Full text of CBN Communiqué No. 84 of the Monetary Policy Committee meeting of July 23-24, 2012
The Monetary Policy Committee met on July 23 and 24, 2012 with 11 out of the 12 members in attendance. The Committee reviewed the economic conditions and challenges in the first half of the year against the backdrop of developments in the international economic and financial environments with a view to considering the monetary policy options for the remaining part of 2012.
The Global Economy
The Committee noted the continued fragility of global economic recovery and the increased downside risks to growth in 2012. In particular, the sovereign debt and financial sector problems, together with recession in the UK and some Euro zone countries and reduced growth rate in the US continue to affect China, India and Brazil’s export-driven growth. This has necessitated a downward revision of the projected global output growth for 2012 by the IMF in the July 2012 WEO Update. While the effort to fix banks and sovereign balance sheets by the European Central Bank using long term refinancing operations eased funding constraints and broadly rallied the assets markets, these gains were short-lived due to the intensification of policy uncertainty after the Greek and French elections, strong dampening effects of the financial fragility in the Euro Area peripheral states and public resistance of austerity measures. In the advanced economies, the weakness in the labor and housing market, the elevated debt level of the households and the need to fix the encumbered balance sheets of banks are likely to continue to constrain growth prospects. Consequently, the growth forecast in the advanced countries was downgraded by 0.2 percentage points to 1.4 per cent in 2012 relative to the April WEO estimates.
In the United States, reduced retail sales and investment, growth rate concerns about public debt and the uncertainty over domestic fiscal plans due to failure to reach an agreement on near-term tax and spending policies constitute severe threats to economic recovery. Thus, output growth in the US for 2012 was revised slightly downward to 2.0 per cent from 2.1 per cent by the IMF in the July 2012 WEO.
In the Euro area, Real GDP growth is expected to contract from an annual rate of about 1.4 per cent in 2011 to -0.3 per cent in 2012 with France, Italy and Spain leading the contraction in growth. The revised growth rate of 1.0 per cent for Germany in July is an improvement of 0.4 per cent over the April 2012 IMF growth projections. The risk to growth in the euro area is amplified by geopolitical uncertainties and the risk of stagnation and long-term damage to potential growth as unemployed workers lose skills and new entrants find it difficult to join the active labor force.
In the UK, despite the Bank of England’s monetary measures to stimulate growth, the effect of the Treasury’s fiscal consolidation for reducing the budgetary risk remains strong, leading to weak business and consumer confidence. Thus, real GDP growth was projected at 0.2 per cent against the initial projection of a contraction of 0.4 per cent. Spain’s latest round of austerity measures failed to reassure investors and markets, as the country’s borrowing costs continued to rise.
In emerging economies, the lag effect of past policy tightening has continued to weaken internal and external demand thereby limiting growth. In China, real GDP growth slowed to 7.6 per cent year on year in the second quarter of 2012, compared with 8.9 per cent in the fourth quarter of 2011, due mainly to weak external conditions, particularly sluggish demand from the euro area. Real GDP growth forecast for 2012 has been reduced to 8.0 per cent from earlier forecast of 8.2 per cent. India’s real GDP growth moderated to 5.3 per cent, year on year, in the first quarter of 2012 compared with 6.2 per cent in the fourth quarter of 2011, with the projection for 2012 put at 6.1 per cent compared with 7.1 per cent in 2011.
Output performance in Sub-Saharan Africa is projected at 5.4 per cent in 2012. While exports to Europe have dropped, strong terms of trade and increased trade diversification towards emerging markets have helped support growth in the region. A major issue in the region, however, is that inflationary pressures and reduced fiscal space present limited flexible policy options for manoeuver, especially if downside risks materialize.
Overall, the slowdown in global economic activities would have serious implications for the Nigerian economy in the following respects: A softening in the demand for oil and consequent decline in oil revenues; reduction in foreign exchange earnings which would impair the build-up of external reserves and consequently exert pressures on the exchange rate; increased budget deficit as government would not be able to realize its revenue projections; and increased public sector borrowing to finance expenditure outlays.
