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Monetary Policy Performance in 2007

The framework for monetary policy management in 2007 remained that of monetary targeting. The Central Bank of Nigeria (CBN) adopted various policy measures aimed at containing the growth of monetary aggregates in order to achieve monetary and price stability. Open Market Operations (OMO) remained the major tool of liquidity management. Other policy measures included increased issuance of treasury securities in the primary market to mop-up excess liquidity; use of deposit and lending facility to encourage inter-bank transactions as well as special sales of foreign exchange, including swap arrangements. NTBs of various tenors 91-, 182- and 364-day were auctioned during the period.

The liquidity management efforts of the CBN yielded the expected results as the single-digit inflation rate was sustained during the year. In addition, the exit reserve money target under the Policy Support Instrument (PSI) was achieved in June 2007. Over the end-December 2006 level, provisional data indicate that broad money supply (M2) grew by 11.03 per cent in June 2007 and further by 21.3 and 25.31 per cent in September and October, 2007 respectively. When annualized, the M2 grew by 28.44 and 30.25 per cent, in September and October, 2007 respectively, compared with 33.3 and 39.6 per cent in the corresponding months of 2006. The growth of M2 was driven by the increase in foreign assets (net) of the banking system as well as the rapid rise in credit to the private sector since the end of the second quarter. With the CBN’s drive to contain excess liquidity in the banking system, both M2 and reserve money may be within targets by the end of 2007. At the end of the second quarter, aggregate domestic credit (net) to the economy declined by 56.11 per cent, but increased by 98.99 per cent in October 2007. Also, credit to government (net) declined by 51.9 per cent in September compared to a decline of 56 per cent at the end of the second quarter. But credit to the private sector, which had maintained an upward trend in most of 2007, rose to 34.37 and 62.0 per cent in June and September, respectively.
As at November 2007, the economy has achieved a commendable level of external reserves of about US$50.0 billion that is capable of supporting approximately 23 months of current foreign exchange disbursements. This represented an increase of 18.06 per cent when compared with the level of US$42.42 billion recorded in the corresponding period of 2006.

With the implementation of the new Monetary Policy Rate (MPR) and the adoption of the CBN standing facilities, volatility in inter-bank rates remained subdued with rates hovering within the MPR. The MPR was reviewed thrice during the year. The first was in June 2007 when it was reviewed downward by 200 basis points, from 10.0 per cent to 8.0 per cent, with the width of the interest rate corridor reduced from +/- 300 to +/- 250 basis points. The second was in October 2007 when the MPR was raised by 100 basis points, from 8.0 to 9.0 per cent, with the interest rate corridor removed, in response to anticipated changes in economic and financial conditions. The MPR was then made to serve as the overnight (repo) rate. The last was in December 2007 when the MPR was increased by 50 basis points, from 9.0 to 9.5 per cent.

Monetary Policy Performance in 2006
In 2006, the New Monetary Policy Framework for monetary policy implementation was introduced. The ultimate goal of the new framework was to achieve a stable value of the domestic currency through stability in short- term interest rates around an Operating Target the CBN Monetary Policy Rate (MPR). The MPR serves as an indicative rate for transactions in the inter-bank money market as well as other interest rates in the money market transactions. The MPR which replaced the MRR was set at 10 per cent with spread of 600 basis points around the rate, i.e. 300 basis points above and 300 basis points below. This translates into an upper limit of 13 per cent and a lower limit of 7 per cent.

The Whole Sale Dutch Auction System (WDAS) replaced the Dutch Auction System (DAS) in the first quarter of the year under review. In pursuant of further liberalization of the foreign exchange market the bureaux de change was admitted into the WDAS window during the second quarter of 2006 .The admittance of the BDC’s to the WDAS window led to the unification of the exchange rate between official and parallel market.

The objective of monetary policy in 2006 was sustaining price stability and non inflationary growth, as enunciated in the National Economic Empowerment and Development Strategy (NEEDS).
The target for single digit inflation was, however, achieved as at December 2006 the inflation stood at 8.5 per cent.

The GDP growth rate for 2006 declined to 5.63 per cent compared with what obtained in 2005 when it stood at 6.51 per cent, but the external reserves rose rapidly from US$28.3 billion to US$41.9 billion, representing an increase of US$ 13.6 billion.
At the end of 2006, the overall performance indicated that the broad money supply (M2) target was overshot as it grew by 30.6 per cent compared with the target of 27.8 per cent. The Reserve money target for December 2006 was missed. The actual Reserve money (RM) at end December stood at N974.9 billion, compared with the target of N 820 Billion.
The non attainment of RM target at end December was largely due to the rapid growth in currency in circulation.

