CBN: Taming inflation with money market reforms - VANGUARD
BY Babajide Komolafe, Economy Editor
Efforts to curtail the upward trend in prices of goods and services driving up the nation’s inflation rate gathered steam with money market reforms recently introduced by the Central Bank of Nigeria, CBN.
The reforms which were aimed at reducing the amount of idle cash in circulation and hence money supply, were designed to complement other inflation fighting measures introduced by the CBN, namely upward adjustments of the Monetary Policy Rate, MPR.
The CBN had raised the MPR eight times and by 7.25 percentage points since May 2022 in response to steady rise in the inflation rate.
From 11.5 per cent in April 2022, the MPR was raised to 13 per cent in May 2022, 14 per cent in July 2022, 15.5 per cent in September, 16.5 per cent in November, 17.5 per cent in January 2023, 18 per cent in March and 18.75 per cent in July 2023.
In spite of these interest rate hikes, the steady rise in the inflation rate continued, hitting 24.8 per cent in July from 17.71 per cent in May when the CBN commenced hike in the MPR.
The steady rise in the inflation rate was driven by factors, including general election spending, fuel subsidy removal and naira depreciation triggered by forex reforms introduced in June.
Money Supply rise
The above factors, among other things, fueled steady rise in Money Supply. According to the CBN, Money Supply, M2, rose by 26 per cent to N66.4 trillion in September from N51.78 trillion in December 2022.
For example, analysts opined that the sharp depreciation of the naira following the forex reforms added about N10 trillion to the money supply.
Further reflecting the impact of the steady rise in Money Supply, daily average (opening balance) of idle cash in the interbank money market rose by 88 per cent to N417.7 billion in first half of 2023 H1’23, from N221.6 billion in the corresponding period of 2022, H1’22.
The increase in daily average of idle cash in the interbank money market continued in July, when it rose further to N564.7 billion.
The above trend prompted the CBN to introduce reforms to curb the continued increase of idle cash in the interbank money market.
Idle Cash Deposits
One of the reforms was the removal of the limit on the amount of interest earning idle cash banks can deposit with the CBN via its Standing Deposit Facility, SDF.
The SDF is a window where banks can place excess funds overnight with the CBN. The interest to be earned on such funds is determined with reference to the lower band of the asymmetric corridor around the MPR as prescribed by the MPC.
However, in July 2014, the CBN observed that banks prefer to keep their idle funds in the SDF rather than lending such funds to the economy.
Consequently, the CBN imposed a daily maximum limit of N7.5 billion placement to be eligible for the 10 per cent interest rate per annum.
In a circular announcing the peg, the CBN stated: “It has been observed that banks and discount houses have preferences for keeping their idle balances at the Central Bank in the standing Deposit Facility, SDF, thereby constraining the process of financial intermediation.
“In order to encourage the banks to increase lending to the productive sector of the economy, the guidelines for the operations of SDF is hereby reviewed as follows: The remunerable daily placements by banks and discount houses shall not exceed N7.5 million. This shall be remunerated at the SDF rate of 10 percent per annum.
“Any deposit by a bank or discount house in excess of the N7.5 million shall not be remunerated.”
The above limit was further reduced to N2 billion in July 2019, following moves by the CBN to ramp up lending to the economy. Hence in a circular issued July 10th, 2019, Director of Financial Market Department, CBN, Dr Angela Sere-Ejembi, said: “The remunerable daily placements by banks at the SDF shall not exceed N2 billion.
“The SDF deposit of N2 billion shall be remunerated at the interest rate prescribed by the Monetary Policy Committee, MPC, from time to time.
“Any deposit by a bank in excess of N2 billion shall not be remunerated.”
This limit was however removed last month by the CBN as part of its measures to aggressively tighten money supply.
Consequently, total banks’ placement of idle funds in the SDF shot up by 272 per cent to N2.16 trillion in October from N791 billion in September. Similarly, average daily placement in the SDF by banks shot up by 256 per cent to N133.9 billion in October from N37.6 billion in September.
OMO Treasury bills
Another reform introduced by the CBN to reduce money supply is removal of limits on issuance or sales of the Open Market Operations, OMO treasury bills.
The OMO treasury bills is one of the instruments used by the CBN to influence money supply in the economy.
To reduce money supply, the CBN issues and sells OMO bills. But to increase money supply, the CBN repays matured OMO bills hence injecting cash into the economy.
However, in the nine months to September 30th, the CBN issued only N150 billion worth of OMO bills. Meanwhile, the CBN had repaid N542.74 billion worth of matured OMO bills in seven months from January to July this year, indicating net cash injection of N392.74 billion during the period.
The apex bank however changed its tactics last month when it sold N400 billion worth of OMO bills on October 30th, 2023. A key factor in this huge liquidity mop up was the 17.5 per cent interest rate (stop rate) offered on the 365-Days OMO bills which prompted N343 billion subscription (demand by investors).
Impact on Inflation
The impact of these reforms, according to the CBN, accounted for the 0.37 percentage point decline in the month-month, m/m change in the headline inflation rate to 1.73 per cent in October from 2.1 per cent in September.
Acknowledging this impact in their review of the inflation data for October, analysts at Vetiva Capital Management Limited said: “In October, headline inflation decelerated to 1.73% m/m (Sep’23: 2.10% m/m). The m/m slowdown in inflation was on the back of broad-based slowdown in both food and core inflation. Notably, food inflation decelerated to 1.91% m/m (Sep’23: 2.45% m/m) while Core inflation slipped to 1.42% m/m (Sep’23: 2.06% m/m). Overall, headline inflation rose by 61bps to settle at 27.33% y/y (Vetiva: 27.58%).
Commenting in this regard, the spokesman of the Central Bank of Nigeria, CBN, Dr. Isa AbdulMumin, expressed optimism that the low rate of increase in the average price level in October compared to September 2023, was a pointer to the fact that the apex bank’s monetary policy stance to tighten rates and its money market reforms were yielding the desired effect.
Aggressive monetary tightening using various liquidity mechanisms, including removing the cap on the Standing Deposit Facility, SDF, and Open Market Operations had raised Open Buy Back, OBB, rates from less than 1% in August to their expected levels around the monetary policy rate today.
In spite of 0.61% increase in the headline inflation rate from 26.72% in September 2023 to 27.33% in October 2023, Isa remained upbeat that the CBN was headed in the desired direction in terms of achieving price stability.
According to him, available statistics showed that the first indication of deceleration in prices was recorded in September and further reforms in the money market, which commenced in October, had accelerated easing in prices as indicated by the substantial drop in month-on-month changes recorded in October.
“Moderation in month-on-month changes in prices observed in the headline, food and core components of the consumer basket followed reforms in the money market and relative stability in the FX market,” he added.