So What If The CBN Drops Its Benchmark Rate By 50bps? -By Uddin Ifeanyi

One of the highlights of children’s birthday parties back in the 1970s was the moment the amateur magician entered the room. Nearly always male (and often a lumbering uncle or much older cousin), he held his trusting audience in awe with various acts of conjuration. Invariably, the entrance theme song, chorused with gusto by so many young voices, either reminded you that “The more you looked, the less you saw”, or invited you to “Come and see American(?) wonder”!

This party metaphor plays more than a cameo role in one of the most powerful descriptions of the role of central banks in an economy. William McChesney Martin, Jr. (chairman of the United States Federal Reserve Bank from April 2, 1951 to January 31, 1970) once observed that “The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up”.

Listening to the Central Bank of Nigeria (CBN) explain the recent decision by its policy committee to reduce the benchmark rate by 50 basis points, you’d be forgiven the sense that the apex bank’s Monetary Policy Committee (MPC) was simply instructing that the now-proverbial punch bowl be returned to the party just as signs of waning interest begun to emerge. You wouldn’t be in bad company, either. For since the decision to pare rates was announced by the CBN, the airwaves have been given to pundits and chaperones of diverse competence, lauding the central bank for its decision to support domestic economic growth by boosting bank lending.

Given that at 6.41 per cent bank lending to the private sector is currently below the apex bank’s target of 9.41 per cent, any boost to lending growth ought to be welcome. However, you don’t need to be a magician of the 1970s vintage to understand that there’s less to the apex bank’s decision than meets the eye. You only must be far more disbelieving than were partying five-year olds 40 years ago.

The last time the MPC adjusted its benchmark rate was on July 26, 2016. In the intervening period, the party that’s the domestic economy has rapidly iced over, defrosted slowly, and warmed up a bit. If the monetary policy rate (MPR) were as important as some sections of the commentariat would now have us believe, it would have required a special category of enchantment to have stayed flat through this topsy-turvy trajectory.

I have argued that as a policy signalling tool, this disconnect between the CBN’s main policy lever and every other domestic economic index is the bane of our monetary policy management. Because it ought to be at the heart of what is described as the “monetary transmission mechanism”, and the latter is crucial for anchoring inflation expectations, it is no surprise that the apex bank continues to struggle with its main remit of keeping domestic prices stable.

Why does it matter that inflation expectations are properly anchored? In a recent IMF working paper, Rudolfs Bems and three others argue that “In economies with a strong anchor, expectations for inflation over a sufficiently long horizon should be centered around the explicit or implicit target and hence not react to transitory fluctuations in actual inflation or in short-term inflation expectations”. On the other hand, the monetary transmission mechanism is “the process by which asset prices and general economic conditions are affected as a result of monetary policy decisions.”

If, as is so obviously the case, the MPR stopped playing its role as a tool for managing asset prices and general economic conditions a long time ago, how (despite this) has the CBN conducted monetary policy? It’s at this point that our magicians, so many years ago, would have invited us to “Come and see American wonder”! In the same statement in which the CBN announced its more accommodative monetary policy push, it purports to retain the cash reserve ratio (CRR) at 22.5 per cent.

A bank’s reserve comprises cash belonging to it and on its account with the central bank. In the Nigerian case, the 22.5 per cent means that of every N1 of deposits raised by a bank, it must hold 22.5 kobo with the CBN. It, thus, has only 77.5 kobo for lending. An increase in banks’ cash reserve ratio, simply by contracting banks’ liquidity, means that they have that much less to lend to their customers; and vice versa.

Now, over the nearly three years that the MPR has remained inert, the CBN has fiddled with the banks’ reserves in a way that shades most thaumaturgists. As banks’ deposits rose, their reserves with the CBN rose, but as deposits fell through those hard times, the CBN failed to return the corresponding portion of these reserves. Effectively, therefore, some banks in the country face a CRR rate of close to 33 per cent. In other words, they are only able to lend 67 per cent of their entire deposits.

I know of many, competent in these matters, who would argue that there’s absolutely nothing wrong in using the reserve requirement as a tool for managing levels of borrowing and interest rates in the country. True, central banks in Europe and north America long abandoned its use; preferring, instead, to drive interventions in the monetary space through open market operations. But, after all, The People’s Bank of China, central bank to the world’s second biggest (and still growing) economy, uses the reserve requirement religiously.

The devil in the counter argument is in the sleight of hand undergirding the CBN’s apparent recent policy switch. The whole point of the magician’s craft is to divert attention to non-essential details while carrying out the switch (that’s the “magic”) behind the plethora of smoke and mirrors. Effective! But hardly transparent. And for an economy in the dire straits that ours is in, and in need of all the help it can get, opacity in its management is a borderline crime. Not just does it make planning by domestic entities impossible. It conceals the lack of competence of managers of the economy in their respective spheres.

Put differently, and until the CBN reverses this policy, domestic monetary conditions remain tight. Why then the ruse around the 50 basis points reduction in the MPR? Simple. Whereas the party to which William McChesney Martin, Jr. alluded had (and still has) adults in it, the party to which the CBN has to chaperone has a surfeit of five-year olds. Baying for magical solutions to the nation’s problems. And unable to look beyond what’s on offer.

Uddin Ifeanyi, journalist manqué and retired civil servant, can be reached @IfeanyiUddin.