November 2017 MPC – Abdul Ganiyu Garba

My favourite MPC member had a lot to say at his last monetary policy meeting. Hope you enjoy it.

GARBA, ABDUL-GANIYU

Decision

  1. My vote is similar to the one I offered in my September 2017 personal statement except that instead of a 50 basis point rate cut, I vote to reduce the MPR by 100 basis points (1%). This implies (i) a reduction in the MPR from 14% to 13% and (ii) a reduction in Standing Lending Facility (SLF) from 16% to 15% and the Standing Deposit Facility (SDF) from 9% to 8%.
  2. My vote is still a vote for (i) consistency and effectiveness of monetary policy; (ii) growth in private investment, creation of new jobs, output growth, financial system stability and medium term macroeconomic stability; (iii) a shift from passive monetary policy (Hong Kong Model) to an active and truly independent monetary policy (Chinese Model); (iv) substantive medium term macroeconomic stability rather than a superficial (whited sepulcher-type) short-term stability and (v) a gradualist approach to the shift from passive to active monetary policy regime.

Justification

  1. My justification is also similar to the one in my September 2017 personal statement. I will therefore provide highlights of my justification and reemphasize the requirements urgently moving along the three interrelated strategic and policy pathways: low inflation conducive to growth, financial system stability (FSS) and fiscal prudence or discipline.
  2. Because this is the last MPC of 2017, I will start with a brief evaluation of the policy environment compared to this time last year. The evaluation and the outlook for 2018 give further context to my vote.

A Brief Review

Year 2016 was a very difficult year for monetary policy, fiscal policy, financial markets, the macro-economy and the well-being of Nigerians. The economy was technically in recession in the second quarter of 2016 and persisted through the first quarter of 2017. However, the economy had been slowing down since 2014. The headline, food and core inflation rates rose sharply by 93%, 64% and 103% in 2016 compared to much smaller growth of 20%, 15% and 44%, respectively in 2015. Money supply (M1) was expanded from N6.9 trillion in December 2014 to N8.6 trillion in December 2015 and to N11.3trillion in 2016. This means that money supply rose by N4.4 trillion between December 2014 and December 2016: a phenomenal growth of 64% within 24 months! In the same period, Headline, food and core inflation rose by 131%, 90% and 131% respectively. A plot of inflation and M1 show a strong tracking of inflation path by the path of money supply in the 24 months between December 2014 and December 2016. The rate of expansion in M1 between 2014 and 2016 points strongly to a strong discordance between the restrictive monetary policy regime of the period and the growth of monetary supply. The main driver of M1 growth is “Central bank demand deposit” which rose from N217.05 million in December 2014 to N3.25 trillion in December 2016. This level of liquidity injection did not justify the increases in MPR and short term interest rates. Neither did it help the goals of price stability, stable exchange rates, investment and output growth or reduction in unemployment. The high growth in inflation to more than twice the upper bound of 9%; the loss of international value of the naira, the high spread of N150/$ depreciation, the recession, the rising unemployment and the incredible growth in public debt are not independent of the revolving door of liquidity injections and liquidity mop-ups.

As I emphasized in previous personal statements, such expansionary growth in money supply are not compatible with a restrictive monetary policy regime or with its associated high interest rates, prohibitive costs of liquidity management or adverse effects on fiscal policy. Between the fourth quarters of 2014 and 2016, respectively, total public debt stock rose by N6.64 trillion from N7.90 trillion. The fiscal problem posed by such phenomenal growth in public debt is beyond the issue of crowding-out to a question of sustainability because at this rate of growth of public debt and the high interest rates, public revenue will not be enough to pay for debt service.

In the first ten months of 2017, the economy exited technically from recession. Any excite however, is premature. First, the economy is far from its level in third quarter of 2015 and is yet to match the growth rates before growth slowed down. What is more fundamental is that the celebrated growth in the third quarter of 2017 of 1.4% was due mainly to growth in oil GDP (2.09%). Despite the growth in Agriculture (0.88%) driven by harvests of crops; non-oil GDP contracted by -0.76% with services (-1.02%), trade (-0.29%) and manufacturing (-0.26%) the lagging sectors. A clear headed analysis would indicate that by excluding the oil and gas, the economy was back to negative growth from the 0.72% in first quarter and 0.45% in the second quarter of 2017. Furthermore, though employment data are not available, it is safe to infer that the upward trend of unemployment from first quarter of 2015 will continue into 2017 and that current unemployment rate will exceed 14.2% and that the most active population aged 15-40 years will account for a disproportionately higher share of the unemployed.

The stock market has rebounded from the lows of 2016, when All Share Index (ASI) shed 6.2% and market capitalization declined by 6.1%. In the 10 months of 2017, ASI rose by 36.5% and market capitalization by 37.3% or N3.45 trillion. It is worthy of note that the stock market is in its third bubble since 2006: 2006- 2008; 2012-2014 and from April 2017. The growth in the stock market were not driven by economic fundamentals, but by policies that attracted portfolio flows and, by the inflows of portfolio flows. The high yields offered portfolio investors and a relatively stable exchange rate at less than half its international price at the end of 2014 offered portfolio investors a riskless and high return investment option that was hard to resist. As a result, portfolio flows began to rise from April 2017: from $57.5 million in March to $119 million in April and steadily to $1.32 billion in September.