Monetary Policy before 1986
The economic environment that guided monetary policy before 1986 was characterized by the dominance of the oil sector, the expanding role of the public sector in the economy and over-dependence on the external sector. In order to maintain price stability and a healthy balance of payments position, monetary management depended on the use of direct monetary instruments such as credit ceilings, selective credit controls, administered interest and exchange rates, as well as the prescription of cash reserve requirements and special deposits. The use of market-based instruments was not feasible at that point because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rates.

The most popular instrument of monetary policy was the issuance of credit rationing guidelines, which primarily set the rates of change for the components and aggregate commercial bank loans and advances to the private sector. The sectoral allocation of bank credit in CBN guidelines was to stimulate the productive sectors and thereby stem inflationary pressures. The fixing of interest rates at relatively low levels was done mainly to promote investment and growth. Occasionally, special deposits were imposed to reduce the amount of free reserves and credit-creating capacity of the banks. Minimum cash ratios were stipulated for the banks in the mid-1970s on the basis of their total deposit liabilities, but since such cash ratios were usually lower than those voluntarily maintained by the banks, they proved less effective as a restraint on their credit operations.

From the mid-1970s, it became increasingly difficult to achieve the aims of monetary policy. Generally, monetary aggregates, government fiscal deficit, GDP growth rate, inflation rate and the balance of payments position moved in undesirable directions. Compliance by banks with credit guidelines was less than satisfactory. The major source of problems in monetary management were the nature of the monetary control framework, the interest rate regime and the non-harmonization of fiscal and monetary policies. The monetary control framework, which relied heavily on credit ceilings and selective credit controls, increasingly failed to achieve the set monetary targets as their implementation became less effective with time. The rigidly controlled interest rate regime, especially the low levels of the various rates, encouraged monetary expansion without promoting the rapid growth of the money and capital markets. The low interest rates on government debt instruments did not sufficiently attract private sector savers and since the CBN was required by law to absorb the unsubscribed portion of government debt instruments, large amounts of high-powered money were usually injected into the economy. In the oil boom era, the rapid monetization of foreign exchange earnings resulted in large increases in government expenditure which substantially contributed to monetary instability. In the early 1980s, oil receipts were not adequate to meet increasing levels of demands and since expenditures were not rationalised, government resorted to borrowing from the Central Bank to finance huge deficits. This had adverse implications for monetary management.

Monetary Policy Since 1986
The Structural Adjustment Programme (SAP) was adopted in July, 1986 following the crash in the international oil market and the resultant deteriorating economic conditions in the country. It was designed to achieve fiscal balance and balance of payments viability by altering and restructuring the production and consumption patterns of the economy. These would be achieved by eliminating price distortions, reducing heavy dependence on crude oil exports and consumer goods imports, enhancing the non-oil export base and achieving sustainable growth. Other aims were to rationalise the role of the public sector and accelerate the growth potentials of the private sector. The main strategies of the programme were the deregulation of external trade and payments arrangements, the adoption of a market-determined exchange rate for the Naira, substantial reduction in complex price and administrative controls and more reliance on market forces as a major determinant of economic activity.

The objectives of monetary policy since 1986 remained the same as in the earlier period, namely: the stimulation of output and employment, and the promotion of domestic and external stability. In line with the general philosophy of economic management under SAP, monetary policy was aimed at inducing the emergence of a market-oriented financial system for effective mobilization of financial savings and efficient resource allocation. The main instrument of the market-based framework is the open market operations. This is complemented by reserve requirements and discount window operations. The adoption of a market-based framework such as OMO in an economy that had been under direct control for long, required substantial improvement in the macroeconomic, legal and regulatory environment.

In order to improve macroeconomic stability, efforts were directed at the management of excess liquidity; thus a number of measures were introduced to reduce liquity in the system. These included the reduction in the maximum ceiling on credit growth allowed for banks; the recall of the special deposits requirements against outstanding external payment arrears to CBN from banks, abolition of the use of foreign guarantees/currency deposits as collaterals for Naira loans and the withdrawal of public sector deposits from banks to the CBN. Also effective August, 1990, the use of stabilization securities for purposes of reducing the bulging size of excess liquidity in banks was re-introduced. Commercial banks' cash reserve requirements were increased in 1989, 1990, 1992, 1996 and 1999.

