Monday, August 8, 2016

Nigerian Economy: The Blind Leading The Blind

By Henry Boyo
A seemingly responsible fiscal plan will become unimplementable, in the modern era, if the underlying monetary indices are out of sync with budget projections. Conversely, the stubborn sustenance of appropriate monetary benchmarks for inflation, cost of funds and exchange rate may still rescue the performance of an otherwise bad budget.
 Buhari For example, if salaries and other incomes double or triple summarily, as happened during the Udoji salary awards of the 70’s, prices will spiral beyond the comfort level of consumers, as the liberal Naira supply chase the relatively modest output of goods and services on offer. Evidently, if inflation rate for example, approaches 20%, as in our present predicament, then we would all have lost a fifth of the purchasing power of our salaries and incomes.   

The dwindling purchasing power caused by inflation will invariably erode consumer demand for goods and services, and also constrain domestic industrial output, while further investment decisions will ultimately be kept on hold. Thus, in addition to a significant loss in real income values and deepening social poverty, an uncontrolled inflationary spiral will severely challenge the implementation of any fiscal plan that does not accommodate the prevailing rate of inflation; for example, the clearly recklessly ambitious 2016 N6tn budget, has become difficult to implement because of reduced revenue and significant Naira devaluation that has increased local production cost and further spurred inflation closer to 20%.

 For the above reasons, Central Banks, in successful economies everywhere, endeavor to sustain strategies that will keep money supply at an equilibrium level that will not push inflation rate beyond say 3-4%, so as to conserve price stability. Similarly, if foreign exchange is in short supply and auctioned in a market where Naira supply is constantly in excess, the local currency will, invariably depreciate in value, and also make all imports (including industrial raw materials) correspondingly more expensive. Furthermore, the competitiveness of local enterprise will become even more seriously challenged, if CBN’s MPC decides to counter inflationary pressures by increasing the rates at which commercial banks borrow from the CBN to as high as 14-16% as per their recent position in July 2016.

The preceding narrative hopefully explains the need for best practice management of money supply to avert the disenabling and distortional consequences of spiraling inflation in the economy. Clearly, horrendous inflation rates above 20% will seriously challenge any attempt to diversify any economy or foster inclusive economic growth. Indeed, if the inflation rate remains untamed, the Naira’s purchasing power will become seriously diminished and the N1000 note may ultimately be worth less than a dollar. Price stability is threatened and the economy will invariably underperform whenever the CBN readily admits its unending engagement in a very costly battle against perceived systemic surplus Naira.

So the critical questions should therefore be, what causes the evidently systemic excess Naira liquidity and why is CBN losing the battle to wrestle inflation to best practice rates below, say 4% and protect our incomes and industries. Naira supply will obviously increase if government continuously prints more Naira or borrows heavily without caution to fund its budget, as clearly demonstrated in the 2016 budget structure. Furthermore, Naira supply also increases inordinately, whenever government’s forex receipts are directly substituted with fresh Naira supply as allocations, while CBN keeps and auctions the dollars. Fortunately, the CBN also has the option to modulate money supply by establishing appropriate cash levels which banks must retain in relation to their assets.

Thus, the amount of spendable Naira will increase if banks are mandated to keep only one percent of their reserves as cash; in other words, even though such low rate of cash reserves will increase the level of risk, it would, however, provide banks with the increased capacity to extend more loans to borrowers. Nonetheless, the increase in spending from such loans will inadvertently instigate a mismatch with the inadequate supply of goods and services to sustain inflation and evoke the adverse consequences earlier discussed above. The persistent presence of excess Naira supply and the adverse collateral of spiraling inflation generally compels the imposition of higher mandatory cash reserve ratios so as to reduce credit liberalization and restrain spending while also improving the risk cover for all banks.

Alternatively, the CBN may resort to borrowing the perceived surplus cash in commercial banks’ custody (this process is described as CBN mopping up of excess liquidity) so as to prevent liberal bank credit which could drive consumer spending and propel higher inflation rates in a market already characterized by much more cash than output. For example, by December 2015, the CBN had already concluded that it would mop up of over N6000bn from the systemic cash surplus projected in the 2016 fiscal year, despite the attendant oppressive cost to government.

Regrettably, the average interest on these CBN loans is about 10%; thus, banks and other portfolio investors will earn easy returns of over N600bn for adding absolutely nil value to the economy, from their purchase of government treasury bills. Over the years, the CBN has disturbingly shown more affinity for using the instrument of liquidity mop up, despite the collateral of its crushing national debt burden; conversely an increase in the mandatory cash reserve requirement for all commercial banks, even beyond 70% if necessary, would similarly mop up excess liquidity, ironically at zero cost. Inexplicably, therefore, despite the crying need of the real sector, particularly SMES, for cheap lonable funds to drive their businesses and increase the rate of employment, the CBN inexplicably still engages in a process that in fact fires inflation and impedes inclusive growth and increasing job opportunities by reducing the availability of cheap loanable funds to businesses.

It is notable that the N6trn plus that will be borrowed for liquidity mop up by CBN this year cannot be dedicated or applied to any capital or recurrent expense; indeed, such application will be counterproductive, and simply amount to re-injecting more liquidity into a market, that is already clearly seriously encumbered by the subsisting stock of admittedly bloated money supply, which will drive inflation beyond the comfort zone for everyone.

Furthermore, the CBN also instigates higher cost of funds to all sectors by increasing the rate at which the Apex bank lends to commercial banks to augment their cash needs from time to time. Indeed, this monetary strategy becomes self flagellation, as the Apex bank also becomes a victim of higher interest rates whenever it sells Treasury Bills to reduce the unyielding systemic Naira surplus and counter spiraling inflation, which truncates our expectations for inclusive growth, improved social welfare and increasing job opportunities nationwide.


*Henry Boyo, an economist, is a commentator on public issues 

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