Key Domestic Macroeconomic and Financial Developments
Output and Prices
The revised GDP growth rate projected by the National Bureau of Statistics (NBS) for the Q2 2012 at 6.37 per cent was higher than Q1 2012 level of 6.17 per cent, indicating increased momentum in the economy. Overall, GDP growth for 2012 was projected at 6.38 per cent, down from the realized growth rate of 7.74 per cent in 2011. The projected decline in GDP growth for 2012 is attributable to a number of factors including: the estimated loss of about N207.41 billion in national output during the nation-wide strike in January; the dampening effects of low crude oil demand from major trading partners notably the US, Euro area, and China; falling oil prices, and weak aggregate domestic demand following rising prices across major segments of the economy; as well as the prevailing security concerns.
The non-oil sector remained the major driver of growth recording 7.52 per cent increase in contrast to the oil sector which contracted by 0.24 per cent during the period. The Committee noted the sustained slowdown in the growth in agricultural output of 4.08% in the second quarter compared with 4.15% in the first quarter, traceable to the continued security challenges which affected a large part of the farming population in the northern parts of the country during the period. The Committee also expressed serious concerns over the continued decline in the contribution of oil to GDP, which became apparent from the second half of 2011, and intensified through Q1 and Q2, 2012. Its contribution to growth, declined by 0.40 per cent apiece in the third and fourth quarters of 2011, and declined to 0.40 and 0.04 per cent in Q1, 2012 and Q2 2012, respectively. There are serious concerns over continuing fiscal leakages, bunkering and oil theft in the Niger-Delta area.
This notwithstanding, the Committee was pleased to note that the growth projections were against the backdrop of severe weaknesses in the global economy. Thus, domestic output growth was anchored by the positive impact of the banking sector reforms as well as the initiatives by government to stimulate the real economy such as improvement in national electricity generation which rose to 2,900 MW/h as a result of increased gas supply to the thermal stations, increased water level at the hydro stations, and the resuscitation of some dormant generating stations.
The Committee noted significant downside risks to growth in the near-term, in particular the fall in the average spot price of Nigeria’s reference crude, the Bonny Light, from US$121.10 in the firstquarter of 2012 to US$109.32 in the second quarter, and the current security challenges which continue to pose a threat to agriculture and manufacturing.
The Committee noted the threat of Inflationary pressure which has re-emerged since the beginning of 2012. The year-on-year headline inflation rose to 12.9 per cent in June, 2012 against the 12.7 per cent in May 2012. Core inflation rose to 15.2 per cent in June, 2012 from the 14.9 per cent level in May, though food inflation, declined from 12.7 per cent in May to 12.0 per cent in June 2012. The major drivers of headline inflation during the period were food and non-alcoholic beverages and housing, water, electricity, gas and other fuels. The acceleration in core inflation in the second quarter was traced to increases in the contributions of processed food and housing, water, electricity/gas and other fuels.
The Committee noted that in addition to the lag effects of the partial removal of petroleum subsidy in January, other factors fuelling the upside risk to inflation in the near-term include borrowing by government to cover large fiscal deficits in the 2012 budget, and the upward review of electricity tariffs and import Duty on wheat and rice in July 2012.
Monetary, Credit and Financial Market Developments
Broad money supply (M2) grew by 1.35 per cent in June 2012 over the level at end-December, 2011, translating to annualized 2.70 per cent growth, which was lower than the growth rate of 10.77 per cent year-on-year. Relative to December 2011, aggregate domestic credit (net) declined by 2.73 per cent in June 2012, annualized to a decline of 5.46 per cent. The decline contrasted sharply with the growth of 49.76 per cent year-on-year. Although overall credit to the private sector increased by 3.60 per cent, the Committee noted that credit to state and local governments grew by 14.23 per cent or 28.46 per cent. On annualized basis, credit to core private sector grew by 3.2 per cent or 6.4 per cent when annualised. Consequently, the Committee reiterated its earlier advice that the CBN should put in place appropriate measures that would enhance the flow of credit to the core private sector, and fix the transmission mechanism.