The rising level of fiscal deficits was identified as a major source of macroeconomic instability. Consequently, government agreed not only to reduce the size of its deficits but also to synchronize fiscal and monetary policies. By way of inducing efficiency and encouraging a good measure of flexibility in banks' credit operations, the regulatory environment has improved. Consequently, the sector-specific credit allocation targets were compressed into four sectors in 1986, and to only two in 1987. From October, 1996, all mandatory credit allocation mechanisms were abolished. The commercial and merchant banks were subjected to equal treatment since their operations were found to produce similar effects on the monetary process. Areas of perceived disadvantages to merchant banks were harmonized in line with the need to create a conducive environment for their operations. The liquidity effect of large deficits financed mainly by the Bank led to an acceleration of monetary and credit aggregate in 1998, relative to stipulated targets and the performance in the preceding year. Outflow of funds through the CBN weekly foreign exchange transaction at the Autonomous Foreign Exchange Market (AFEM) and, to a lesser extent, at Open Market Operation (OMO)exerted some moderating effect.

The reintroduction of the Dutch Auction system (DAS) of foreign exchange management in July, 2002 engendered relative stability, and stemmed further depletion of reserves during the second half of 2002. However, the financial system was typically marked by rapid expansion in monetary aggregates, particularly during the second half of 2000, influenced by the monetization of enhanced oil receipts. Consequently, monetary growth accelerated significantly, exceeding policy targets by substantial margins. Savings rate and the inter-bank call rates fell generally due to the liquidity surfeit in the banking system though the spread between deposit and lending rates remained wide.

Introduction Of The Monetary Policy Rate (MPR)
Overtime, the CBN has recognized that achieving stable prices would require continuous reassessment and evaluation of its monetary policy implementation framework to enable it respond to the ever-changing economic and financial environment. It is against this background that the Bank introduced a new monetary policy framework that took effect on 11 th December, 2006 . The ultimate goal of the new framework is to achieve a stable value of the domestic currency through stability in short-term interest rates around an “Operating Target”, the interest rate, which is determined and operated by the CBN . The “Operating Target” rate i.e the “Monetary Policy Rate” ( MPR ), serves as an indicative rate for transaction in the inter-bank money market as well as other Deposit Money Banks' (DMBs) interest rate.

The main operating principle guiding the new policy is to control the supply of settlement balances of banks and motivate the banking system to target zero balances at the CBN , through an active inter-bank trading or transfer of balances at the CBN . This is aimed at engendering symmetric treatment of deficits and surpluses in the settlements accounts, so that for any bank, the cost of an overdraft at the Central Bank would be equal to the opportunity cost of holding a surplus with the Bank.

The Central Bank intervention in the market takes the form of a standing lending facility that which ensures orderly market operations or behaviour by alternating avoidable interest volatility. The standing lending facility is available as an overnight lending to banks with deficits, at a fixed interest rate, i.e the upper band of the CBN standing facility. The Bank stands ready to supply any amount the banks may require at the lending rate. The Central Bank also set up a standing facility that pays banks with surplus funds, a fixed interest rate in their deposit or reserves which they keep with the Bank. This arrangement allows the Bank to keep the overnight inter-bank interest rate in between the corridor with an upper and lower limit on interest rate.

MPR was set at 10 per cent, using the then rate of inflation rate and the expected inflation rate outcome of 9.0 per cent for fiscal 2006 as a guide to ensure that interest rates remain positive in real terms. There is a spread of 600 basis points around the rate, i.e 300 basis points below and 300 basis points above. This translates into an upper limit of 7 per cent, representing that rate at which CBN takes deposits from the banks.

A major advantage of the new framework is that the Central Bank is able to operate in the market daily and ensures adequate liquidity is provided to enable banks trading in the inter-bank market to complete settlement at interest rates around the MPR . Inter-bank rate is, therefore, maintained at a level between the lending and deposits rates at CBN . The maintenance of interest rates band has helped significantly to reduce volatility in the market compared to the inter-bank rates experienced in the past.

MPC meeting, 5 th December, 2007 .
The Monetary Policy Committee of the CBN met on 5 th June, 2007 and decided to reduce the MPR by 200 basis points, i.e from 10.0 per cent to 8.0 per cent. The width of the interest rate corridor was also reduced from +/-300 to +/-250 basis points. The implication of these actions is that the deposit facility now stands at 5.5 per cent while the lending facility would be 10.5 per cent, both down from 7 and 13 per cent, respectively.

MPC meeting, 3 rd October, 2007
The Monetary Policy Committee of the CBN met on 3 rd October, 2007 and decided to raise the MPR to 9.0 per cent which would be the repo rate and the rate at which the CBN lends to banks. The deposit money banks' deposits with the CBN will no longer earn interest. There measures are intended, amongst others to deepen inter-bank trading and encourage banks to free-up resources to encourage credit market.

