Central Bank Policy, Inflation and Depreciation

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Last week, the Central Bank of Nigeria raised the policy rate again, in line with public forecasts, but in defiance of the World Bank’s warning. The bank justified its action on the grounds that there is too much money in the economy which is fueling inflation due to more money for few goods. The rate was increased by 150 basis points, from 14% to 15%. This position aligns perfectly with the monetarists’ thesis on inflation in which they postulated that inflation is first and foremost caused by money. The questions we need to ask ourselves are: Who is responsible for the economy’s excess money in the economy? Where is the excess money? Is excess money really the cause of inflation in Nigeria? If not, what are or are the causes of inflation in Nigeria?

The central bank of any country is responsible for issuing the national currency like naira and monitoring the amount of currency in the economy. In fact, the traditional view is of the view that the central bank has supremacy in determining the quantity of money in an economy given its tools and techniques that can be deployed to control money creation by banks and money in the hands of the non-banking public. A modern view, of course, repudiates this supremacy by stating that the activities in an economy determine the demand for funds from banks by the non-banking public, which invariably prompts banks to create or not create money.

Of course, it is the money of the banking system that the central bank can control and not that held by the non-banking public. Some of the money would be held secretly while some would be held openly for transactional purposes, especially in developing countries where the spread of banks is limited and where they exist they are largely inefficient. In developed economies, financial inclusion is entrenched and people barely touch money since they can use their credit cards or ATMs to make payments. The central bank naturally has greater control over the currency in circulation. This is not the case in developing countries which have a limited range of financial instruments and financial institutions. This is where Nigeria falls.

The CBN knows how much money it has issued or the amount of money in the economy, but it doesn’t seem to know who holds the money or where the money is kept. The public shouts that there is a shortage of money for transactions. State governments are unable to pay salaries due to a lack of funds, but the CBN is concerned about high levels of cash in the economy. This shows a lack of understanding of the Nigerian economy or an official claim.

Besides the underdevelopment of the financial system in developing countries, many illegal transactions, mainly bribes and corruption, cause avoidable disruptions. These illegal transactions take place in foreign currencies rather than in paper or electronic money financial instruments. These currency transactions are usually done to avoid tracing the movement of huge funds through the banking system and the resulting queries to the country’s anti-corruption agencies. Many of those who steal our money have private lockers for that money. In many cases, they have specially built secret safes for local and foreign currency respectively in their homes.

Explaining the actions taken so far by the bank’s monetary policy committee on increasing the MPR over time to curb inflation and bolster fragile economic growth, the CBN said that “the amount of money in the system was too large for the economy to absorb”. A CBN spokesperson attributed the high level of liquidity to stimuli introduced internally through the CBN and externally through the use of dollars since the time of COVID-19 and even the current war between Russia and the Ukraine. The inability of the economy to absorb such a large amount of funds, the bank explained, fueled inflation. The CBN was just looking for an alibi as he is the main culprit and maybe trying to play on Nigerian insiders. How?

For the past five years or so, the CBN had been engaged in financing by its ways and means the government’s exaggerated budget deficit. The government can finance its deficit by domestic borrowing via bonds and notes for example; through external borrowing from development finance institutions such as the World Bank Group, African Development Bank Group; through private commercial banks in the Euro-dollar and Euro-bond markets; through bilateral/multilateral credit arrangements; by raising taxes and through ways and means otherwise known as direct borrowing from the central bank. This last source is little used because it is inflationary. Invariably, the government can decide to borrow from all sources simultaneously if it is running the kind of phony budget we are implementing in this country. We refuse to cut our coat according to our fabric size and do not adopt ‘unusual business’.

As soon as it became increasingly clear that external funding sources were drying up, the CBN and the Debt Management Office, having pledged to assist the federal government in its debt accumulation mission, have partnered to mobilize loans from domestic sources. While the DMO raised funds for investment projects through monthly bond sales and sukuk bond channels, the CBN supported the government with its direct loans. Direct lending is not backed by production but by consumption and theft because the money has been used largely for recurrent expenditures of the annual budget schedule. The beneficiaries of spending are politicians, civil servants and businessmen. Some of them, being paid huge salaries or overpaid for work done or not done! Ultimately, some of the money goes to the foreign exchange market to buy foreign currency and depreciate the naira gradually or massively while some is kept in personal coffers to be used during campaigns leading up to elections. And, let me welcome you to the period.

This is where the CBN comes in as the architect of the inflation and massive naira depreciation we are witnessing today. The CBN prevents banks from creating money and lending at high rates so that by the time it unloads its credit to the government, the economy will not be overheated or flooded with excess liquidity. After the MPC, I commissioned an economist to help perform an econometric analysis of the effects of money supply, MPR and exchange rate depreciation on inflation in Nigeria using monthly data for 39 periods. Preliminary results show that naira depreciation is fueling inflation largely among the three, unlike money supply and MPR. Other structural factors are also fueling inflation.

In economics, raising interest rates as undertaken in some countries earlier and by the CBN monetary policy committee last week is capable of a number of benefits if we are dealing with a developed economy with a convertible currency. Rising interest rates can lead to capital inflows from other countries to improve reserves and the balance of payments, as well as to strengthen the value of the national currency. It should encourage domestic savings, thereby making funds available to investors. But high interest rates would normally discourage investors from borrowing from banks and they turn to the capital market, invariably making the market active and profitable. Such a situation may encourage portfolio investments or investments in financial instruments.

These benefits cannot be realized in Nigeria at the moment. The rationale is that Nigeria has a very weak and non-convertible currency to attract foreign direct and portfolio investment. Investors, for example, know that when they make profits to be sent home, the value would be very low given the massive depreciation. A high MPR cannot attract savings because the high rate is normally reflected in loans rather than savings. Nigerian investors are forced to borrow at a high cost which is passed on to price formulation, making Nigerian-made products uncompetitive in international markets. Let the CBN be clear, let’s stop lending to the government with the inflationary pressure and currency depreciation that comes with it, but let’s make the government more responsible in its fiscal policy. This may force the government to go back to production and change those unpleasant narratives.

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