The Committee noted that rates in all segments of the money market trended upward between May 21 and July 11, 2012. Inter-bank call and OBB rates which opened at 14.61 and 14.43 per cent, closed at 15.55 and 15.50 per cent, respectively. The increase in the rates was a reflection of the tight liquidity in the banking system traceable to the aggressive open market operations, given that the MPR remained unchanged during the period.
Retail lending rates remained high in June 2012 as the average maximum lending rate remained unchanged at 23.44 per cent in June 2012. On the other hand, the consolidated deposit rate fell marginally from 3.83 per cent in May to 3.82 per cent in June. In view of these developments, the Committee reiterated its earlier call to put in place an appropriate mechanism for reducing the interest rate spread, while stabilizing interbank rates to sustain liquidity and facilitate intermediation in the banking system.
External Sector Developments
Gross external reserves as at July 19, 2012 stood at US$37.16 billion, representing an increase of US$ 0.33 billion over the level of US$36.83 billion at end-May 2012. The exchange rate at the wDAS-SPT opened at N157.26/US$ on May 21 and closed at N157.43/US$ on 12th July 2012, representing N0.17k or 0.11 per cent depreciation during the period. At the interbank segment, the selling rate opened at N158.80/US$ and closed at N161.20/US$, with a period average of N161.60/US$, representing a depreciation of N2.40k or 1.51 per cent. At the BDC segment of the market, the selling rate opened at N160.00/US$ and closed at N163.00/US$, representing a depreciation of N3.00k or 1.87 per cent for the period. During the period, the naira weakened to as low as N163.00/US$ due to developments in the external economy and the CBN had to intervene significantly in the interbank market to restore stability. The Committee expressed concern about the declining accretion to external reserves. The Committee noted that the premia between the rates at the wDAS and the interbank and between the wDAS and the BDCs narrowed towards the end of the review period, and therefore urged the Bank to sustain the existing measures to discourage speculative demand in the market.
The Committee’s Considerations
Against the backdrop of the foregoing review of the global and domestic economic and financial environments, the Committee observed that monetary policy faces a difficult task in terms of delivering price stability. Domestic conditions indicate rising unemployment, poverty, declining growth and rising inflation. Consequently, the money and foreign exchange markets appeared to be operating at sub-optimal levels. It noted that with the weakened global outlook underpinned by the slowdown in economic activities in the US, and major emerging economies like Brazil, China and India, contraction in output in the Euro area along with the persisting debt crisis which is proving difficult to resolve, lower demand for crude oil and lower crude oil prices, coupled with the lower domestic output growth, build-up of inflationary pressures, slowdown in the accretion to external reserves and the attendant pressures on the exchange rate as well as possible shortfall in the projected revenue for 2012, the ominous signs for the domestic economy are evident. In this regard, therefore, monetary policy is faced with very difficult choices, as whatever policy action taken must be weighed against the possible trade-off(s) and implications for the wider economy.
The Committee further noted that the inflation environment remained uncertain with the possible pressures coming from the core component in the medium term. Domestic inflation has maintained its upward trend, and is expected to remain within that region over the six month forecast period. More so, the Committee observed that since its meeting in May 2012, growth prospects continued to be threatened by developments in Europe, China, India and the US, as well as the very slow progress in structural reforms and poor implementation of the capital budget for 2012.
The Committee observed further that during 2008-2009 when oil prices declined sharply and the domestic currency came under intense pressure, the CBN was able to defend the Naira because the nation had buffers, having accumulated substantial foreign exchange reserves when oil prices were high, but that this time around that luxury does not exist, as the excess crude account has largely been depleted, and is still being depleted by the tiers of government.
