An Excerpt from the last MPC meeting…

Few Nigerian ‘economists’ seem to make much sense. This select class includes Professor Abdul Ganiyu Garba of the Ahmadu Bello University. His statement at the last MPC is very rich. If you don’t know much about monetary policy in Nigeria this piece is a good start.


Foundation for Decision

1. I voted for cut in MPR by 50 basis points at the last three MPC meetings (January, March and May). The primary reason was to discourage portfolio inflows which are distorting asset prices and triggering asset price bubbles and encouraging complacency among investors and undermining the stability of the financial system and the economy. The trend of portfolio flows from January 2012 is incompatible with short and medium term goals of price stability with growth. The Bernanke effect which crystalized a few weeks ago and its contagion effects on Nigerian asset prices and net forex flows give weight to my consistent concern.

2. The short term volatility of portfolio investments in equities and the obvious asset bubble it has triggered in Nigeria raises at least three questions. First, what is the likelihood that post February 2008 bubble will not be repeated and if so, what are the likely costs? Second, what are the real economic benefits of the portfolio flows? To what extent do the flows increase investments; productivity growth, output growth, employment growth, incomes, consumption or, sustainable reserve growth? Three, what are the opportunity costs and the gains of countering reverse portfolio flows?

3. The threat of portfolio flows in 2013 arises from the fact that (1) asset price bubble is a global phenomenon; (2) financial markets are malfunctioning all over the world (assets and commodities are overpriced and, growth in credit to productive activities is tepid); (3) the quantitative easing regimes in the US, Europe and Japan and the structural changes that loosened the links between finance and the real economy have overtime, considerably weakened if not broken the transmission mechanisms of policies (monetary and fiscal) globally and (4) liberalism appears to have self-fulfilled its prophecy about a dichotomy between financial and real variables: financial variables now have stronger effects on financial variables and very weak effects on real variables even in the short run. More precariously, good real market news (lower rate of unemployment and better than expected real growth) now trigger financial market instability (sell off in anticipation of easing of easing).

4. The fragility of the global economic system was revealed in the last few weeks following Bernanke‟s signal about an ending of QE3. The selloff that it triggered was global and with its exposure, the contagion effects on Nigeria were strong and the mechanism was as expected. This means clearly, that more volatility lie in the short term because easing of quantitative easing is just a question of when not if.

5. It is important for our policy process to recognize that portfolio flows and its volatilities are symptoms of deep seated failures or malfunctioning of markets and of fiscal systems globally also, of a progressive deterioration in the communitarian virtues that built many great economies. It is strategically important therefore, to deal with the underlying causes of malfunctions rather than the symptoms.

6. In recent times, one of the causes of malfunctions in the Nigerian financial system is 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 over-borrowing, 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.

7. The Central Bank is the banker to the government. Government deposits belong with its banker: the Central Bank especially as the Federal Government is committed to a Single Treasury Account. Such a good initiative ought to be successfully implemented because it has many fundamental implications for the economy.

8. A policy of increasing CRR on government deposit will help the government to proceed quickly to the Single Treasury Account. By doing so, the government will better manage public resources, cut down wastes and costs. This will help the fiscal consolidation programme of the government and help government succeed in cutting down deficits and borrowing.

Acting now is important given the inevitability of the end of Bernanke‟s QE3 and the corrections in asset and commodity prices that is most likely to follow. The expected crowding-out of crude exports by shale exports is another incentive for government to cut cost and borrow less now. The expressed desire of the government for lower interest rates is an additional incentive: lower borrowing will reduce borrowing costs and conduce easing.

9. An increase in CRR on government deposits will also “incentivize” the DMBs to seek for deposits from the private sector and, to lend to the private sector.  After all, the DMBs and other organized private sector players canvass for a market driven economy. A dependence on Government Deposits breeds complacency among DMBs. This policy is thus compatible with a market driven economic model. The policy therefore, helps DMBs to rethink their business models which have lulled them into complacent rent seeking behaviours. Complacency is dangerous in a highly volatile world and complacent financial institutions are the least able to survive in a volatile and highly competitive world. Our recent history and, the costs of cleaning up the consequences of complacent mismanagement of the recent past makes it necessary to support DMBs to develop more sustainable business models. A rate of 50% is strong enough but not debilitating. The future direction is sufficiently strong signal for DMBs to quickly change their business model and adapt to new realities.

10. The trends of government revenue, expenditure and deficit in 2013 have been highly volatile around a growing trend for expenditure and deficits. The volatile trend may not be surprising given that the fiscal anchor (oil revenue) is volatile. Yet, it is also, surprising given (1) the adoption of the excess crude account as a stabilizing mechanism and (2) the fact that the “nondiscretionary” component of thebudget is very high. The data indicates (1) an expansionary fiscal policy and (2) over-borrowing in excess of the size of fiscal deficit. Given the size of Federal Deposits in DMBs (about N1.16 Trillion) and Federal Deficits (N413.52) there is no economic reason for the size of borrowing or the extent of drawdown on the excess crude account in the first half of 2013. With better cash management, the Federal, State and Local Governments will require much less credit from domestic and foreign sources.

