Stagflation And The MPC’s Dilemma By Uchenna Uwaleke

Perhaps, nothing better captures the dilemma faced by the Monetary Policy Committee when it met in July than the fact that unlike in the previous meetings held this year, members of the MPC, as their voting pattern showed, were divided on the appropriate response of monetary policy to the current challenge of stagflation (a situation of rising inflation and declining economic growth) facing the Nigerian economy. Recent data from the National Bureau of Statistics indicate that inflation rose from 15.58 per cent in May to 16.48 per cent in June. The NBS had earlier reported a negative output growth of 0.36 per cent and unemployment rate of 12.1 per cent in the first quarter of 2016.

At that meeting, the fourth this year, members were split between those in favour of raising the Monetary Policy Rate to tame inflation and those in support of holding it to help protect the economy and jobs from a further downturn. Eventually, the “hawks” won the “doves” thereby signalling further tightening of monetary policy. By a vote of five to three, the MPC decided to increase the Monetary Policy Rate from 12 per cent to 14 per cent. By so doing, it opted to tackle inflation at the expense of restarting growth even after recognising that “tightening at this point would only serve to worsen prospects for growth recovery.” Justifying the decision to raise the bank rate, the MPC took the view that the negative real interest rates in the economy on account of high inflationary trend “did not support the recent flexible foreign exchange market as foreign investors attitude had remained lukewarm, showing unwillingness in bringing in new capital under the circumstance.” And since in its own assessment, “the balance of risks remains tilted against price stability”, the Committee was mindful not to “undermine its primary mandate and financial system stability.”

Much as a rate hike would assist in the management of the new forex regime by attracting foreign investments resulting in improved liquidity in the forex market, recent global developments such as the widespread uncertainty created by Brexit, will keep foreign investors on the sidelines for a while. Therefore, the expected foreign investment inflows may not materialise to a significant level any time soon.

While in one breath, the MPC admitted that the current episode of inflation was largely a reflection of structural factors such as high cost of electricity, fuel, transport, as well as high prices of both domestic and imported food products, in another breadth, it reckoned that inflationary pressure was increasing and that it would be risky not to hike rates at this time. The painful truth is that the Nigerian economy has shown little evidence of a positive response to monetary policy tightening in times of declining output. For example, in response to the uptick in headline inflation to 11.4 per cent in February from 9.6 per cent in January, the MPC had in March 2016 voted to review the MPR upward from 11 per cent to 12 per cent as well as the CRR from 20 per cent to 22.5 per cent. In spite of this, headline inflation continued an upward trajectory rising to 12.77 per cent in March and 13.72 per cent in April. In fact, the weak response of inflation to monetary policy tightening since 2016 suggests that indeed prices are “sticky downwards”, to borrow from Keynesian economics, and that another round of tightening would lead primarily to a further contraction in GDP.

The persistent upsurge in inflation under normal circumstances should warrant an increase in policy rate. However, in a situation of stagflation as we have in Nigeria currently, there is a substantial body of knowledge that supports the view that increasing the bank rate will be counterproductive. The banking sector will be adversely affected. The increase in MPR will automatically lead to another round of credit squeeze within the banking system as the CBN had in June 2016 withdrawn substantial domestic liquidity through the foreign exchange market following the introduction of the flexible foreign exchange market regime.

As noted by Fitch, one of the world’s leading rating firms, “rising rates are likely to put additional pressure on banks’ asset quality”. Commercial banks are going to reprice their loans with borrowers facing more difficulties in servicing their debts resulting in an increase in the rate of non-performing loans. The real sector of the economy will suffer as banks show preference for placing their funds in high yielding government securities. Many small businesses will suffocate under a harsh environment occasioned by the high interest rate regime leading to loss of jobs.

The increase in the MPR will also jerk up the cost of servicing the country’s public debt as bond yields go up especially in view of the fact that domestic debt constitutes a significant proportion of the country’s public debt stock. Similarly, the stock market will be impacted negatively as equities become less attractive to portfolio managers as an asset class due to increase in bond yields and fall in bond prices. The marginal gains recorded in the equities market during the few days that followed the announcement of the MPC decision was more from investors’ reaction to half year results released by some quoted companies. In the coming weeks, without a counter fiscal stimulus, the bears will most likely hold sway in the stock market.

Indeed, the 200 basis point hike in the MPR inspires little hope of early economic recovery as it is capable of further dragging down growth contrary to the government’s expectation that the negative growth will be short-lived. Unfortunately, the unintended consequences of the MPC decision will stay with the economy for a while – at least till the next scheduled meeting of the MPC sometime in September when it gets another opportunity to review the situation. In the meantime, the attendant risks of the rate hike can be mitigated by appropriate fiscal policies aimed at stimulating growth.

Improvement in electricity supply is critical to driving growth. The electricity distribution companies are complaining of insufficient power to distribute partly on account of disruptions in crude oil and gas production in the Niger Delta. The government should move fast to address this challenge through proper engagement. Also, great effort should be made to implement the capital component of the 2016 budget especially as it affects power, transport and agriculture. Recoveries of looted funds can be funnelled to these areas to cover for present shortfalls in revenue.

It is time to recognise that monetary policy cannot achieve much in a period of stagflation without complementary fiscal policies. To this end, the CBN Governor, Godwin Emefiele, should be holding regular meetings with the Minister of Finance, Kemi Adeosun, with a view to harmonising monetary and fiscal policies.

Uwaleke, a chartered banker, is an Associate Professor of Finance and Head of Banking & Finance Department at Nasarawa State University Keffi.

Punch

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