The Committee also noted that the upside pressure could be further exacerbated by pressures in the foreign exchange market in view of the high demand in the market and the likely impact of the decline in international oil prices in recent weeks on the country’s external reserves. Bonny light crude oil prices have not rebounded from their recent lows of around US$97 per barrel in June, partly due to the crisis in the Euro area, a major export destination of Nigeria’s crude oil.
The Committee, therefore, identified a number of key concerns that it was confronted with:
- Stemming the inflationary pressures arising from both domestic and external sources;
- Sustaining a stable exchange rate for the naira;
- Creating a buffer for the external reserves; and
- Mitigating the impact of the continued slowdown in global economic activities, particularly, in the US, Europe and China on the Nigerian economy.
In the Committee’s view, these challenges would persist in the medium-to-long term with the attendant consequences on oil receipts. The Committee noted the fears about Europe’s debt crisis which flared recently as concerns intensified that Spain would be next in line for a government bailout. It noted that the potential cost of a Spanish bailout far exceeds what is available in existing emergency funds. Already, the European decline has taken its toll on oil demand and exports. The rising global uncertainty and weaker external demand are causing headwinds for export-dependent economies. The unfavorable outlook is further strengthened by the fragile domestic conditions. The MPC is of the view that growth could further decline during the rest of the year.
Thus, the MPC is confronted with basically three choices: first, lower the MPR in the face of sustained slowing domestic output growth and concerns about global growth prospects. The MPC viewed that a lowering of the rates in the face of sustained slower growth of output and global growth prospects could further weaken the exchange rate and adversely affect reserves at a time when the country needs to build up buffers against external shocks. It also reiterated its view that the growth challenge is a result of poor record of implementation of structural reforms and the capital budget.
Second, to leave the MPR unchanged. This is against the background of upward trending inflation figures and the precarious picture painted by the six months inflation forecast of the Bank, revised upwards since the MPC meetings of May, 2012. Inflation is expected to average 12.0 per cent during the next six months with core and food inflation being much higher. The forecast is mainly due to the increase in electricity tariffs and the tariff on imported rice and wheat.
The Committee recognized that a logical response to the increasing inflationary outlook would be an increase in the MPR, especially considering the impact of sustained liquidity in the banking system on exchange rates. It was, however, conscious of the impact of higher interest rates on small businesses and the potential for higher non-performing loans on the books of banks. In addition, it is important to leave room and flexibility for further tightening should conditions so warrant in the near future.
However, it is important to note that the significant liquidity on the books of banks has not led to intermediation and lending to the real economy. Banks have continued to take advantage of high yields on government securities to direct credit away from the core private sector. In addition, the liquidity has provided ammunition for speculative activity in the foreign exchange market with implications for inflationary expectation.
Against the foregoing, therefore, the MPC reiterated the need to choose a policy trajectory that would have the least negative impact on the wider economy, to the extent that the longer-term benefits to the economy far outweigh the short-term costs. It was therefore, imperative to reduce the liquidity in the banking system and minimize the upward movement in MPR.
The Committee’s Decisions
In view of the foregoing, the Committee, decided as follows:
(i) Retain the Monetary Policy Rate (MPR) at 12.00 per cent with symmetric corridor of /-200 basis points by a vote of 10 to 1. One member voted to reduce MPR by 25 basis points to 11.75 per cent.
(ii)Voted by a decision of 10 to 1 to increase the Cash Reserve Requirement (CRR) from 8.0 per cent to 12.0 per cent with effect from July 25th. One person voted to retain the CRR at 8.0 per cent.
(iii) Unanimously agreed to reduce the Net foreign exchange Open Position (NOP) to 1.0 per cent from 3.0 per cent with immediate effect.
* Sanusi Lamido Sanusi, CON, Governor, Central Bank of Nigeria.