As inflation breaks below MPR, will the CBN now cut rates?

All eyes are on the next meeting of the Monetary Policy Committee (MPC) on May 22 to see if the members would move to cut rates. This follows the release on May 15 of the latest inflation figures from the National Bureau of Statistics (NBS) showing that the inflation rate for April has dropped to 12.48 percent, the lowest since March 2016.

The inflation rate first rose above the single digit in February 2016 rising to 11.4 percent from 9.6 percent in January 2016. A steady increase in the inflation rate forced the MPC to raise the Monetary Policy Rate (MPR) by 200 basis points, or two percent in July 2016 to its current rate of 14%.

At the point the MPC raised the MPR in July 2016, the inflation rate had jumped to 17.1 percent and it kept rising, hitting a high of 18.7 percent in January 2017. With inflation on the rise, the MPC resisted all calls, specifically from the Minister of Finance, Kemi Adeosun to cut interest rates, rightly concerned that such a cut would lead to a further spike in inflation.

So, the CBN has kept the MPR unchanged since July 2016, in a bid to walk a fine line between the government’s desire for lower interest rates and its own desire to ensure that a cut in rates does not complicate what was then a difficult economic situation.

Good enough, after inflation hit the peak of 18.7 percent in January 2017, it started declining as the devaluation impact of the naira cooled off and higher oil prices helped stabilise the macroeconomic environment. Now for the second consecutive month in about 22 months, the inflation rate has fallen below the MPR. The MPR is at 14 percent, while the inflation rate stands at 12.48 percent, lower than the 13.3 percent in March. Technically, this gives the CBN a headroom of about 1.52 percent to cut the MPR at its next meeting of the MPC on May 22.

The big question is if the CBN’s MPC will choose to cut the MPR at this time, or would want to hold onto its 14 percent rate for a bit longer? What even makes the argument to cut stronger, is the rapid deceleration in food inflation to 14.8 percent in April, the lowest level in about 24 months and the fifth consecutive month of decline in the rate. Core inflation is down to 10.9 percent in April 2018, and is also the lowest in 27 months, and also showing the fourth month of consecutive decline.

To complement the drop in inflation and strengthen the argument for a cut in the MPR, the naira has been largely stable in the Investors and Exporters (I&E) window, at an average exchange rate of N360 to the US$. The stability has been helped by the fact that the CBN has been able to rapidly build reserves to about US$48 billion, enough to pay the country’s import bills for between 15 to 17 months.

Even more positive for the economy, is the fact that geopolitical tensions in the middle east have led to a spike in oil prices, which look headed to about US$80 per barrel with a US$100 per barrel now looking realistic again in the near future. In summary, all the right things are falling into the right places for the MPC to consider a cut in interest rates at its next meeting.

But there is a snag. The same day that the NBS released its inflation figures, the news broke that the National Assembly is now ready to release the long delayed 2018 budget. However, it is not just in the fact that the budget is coming late, it is also the fact that it is going to be the country’s biggest ever budget in nominal terms.

The total budget sum approved by the National Assembly is N9.12 trillion, which is N508 billion more than the initial N8.61 trillion proposed by President Muhammadu Buhari. The extra N508 billion added to the budget may have been proposed to cover the president’s N496 billion request to pay for Super Tucano aircraft from the US. The total budget size is now N1.2 trillion higher than the N8.4 trillion budgeted for 2017.

Members of the MPC will definitely be concerned about the size of the 2018 budget, especially in a pre-election year, when there is a very good chance that a good chunk of the budgeted amount will be spent. The capital component of the budget stands at a significant N2.87 trillion, the highest ever, in nominal terms to be budgeted by the country.

In a pre-election year, there is a good chance that every penny of this amount will be spent. Revenues to back the expenditure will likely not be much of a challenge, considering the higher than normal oil prices and the government’s higher than normal propensity to borrow. Also, in a pre-election year, with the government eager to impress the electorate, there is a good chance it would hasten the process of releases of capital expenditure for roads and other infrastructure projects across the country. So what we are likely to see is a government in a hurry to spend N2.8 trillion between now and the end of the year or at most March next year. This is going to put significant pressure on prices of goods and services.

Already, the 2017 budget has spilled over into 2018. Minister of Finance, Kemi Adeosun confirmed this week that total releases for capital expenditure in respect of the 2017 budget stands at N1.5 trillion. About N300 billion of the N1.5 trillion must have been released in the first five months of this year. Adeosun had stated in December 2017 that total capital releases for 2017 budget stood at N1.2 trillion, N750 billion on which was released in December. So between December 2017 and May 2018, total capital release was N1.05 trillion.

This represents a significant amount of naira flowing into the economy within such a short period of time besides recurrent expenditure, which is usually executed 100 percent. The MPC members will definitely be concerned about this amount of money flowing into the system and its impact on prices of goods and services.

But these significant inflows of money from the government into the economy are not having the desired impact on the private sector. Economic growth remains sluggish. Expansion of banking sector credit to the private sector has not been impressive. There is no indication that it will change with a lower interest rate. The low appetite for banking credit is related to growing inventories in the books of businesses on the back of Nigeria’s suffering middle class which have seen their purchasing power diminished significantly.

The purchasing power of the middle class has come under attack from rising inflation, as well as rising unemployment and under-employment. Business appetite for expansion is therefore currently low and cannot be repaired by just lower interest rates.

The MPC may therefore be concerned that a lower interest rate will just help boost the government borrowing appetite, especially at the sub-national level, in a pre-election year and consequently put pressure on the exchange rates through increased demand for dollars, either for imports to execute infrastructure projects or other invisible imports, or even politically exposed individuals trying to launder money outside the country.

Obviously, the risk of cutting rates looks to outweigh the benefits. Our best bet is that the MPC would want to hold rates where they are in its next meeting, except of course they want to play to the ‘political card’ by cutting the rates, as that will look politically right. But a hasty rate cut could easily see the downward trend in inflation being reversed and that would be politically even more costly.

 

Anthony Osae-Brown