CBN Governor Mallam Sanusi Lamido Sanusi
Oct 11, 2011 – To strengthen the naira, the Central Bank of Nigeria (CBN) yesterday raised the interest rate by 275 basis points from 9.25 to 12 per cent.
It was the highest increase since the introduction of the Monetary Policy Rate (MPR) in 2007.
The hike followed a special meeting of the Monetary Policy Committee (MPC) on the dwindling naira in Abuja.
Rising from the meeting, the CBN also doubled banks’ Cash Reserve Ratio (CRR) from four to eight per cent effective from today.
It also reduced the net open positions banks can hold as reserves to 1 percent of shareholders funds, from 5 per cent with immediate effect and with full compliance by Friday.
MPC members also “agreed that the reserve averaging method of computation be suspended in favour of daily maintenance until further notice.”
These measures are expected to reduce the quantity of naira in the system and free up dollar supply.
The MPR, which was raised for the sixth time this year, is the nominal anchor of all interest rates in the economy. It is the rate at which the CBN gives loans to banks and, as such, directly influences the level and direction of change in interest rates. Consequently, the MPC had increased its benchmark interest rate by a total of 3.25 percentage points.
The CRR is the proportion of banks total deposits held in cash balance with the CBN. This will automatically reduce the cash disposable by banks for on lending to fund the foreign exchange (forex) market that has been under intense pressure.
The increase in MPR means depositors will get higher interest on their deposits, which the banks will pass on to corporate borrowers, who will also pass it to consumers by raising prices.
Yields on bonds will also rise. And since the government is the major borrower through the purchase of bonds for cash, it means that the government will pay more for its local debt – thus raising the cost of borrowing and that of firms in the bond market.
The apex bank however, kept its 200 basis point corridor around the benchmark rate; its recommended deposit rate is 10 per cent and lending rate, 14 per cent.
Currently, average lending rate for prime customers, which is expected to go up is 17.79 per cent per annum, while that of those who are not prime customer is 20.40 per cent.
Also, interest rate on savings account, which is currently 2.27 per cent per annum is expected to rise.
Interbank rates – rates at which banks borrow from one another to cover their positions is also expected to rise.
Briefing reporters after the meeting, CBN Governor Sanusi said: “The committee recognised the need to remain very clear on the bank’s primary mandate and maintain the credibility it has established so far by sending strong signals on price and exchange rate stability.
“In the face of the spectre of declining oil prices, declining foreign reserves, increased demand for foreign exchange, fiscal dominance and capital flow reversals, monetary policy must bear a larger burden of economic adjustment in the short-term,” he added.
The naira, he said, has come under increasing pressure, and has recently traded outside the band of N150 +/- 3.0 per cent.
He said: “In the committee’s view, the increasing pressure on the domestic currency has been emanating from a number of sources not all of which can be addressed by purely monetary interventions.”
The committee, he added, is concerned about the likely impact of a double dip recession on oil prices and already declining foreign reserves in addition to the delay in implementing fundamental economic decisions that will shore up reserves.
By selling dollars at auction the CBN is eating into Nigeria’s foreign reserves, which are built up through the sale of its crude oil.
Despite high oil prices and production, reserves stand at $31.4 billion, down from $35.4 billion a year ago.
But the naira touched a new all-time low in the interbank market and weakened at the CBN’s official window yesterday.
This came hours after the Minister of State for Finance Yerima Ngama said interest rates must rise to make government instruments more attractive and to support the naira.
The naira reached N167.40 against the dollar in the interbank market initially before recovering to close at 164.30, down by 4.2 per cent from Friday’s close of N160.10.
CBN sold $400 million at N156.91 to the dollar at its bi-weekly foreign exchange auction yesterday, short of the $736.94 million demanded and at weaker levels than at the official window last week.
Sanusi, however, warned that unless timely decisions are taken to remove petroleum subsidies, Nigeria may end up with the Greek experience, which has seen about 30 per cent to 40 per cent of the country’s work force out of job.
The petroleum subsidy, Sanusi said, depletes the external reserve by about US$6 billion annually.
The removal of oil subsidy, he emphasised, would free up about N1 trillion to be used in other sectors of the economy.
He said passing the Petroleum Industry Bill (PIB) and removing subsidies on Premium Motor Spirit (PMS) will add at least US$10 billion to national reserves annually.
The Committee equally expressed concerns about the genuineness of demand for petroleum imports. According to the CBN governor, “this year alone, oil importers have bought over US$7.0 billion from the wholesale Dutch Auction System (wDAS), thereby, depleting the nation’s external reserves.” This demand, he said might have been fuelled by rent-seeking and subsidies.
Sanusi was of the opinion that the labour unions have genuine concerns about the impact of subsidy removal on the poorer segments of society, but he maintained that “the stark reality is that the country is living above its means.”
Commenting on the monetary tightening, Managing Director, Financial Derivatives Company Limited, Mr. Bismarck Rewane, described it as “a big pill to swallow”.
Noting that the development has very wide implications, he said it would have been easier for the MPC to adjust the exchange rate.
“This will tighten liquidity so much and make banks to liquefy their Asset Management Corporation of Nigeria (AMCON) bonds. The cost would be passed on to corporate borrowers, who will also pass it on to consumers by raising the prices of their jobs.
“But these measures can also benefit to the naira but it could be distruptive to corporate borrowers.
“I am not sure that the naira can be protected but let’s see what happens to the forex market tomorrow (today),” he said.
Razia Khan, Head of Africa research at Standard Chartered, said she expects retracement in the exchange rate of the naira against the dollar and speculation in the foreign exchange market to ease off.
“Any speculation that had been building up prior to this meeting, that perhaps the CBN’s appetite to maintain currency stability was starting to wane, will now be dealt a decisive blow. Although the CBN has clearly demonstrated that in view of global risks it is not going to run down FX reserves dramatically in order to meet higher FX demand (which, in our view, is a sound policy – given the need to rebuild buffers), it has taken just about every other policy step available to it, in order to combat excessive liquidity growth,” she said.
Besides, the expert said she expects bound to sell off significantly in response to the MPC measures.
“This certainly isn’t a Central Bank that does things in half-measures. The changes announced this afternoon are huge – leaving little room for doubt in anyone’s mind about the resolve to maintain price stability in Nigeria,” said added.