The fiscal operations is characterized by an abnormally significant growing fiscal deficits and public debts. In the first three quarters of 2017, the public debt was 77% higher than it was last year, when it was about N1.512 trillion. In the same period, public debt rose by N2.65 trillion or 18.2% in just 9 months! The growth in public debt in the first nine months of 2017 is already 114.2% of the total borrowing plans for 2017 and 112.2% of projected deficits for 2017. The high and unusually generous interest rates used to attract portfolio flows into treasury bills, treasury bonds and FGN bonds auctions are causal to the growth of public debt stock and money supply, which tend to exert crowding-out effects on credit to the real private sector and to public spending on social and economic infrastructures. Every y naira of new public debt at x interest rate grows the public debt by y*(1+x) n. The higher the values of y and x and n the higher the public debt and money supply. For every y Naira of public borrowing, public debt grows by x*y. Keeping x high (via restrictive monetary policy) and y high (through lax fiscal spending), causes the public debt to grow at the risk of fiscal unsustainability, financial system instability, negative growth and high unemployment especially when the employment and output elasticities of government expenditure are very low. Clearly therefore, restrictive monetary policy and lax fiscal policy are great threats to effective and efficient macroeconomic management. In the same period (January to September, 2017), the Federal government spent N1.24 trillion to service domestic debt. With a growing appetite for external debt developing in complete disregard to the experience of 1978- 2006 and the costly road shows and financial service costs, the growth of both public debt and public debt service next year would most likely exceed that of 2017. It is thus obvious that the fiscal challenges are extending beyond the usual crowding-out effects to a problem of fiscal unsustainability: a point where revenue may not be sufficient to pay debt commitments.

In my outlook for 2017 in my January MPC personal statement I wrote: “Year 2017 will be very challenging for macroeconomic management globally and for global markets because of heightened uncertainties due mainly to political and associated economic risks. . . . The domestic outlook indicated by the fiscal deficit, the structure of expenditure, revenue shortfalls, high levels of public debts and the crowding-out effects of public debt service and public borrowing on private sector investments and current account deficits make for a difficult 2017. The challenges of sourcing credit within and outside the Nigerian economy may exert pressures on the growth in money supply. Yet, as 2015 and 2016 clearly show, it would be damaging for the credibility of monetary and fiscal policy to allow M1 match the growth of previous years. It would significantly damage the purchasing power of the naira domestically and internationally and destabilize the economy. There is also, the challenge of twin deficits (fiscal and current account) and ensuring financial system stability to contend with.” Indeed, as the review suggests, despite the positives (slower growth in M1, rise in price of crude oil, managed stability in the exchange rate, decline in headline inflation caused mainly by fall in core inflation), 2017 was a difficult year for Nigeria. The costs of creating an enabling environment to attract portfolio flows is unlikely to justify the benefits of portfolio flows at least in the medium term. Two previous episodes of capital market bubbles (2006-2008 and 2012-2014) triggered by capital account liberalization and portfolio flows had devastating effects on the capital market, money market, external account, forex reserves, exchange stability, inflation, investment, public debt, public deficits and structure of public expenditure. The game of attracting portfolio is a very risky gamble as it was in 2006-2008 and 2011-2014.

Outlook for 2018

Bank staff suggest that inflation is likely to trend downward and the exchange rate would be stable provided that oil output and prices rise, the Investment and Export window remains stable and portfolio investors continue to pour their capital into Nigeria. The perennial challenges (crowding-out of the private sector, growing costs of liquidity management, low financial intermediation and so on) are likely to persist.

Political activity will dominate 2018 as we count down to the 2019 elections. Politics tend to correlate positively with money supply and exchange rate and inflationary pressures. Thus the political premium is likely to be positive and significant. With the balance sheet normalization plans of the US Fed well underway and inflationary pressures expected to rise significantly in 2018, the economic premium is also likely to rise. Hence, the risk of capital reversal is very high. A macroeconomic management strategy hinged on portfolio flows is badly flawed. Two major episodes of portfolio flows related bubbles have provided more than sufficient empirical evidence about its destructive payloads. I can hardly find any reasonable empirical support for a strategic support for a third capital market bubble in just over a decade!

