By Kayode Tokede
A member of the Central Bank of Nigeria’s (CBN) Monetary Policy Committee (MPC) has said excess liquidity in the banking system is a real threat to the stability of the naira exchange rate just as it is to inflation.
The MPC members in January had voted to change the Cash Reserve Ratio (CRR) from 22.5 to 27.5 per cent in a move to curb inflation and address risk of excess liquidity in the banking system.
The nine members also retained the Monetary Policy Rate (MPR) at 13.5 per cent and retain the Liquidity Ratio at 30 per cent.
The Deputy Governor, Corporate Services, CBN, Edward Adamu in a his personal statement said the naira exchange rate remained stable in 2019 just as interest rates moderated especially following the implementation of a minimum loan-to-deposit (LDR) for banks in the second half of the year.
He said, bolstered by increased liquidity and a variety of structural constraints, consumer price pressures continued to build in the rest of the fourth quarter of 2019.
According to him, “At 11.98 per cent in December, headline inflation was almost at the upper limit (12 per cent) of its (optimal) threshold for the economy, and if not addressed, could soon begin to undermine economic growth.
“Considering this and some other risks to overall stability, I voted to raise the CRR primarily to rein-in excess liquidity in the system and stem inflationary expectations.
The last quarter of 2019 witnessed significant liquidity build-up which resonated in very low short-term (interbank) rates.
“The sources of the excess liquidity that accounted for the slide in short-term interest rates included improved Federation Account allocations to the three tiers of government, open market operations (OMO) maturities and Federal Government of Nigeria (FGN) domestic debt maturities. More importantly, perhaps, the restriction of access to OMO securities which came into effect in 2019 had left the DMBs with extra liquidity.
“Meanwhile, the outlook for system liquidity in 2020 remains inclement on account of these same factors in addition to the high prospects of an expansive fiscal stance. In effect, I see the need for monetary policy to brace for a relatively stronger excess liquidity challenge in 2020.
“Directly related to the problem of liquidity surfeit is the creeping pressure in the economy’s external accounts. In Q3 2019, the country’s current account balance (CAB) recorded the third consecutive deficit, not because exports slacked; rather, imports and net invisibles (negative) increased.
“This trend constituted, in my view, an important pressure point, and therefore required a policy response. Persistent excess liquidity would no doubt exacerbate pressure on the country’s external sector, which outlook is currently not very strong in view of the protracted low prices of oil (the country’s most important export) and unstable capital inflows.
“Given the strong connection between Nigeria’s external sector and the real sector, a pressure in the former rapidly transmits to the latter through the exchange rate. Typically, both domestic output and consumer prices are pressured by vulnerabilities in the external sector, and could easily degenerate into a self-propelling process of economic instability.
“Of course, in deciding to raise the CRR, I was not unmindful of the need to support the fragile output recovery, which consideration had greatly influenced my thought and judgment during the last couple of meetings.
“However, as I evaluated available statistics including the massive expansion in credit to the real sector over the past few months owing to the implementation of a minimum Loan-Deposit-Ratio (LDR) policy for DMBs, the level of progress made by the Bank with the implementation of the differentiated CRR and the growth-enhancing developments on the fiscal side, I viewed that the balance of risks was tilting towards price stability which remains the primary goal of monetary policy.
“Notwithstanding the headwinds I hold a broadly optimistic view of the economy. In particular, the timely conclusion of the 2020 budget process and the ongoing payment of contractors’ arrears should reinvigorate business confidence and spur economic activity.
“This is already showing in the capital market with the All Share Index (ASI) rising by about 10per cent between end-December 2019 and January 22, 2020.
“Equally encouraging is the significant improvement in the banking industry’s resilience (with the non-performing loans ratio falling to about six per cent at end-2019 from 11per cent in April) and the considerable growth in new credit to key sectors like agriculture and manufacturing.
“I should emphasize that these developments would only have the desired maximum effect on output and employment in an environment of stable prices, which underscores the need for adjusting monetary policy at this time to restore liquidity to its optimal path.
“As I have argued previously, preserving the stability of the exchange rate of the naira continues to be essential for both consumer price stability and output recovery. Excess liquidity in the banking system is a real threat to the stability of the naira exchange rate just as it is to inflation.”