Additional Committees Set Up To Enhance Formulation Of Monetary Policy
The newly constituted Fiscal Liquidity Assessment Committee (FLAC) has the mandate to design and regularly update the framework for obtaining information for forecasting fiscal liquidity. Another committee is the Liquidity Assessment Group (LAG) which takes decision on intervention in domestic money and foreign exchange markets.

2. Fiscal liquidity Assessment Committee (FLAC)
The Committee shall be made up of CBN Departments that have responsibility for monetary policy formulation, operations and monitoring; and ministries, departments and agencies of the Federal Government involved in fiscal operations.
Chairman: The MPD will serve as Chairman.
Members: The membership shall consist of the following department. MPD, BOD, TED, RSD, FOD, from the bank; FMF, Budget Office, customs & Excise, FIRS, NNPC, DPR, OAGF, from government.


Functions: The Committee shall be responsible for:

• Daily collection and update of liquidity data arising from government fiscal operations – injections (expenditures) and withdrawals (revenues) particularly information on float and any intending operations that have liquidity implications – through the desk officers of the relevant departments for the use of MPD in determining the system liquidity. FLAC shall also forward the forecast fiscal liquidity to the liquidity Assessment Groups.
• Assembling all available information on projected revenue and expenditure for the near future.
• Making daily and monthly projection/forecasting to determine the net fiscal injection and withdrawal of liquidity to the system.
  

Meeting: The FLAC meet daily in the morning. However, where the physical meeting may not take place, it is expected that the Committee members would contact one another through phone, e-mail e.t.c.


2. Liquidity Assessment Group (LAG)
Chairman : The Director, Banking Operations Department shall serve as Chairman with Director, Trade and Exchange Department as alternate Chairman.
Members: the Group shall be made up of CBN departments involved in the conduct of monetary policy. BOD, TED, MPD, RSD and FOD.

Functions: The Group would take decisions on intervention in domestic money and foreign exchange markets; and the mode and measure of such intervention required to achieve optimum system liquidity position.

In specific terms, the LAG shall be responsible for making suggestions on policy actions to be taken by the Group each day in both forex and domestic money market including:

• The need for intervention
• Timing of intervention
• Size, type and tenor of instruments
• LAG shall also decide the choice of market through which intervention should be undertaken (whether domestic money market or forex market).
• The LAG shall communicate its decision to the MPIC Chairman by 9.00 am every morning
• The DG shall obtain approval from the Governor by 9.15 am
• The LAG will build a data base on its expectations on daily /weekly/monthly/yearly basis to facilitate forecasts.
• LAG will follow up implementation of policy measures and report to MPIC

Meeting : The group shall meet at 8.45 am daily.

Background To MPC Decisions

Liquidity Position: June, 2007
The Bank sustained its market driven approach to ensure that the reserve money targets under the Policy Support Instrument ( PSI ) programme were achieved in the first half of 2007. Reserve money rose from N841.25 billion in March, 2007, to N902.40 billion in May 2007, showing an increase of N61.15 billion and excess liquidity of N42. 40 billion. However, at end-June, 2007, reserve money was N858.20 billion compared with the target of N860 billion. The attainment of the programme target in the second quarter reflected the effect of the intensive liquidity mop-up operations through the use of both the money market and foreign exchange instruments.

Liquidity Position: August 2007
As at September 17, 2007 , reserve money was N919.7 billion compared with the target of N880.0 billion for end – September, 2007. The major driver of the growth in reserve money in the third quarter was currency in circulation, which increased from N719.2 billion at end – August, 2007 to N735.4 billion on September, 17, 2007

Liquidity Position: October, 2007
As at end-September, 2007 reserve money was N928.6 billion compared with the target of N880.0 billion for the third quarter of 2007.

Liquidity Position: December, 2007
The current forecast suggest a reserve money level of N989.0 and N1,033.39 billion in November and December 2007, respectively, compared with the indicative target of N1,007.0 billion for the fourth quarter, 2007.

Implication Of The New CBN Act On The Formulation Of Monetary Policy
In line with the CBN Act, 2007, one of the principal functions of the Central Bank of Nigeria is to “ensure monetary and price stability” In order to facilitate the attainment of the objective of price stability and to support the economic policy of the Federal government, the Act provides the constitution of a Monetary Policy Committee (MPC) which will comprise the Governor as the Chairman, 4 Deputy Governor's two members of the Board of Directors of the Bank, three members appointed by the President and 2 members appointed by the Governor.

The implication for the formulation of monetary policy is that with the new mandate derived from the CBN Act and the composition of the MPC, monetary policy credibility of the Bank will be strengthened. This is because monetary policy will now be conducted in a more open and forward looking way.