The combinations of heightening political and economic risks dooms a monetary policy pivoted on attracting portfolio flows in 2018. It has been suggested that cutting the MPR now is premature because the inflation rate is still high at 15.91%. The fact however, is that the link between MPR and inflation broke down with the introduction of Hong Kong Model: capital account liberalization and exchange rate stabilization. Proof: at the onset of restrictive monetary policy in September 2010, headline inflation was 13.6% (August 2010) while MPR was 6%. In 2012, MPC fixed the target headline inflation band with 6% as the lower bound and 9% as the upper bound. By the time headline inflation fell within the band in January 2013, the MPR was stable at 12%, a rate that was fixed at the emergency MPC Meeting of October 2011. For 29 months (January 2013 to May 2015) headline inflation did not exceed 9% yet, in November 2014, MPR was increased to 13%. The increase was a response to pressures on the exchange rate and was in defense of the exchange rate. Practice and theory both affirm that a passive monetary policy in a small open commodity dependent economy with capital account liberalization and fixed exchange rates surrenders active and independent monetary policy. The resulting passive monetary policy not only helped handicap the economy, it is more likely to undermine the economy through high interest rates required to keep portfolio investors excited. The fear of capital flight locks policy to a high interest rate regime. Yet, what portfolio investors provide are whited sepulchers for reserves; and exchange rate; and the capital market. Sooner rather than later, the white paint wears off and the truth about the sepulcher becomes very obvious. I cannot support a temporary coat of paint that will sooner wash away by the political and economic realities of 2018 and beyond.

What has not changed?

  1. My conviction about the importance of urgently finding sustainable paths to low inflation growth conducive to job creation and economic growth, financial system stability and fiscal prudence are the most urgent strategic and policy priorities building on the “March MPC Retreat”. “Can two walk (and work) together unless they are agreed” (Amos 3:3). The answer is a resounding no! A person with two legs will be foolish to walk only on one leg. He/she will also be foolish to set the two legs in competition with each other causing them to constantly disagree about which directions to go.
  2. The foundations of the March Retreat in the following three key area remain fundamental: (i) the relationship principles of humility, sincerity and integrity; (ii) the organic links between fiscal, monetary and prudential policy and the urgent necessity for interdependent and coordinated strategic and policy analysis, choices and actions and (iii) the urgent need for coordinated and effective movements along the three pathways: low inflation conducive to growth, financial system stability (FSS) and fiscal prudence or discipline.
  3. The growing costs of ignoring the lessons of Nigerian and global economic history to the present and the future of Nigeria. Failure to learn from mistakes
  4. The macroeconomic challenge remains overwhelming: (a) a tentative exit from technical recession driven by oil GDP – a long way from recovery to 2014 level let alone growth from 2014 level; (b) an unemployment rate of 14.2% as at 2016:Q4 (likely to be higher given the trend); (c) a 0.04% fall in headline inflation driven by seasonal effects, which caused a decline in food inflation of 0.03%, partly offset a 0.1% rise in core inflation; (d) a N2.01trillion rise in public debt, a Federal deficit of N1.9 trillion in the first 8 months, debt service of N1.58 trillion (2.4 times the spending on capital project); (e) rising maximum lending rate to 31.2% (by 0.26%) and prime lending rates of 17.69% (by 0.04%) and widening interest rate spread to 26.95% (from 26.83%); (f) a very active revolving door of liquidity – pumping in and mopping out; (f) collapse of the interest rate corridors which makes Standing Lending Facility and Standing Deposit Facility rates redundant as effective monetary policy tools; (g) 32.1% growth in All Share Index driven mainly by banking stocks (58.6%) and Consumer Goods (31.81%) that are in turn powered by (h) a monthly average growth in portfolio and FDI investments in the capital market that averaged 52% between April and August 2017.
  5. The unresolved issues: (a) a forward looking medium to long term strategic macroeconomic management framework for Nigeria as the context for policy analysis and choice; (b) continuing malfunctions in the credit market which tends to allocate credit to sectors with traditionally high NPLs and low output and employment elasticities as well as a tendency to restrict access and to charge maximum rates on credit to sectors and economic agents with traditionally lower NPLs and higher output and employment elasticities; (c) the dominance of rent havens in both the real and financial sectors, and the public space; (d) prevalence of present hedonistic and backward looking orientation and (e) inefficient and ineffective use of existing Nigerian capacity in all aspect of the political economy.
  6. The Hong Kong model within which monetary policy has been conducted since January 2012, which uses high interest rates to attract portfolio flows while hurting domestic investment, growth, employment and expanding public debt and money supply and distorting the structure of public expenditure and reducing its output and employment elasticities of public spending. The case against reducing interest rates has less to do with the inflation rate than with fears about possible reversal of portfolio flows. The questions we must answer include: which is best for growth and employment: portfolio flows or domestic investment? Is portfolio flow more stable and heavier than remittances? Does portfolio flows have higher employment and growth elasticities that remittances? If the answer to the questions is a resounding no, a strategic policy overhaul is imperative.
  7. My preference for the Chinese model as a better option to the Hong Kong model. I still believe that the Chinese model limits vulnerability to destabilizing financial flows and frees monetary policy to support growth, employment, financial system stability and lower fiscal imbalance. Finally 8. My vote is still for a gradualist approach in a shift from an outwardoriented passive monetary policy to an inward-oriented independent monetary policy. 9. A 100 basis cut in MPR is still, just a first step on the paths to low inflation conducive to growth, financial system stability and fiscal prudence. It should be a consensus point on which the monetary and fiscal authorities could build on to produce a consistent forward looking strategic framework for coordinated, effective and constrained monetary, prudential and fiscal policies

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