reproduce part of my justifications. I had concluded that ‘’a 50% CRR on government deposit in the first instance is necessary to start the process of correcting market and state failures in a concrete and effective way. The very short-run effects and the likely reaction functions of key players have also been well analyzed and anticipated. The right institutions to support the policy are also clear and well within the capacities of the Banking Supervision Department of the Central Bank.’’ The market and state failures led to ‘’the paradox of substantial government deposits in Deposit Money Banks (DMBs) and high government borrowing from the DMBs. As at June 13, 2013, the three tiers of government had N2.384 Trillion in the DMBs out of which about 90% are in zero interest bearing Current Accounts. To mop up the liquidity at 14% will cost N301.33 billion which is more than the annual budgets of most states. Clearly, governments are overborrowing, are wasteful in the management of public resources and are undermining the competitiveness of the DMBs. This corporate welfare, transfers or subsidy is clearly wasteful and costly. In addition, it undermines and corrupts the public sector and makes public resources to generate inefficient outputs and ineffective outcomes. Improving the market and the state demands the correction of the causes of distortions.’’

As I wrote, ‘’I voted for a 50% CRR on government deposit as a necessary first step in the process of correcting market and state failures in a concrete and effective way. I expected that a 50% CRR will (i) eliminate the highly profitable repeated game of lending to government its deposit; (ii) compel banks to adapt to new realities, change their business models and become more efficient; (iii) incentivize banks to seek for deposits from the private sector and, to lend to the private sector, (iv) encourage the Federal government to proceed quickly to the Treasury Single Account (TSA), all governments to better manage public resources, cut down wastes and unnecessary costs and (v) reduce the levels and costs of government borrowing, the crowding-out effects of public sector borrowing and, the cost of implementing monetary policy. In addition, I expected (i) some portfolio adjustments in the structure of DMBs’ assets and liabilities, (ii) short lived rise in the operating targets of the monetary policy transmission mechanism (OBB and Call rate) and (iii) decline in liquidity ratios from the very high levels that prevailed in the last one year.’’

My initial assessment of the policy in my personal statement of September 2013 was: ‘’the data shows significant changes in the ownership and instrument structure of the deposits of DMBs in favour of growth in government deposit and a more efficient use of financial instruments by the government . . . between June and August, Federal Government Naira deposit with DMBs rose by almost N1.5 Trillion. By corollary, private deposits declined by N1.077 trillion. As a result, total public sector Naira deposit rose to N3.73 Trillion in August 2013 from N2.384 Trillion in June 2013 while private sector Naira deposits fell to N8.7 Trillion from N9.78 Trillion in the same period. In addition, a significant part of the increase in Federal government Naira deposit (81%) was held in Time Deposit in August 2013. These changes are positive signs that the 50% CRR on government deposit is a game changer for the government deposit. Also, that the efficiency of both money markets and public finance are likely to improve. Second, though, there was an increase in the average Open Buy Back (OBB) and interbank rates, the rates trended downwards between August 20 and September 3, 2013. . . The short term interest rates (intermediate targets) were on average flat: the Maximum Lending Rate (MLR) declined on average by 16 basis points and the Prime Lending Rate (PLR) rose by just 8 basis points. Third, the exchange rate was relatively stable even as the currencies of most emerging markets lost value against the US$. In addition, the inflation maintained the downward trend, and government borrowing, OMO, Treasury Bills Rate and OMO costs, Liquidity ratio all trended downwards.’’

In January 2014, I voted for the CRR on public deposit to be raised to 75%. I justified my vote on the need to ‘’speed up the process towards the Treasury Single Account (TSA) which I have consistently argued is “indispensable (i) to avoiding a high interest rate trap and (ii) to preparing the economy to soften the likely adverse effects of the imminent implosion of the low interest rate trap.” I also anchored my vote on the premise that with “a more efficient and effective cash management that a Treasury Single Account.’’ I also expected less dependence of the DMBs on government securities; improved efficiency in the pricing and allocation of credit; transition from crowding-out effects of borrowing to crowding-in effects of government lending; rise in money multiplier through increased intermediation by DMBs; (v) potentially lower interest rates; less dependence on portfolio flows; more efficient pricing and allocation of financial assets and reduced risks of financial contagion.” I have absolutely no reason at this MPC meeting to vote for a harmonization of CRR. I have listened to and contemplated all the arguments put forth. But I am not convinced. It was clear to me based on available data that it was not valid to claim that the policy was not successful. What was clear was that the policy particularly from December 2014 was being undermined by deliberate reclassifications that needed to be penalized. The right solution was enforcement of the rules of the game not changing the rules. The claim that discriminatory CRR was fiscal policy is not valid and as revealed by Staff Reports, discriminatory CRR is being effectively implemented in Brazil to achieve their peculiar objectives. The CBN Act gives MPC the responsibility of attaining price stability and supporting the Federal Government to achieve its economic objectives. What is more, the fifth principal object of the Central Bank is to act as banker to the Federal Government and provide economic and financial advice to the federal government.’’ It is important and necessary for policy success that the CBN is able to be an effective banker and economic and financial adviser to the Federal Government and that the Federal Government supports the CBN to fulfill its responsibilities.

In voting for a rise in private CRR to 25%, I am acted on analysis provided by Bank Staff that there was a need to sterilize about half a trillion Naira to reduce the pressure on the Naira. I vote to hold all other policy variables: MPR at 13% with the symmetric corridor of ±2% and Liquidity Ratio at 30%. The challenge I remain convinced is about developing a forward looking and coordinated policy framework. It is important that a new era of monetary-fiscal policy coordination is ushered in urgently to improve the effectiveness of both fiscal and monetary policies.

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