11. Lower government borrowing will bring fiscal policy into alignment with monetary policy and have downward effects on interest rates, debt service and crowding-out effects. A rate cut in MPR will then be more likely passed on to borrowers. Creating the enabling conditions for a stronger transmission mechanism is a necessary first step to a potentially effective price stability with growth monetary policy regime. In the United States and in the United Kingdom with historically low interest rates, lending to the real sector is low and only carry traders are profiting the most. It is important to counter the adverse effects of “carry trading”. This begins for Nigeria with a fundamental change to the substantial and growing arbitrage opportunities offered by the spread between government deposit and government borrowing.

12. A significant decline in government borrowing will shrink considerably the rent (guaranteed above normal profits) appropriated from the games of government deposits and government borrowing. First, lower levels of government borrowing will directly reduce nominal rates on treasury bills and FGN Bonds. Second, lower guaranteed profits will force DMBs to shift from inverted intermediation to virtuous intermediation that is more likely to expand access at lower cost to investors in real and service activities. The policy thus, is to help DMBs to transit from a precarious rent seeking model to more sustainable business models.

13. The excessive government borrowing has made it very costly to maintain price and exchange rate stability in the last two years. The expected impact of a 50% CRR on government deposit should significantly reduce OMO interventions and reduce considerably the costs of maintaining price and exchange rate stability. The rent from the games of government deposits and the associated games of government borrowing show up as demand for foreign currency in WDAS and interbank market and, as capital outflows in the balance of payments. The data shows that such suboptimal capital exportations have been financed by maintaining balance of trade surplus.

The national account identity implies that when domestic output consistently exceeds domestic absorption, (1) investment is likely to be less than savings; (2) potential output is likely to far exceed actual output and (3) resources (including labor) are most likely underemployed. The costs of the games of deposit-borrowing arbitrage are systemic. Thus, eliminating the costs is critical to enhancing the effectiveness of both monetary and fiscal policies.

14.In my personal statement after the July 2012 MPC I argued for “a creative mix of policies and incentives changing actions to change the financial games to ones in which the rational game in town is one that produces rational reaction functions that (1) enhance the efficiencies of the money, bond and FX markets; (2) deploy liquidity to create rather than destroy money by lending to sectors and activity with highest contributions to output and productivity growth and jobs instead of holding as war chest for speculative opportunities and attacks and; (3) enhances the effective management of liquidity at firm level and economy-wide.” I argued further that the “creative mix” is necessary to (1) limit the capacity of speculative and rent seeking players and activities to damage the Nigerian financial system and economy and (2) empower efficiency driven economic agents and activities.

15. I am convinced therefore, 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.

16. The data also shows that DMBs are maintaining liquidity ratios that are more than 30% above statutory liquidity ratios. In addition, DMBs are maintaining reserves with the Central Bank far in excess of the CRR requirements. Both behaviours are symptoms of the rent seeking business model.

17. In addition to the 50% CRR on government Deposits, I support (1) an asymmetric corridor for Special Deposit Facility (-4%) and Special Lending Facility (2%) and (2) zero remuneration for all CRR. Strengthening the transmission mechanism of monetary policy requires the right incentives. A 10% interest on Special Deposit Facility (SDF) is a disincentive to lending and creation of money. Reducing the returns on DMB deposits under SDF will reduce such deposits. While this may generate changes in portfolio allocations (such as increase in demand for government securities, OMO bills or forex), I am not convinced that the benefits (lower costs and lower incentive for rent seeking) is outweighed by the risks of portfolio realignment. This is more so, since it is not a standalone policy but, complementary to the 50% CRR on government deposit.

18. I am not voting for a rate cut at this MPC for strategic reasons. At this point, changing the business model and correcting the failures in the market is primary. For unless, the transmission mechanism is strengthened, rate cuts will not pass on to borrowers. For instance, the latest data shows that in the last one year (June 2012 to June 2013), only N13.6 billion new loans was extended to the manufacturing sector. In contrast, professional, scientific and technical activities (N61.34 billion) and administrative and support service activities (N31.52 billion) attracted far more. Most worrisome, the DMBs revealed a preference to lend to the top five sectors with highest share of the non-performing loans acquired by AMCON: capital market, oil and gas, general commerce, construction and Transportation. The contributions of these sectors to GDP and employment are minimal relative to agriculture and manufacturing which face the problems of access in addition to the problem of cost.

19. My vote at this MPC is a first step because there are more opportunities for a creative mix of policies to improve the efficiency of markets and the state. Once the arbitrage opportunities in the deposit-borrowing game are eliminated; price stability with job creating growth monetary policy will be feasible.


20. I vote:

i. to raise CRR on government (Federal, State and Local) Deposits with Deposit Money Banks to 50%;

ii. To retain CRR on Private Deposits with DMBs at 12%; and

iii. for an asymmetric corridor of -4% (SDF) and 2% (SLF) around the MPR of 12%

One comment

  1. Ibezim Okehie · · Reply

    Another interesting post! I congratulate you on your ability to get at all this primary source information.

    Personally, I THINK I agree with the Prof. Garba.

    1. I believe interest rates should be cut.

    2. The debt profile of govt is a scandal…..whether the debt is foreign or domestic. Just the servicing costs of the debt is a needless waste.

    3. As would be implied by an interest rate cut, the naira should be devalued and REDENOMINATED.

    I would at this point even consider adopting the US dollar as the official currency and be done with this constant battle to maintain a viable national currency. Either that or insist that buyers of Nigerian goods and resources (mostly crude oil, of course) should pay in NAIRA.

    Probably doesn’t make sense, but that’s my own.

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