The Monetary Policy Committee (MPC) met on 19th September, 2011 to review domestic economic conditions during the first eight months of 2011 and the challenges facing the Nigerian economy against the backdrop of developments in the international economic and financial environment in order to reassess the challenges facing monetary policy for the rest of 2011.

On the global scene, the Committee noted that current international developments presented substantial economic uncertainties, clouding the outlook for global growth and inflation. These developments included: increasingly weak and volatile global financial markets, deepening debt crisis in the Eurozone, global implications of slow growth at a time of limited fiscal flexibility, rising commodity and food prices, and costly natural disasters. There is a general expectation that there would be a slowdown in almost all advanced economies in the near term, raising fears of a second recession.

These developments, in the Committee’s view, affect the domestic economy through trade and financial flows. Also, international financial markets present a very volatile and uneven picture, reflecting a high degree of uncertainty.

The Committee also noted that, there is increasing concern about the sustainability of public debt globally. The high fiscal deficits suggest that policies to usher in fiscal discipline are critical for restoring public confidence in Government finances. The Committee welcomed the Federal Government’s expressed intent to contain fiscal deficits within credible limits over the medium term.

On the domestic front, the MPC noted that inflationary pressures faced by the domestic economy had slightly moderated following the series of monetary policy tightening measures adopted by the Bank, complemented by a favourable harvest. The output growth remained robust, although the current security challenges could undermine investors’ confidence and output in the near term. Nonetheless, the inflation outlook appears uncertain despite the expected favorable agricultural production, the stability in expectations engendered by the imminent conclusion of the banking sector reforms, and the prospects for a return to a regime of fiscal prudence in the medium-term following the reconstitution of the Federal Government of Nigeria (FGN) Economic Management Team. It is against this backdrop that the Committee considered the monetary policies required to attain the objectives of price and financial stability in the short to medium term.

Key Domestic Macroeconomic and Financial Developments

Output and Prices

The Committee observed that the output growth rate for the second quarter 2011 remained robust. Provisional data from the National Bureau of Statistics (NBS) indicated that real Gross Domestic Product (GDP) grew by 7.72 per cent in the second quarter of 2011, which is above the 7.69 per cent recorded in the second quarter of 2010. Overall GDP growth for 2011 is projected at 7.85 per cent which is slightly lower than the 7.87 recorded in 2010.

The non-oil sector remained the major driver of growth, recording 8.82 per cent growth rate compared with 1.81 per cent for the oil and gas sector in the second quarter of 2011. The growth drivers remained agriculture, wholesale and retail trade, and services, which contributed 2.48, 1.88 and 2.52 per cent, respectively.

Domestic Prices

The Committee noted that the moderation in inflationary pressures, which commenced towards the end of the second quarter of 2011, continued into the third quarter. The year-on-year headline inflation rate decreased from 9.4 per cent in July 2011 to 9.3 per cent in August and core inflation decelerated from 11.5 per cent to 10.9 per cent during the same period. However, food inflation rose to 8.7 per cent in August 2011, from 7.9 per cent in July.

The harvesting of early maturing crops, especially maize, tomatoes, vegetables, potatoes and fruits played a key role in the moderation of headline inflation. The recently announced government policies and programmes are likely to have a salutary impact on agricultural output, if speedily implemented.

These expectations are however currently under threat from anticipated fiscal injections, increased government borrowing to finance the huge fiscal deficit in the 2011 budget, the recent upward revision of electricity tariffs and the anticipated deregulation of petroleum product prices, among other factors.

Monetary, Credit and Financial Market Developments

Broad money (M2) grew by 8.55 per cent in the eight months to August 2011, which annualized to a growth rate of 12.82 per cent. Aggregate domestic credit (net) grew by 14.72 per cent in August 2011 when compared with the level in December, 2010. On annualized basis, the growth in net domestic credit translated to 22.08 per cent compared with the growth rate of 15.0 per cent in the corresponding period of 2010. The growth in aggregate credit was accounted for by increases in credit to the Federal Government and the private sector. Credit to the Federal Government grew by 18.99 per cent, which annualized to 28.48 per cent, close to the indicative benchmark of 29.29 per cent for 2011.

Similarly, credit to the private sector grew by 10.88 per cent, which annualized to 16.32 per cent, as against the benchmark of 23.34 per cent. With the banking crisis approaching a final resolution with the recapitalization of banks, it is expected that banks will increase lending once integration issues are concluded.

Interest rates in all segments of the interbank money market rose in response to the upward review of the MPR at the previous MPC meeting. The Inter-bank and Open Buy Back (OBB) rates both opened at 7.49 per cent on July 27, 2011 and rose to 11.0 per cent and 10.36 per cent on September 15, 2011, respectively.

The retail lending rates which had remained relatively high, however, declined during the period. The average maximum lending rate declined to 22.27 per cent in August, 2011 from 22.42 per cent in July. The weighted average saving rate rose to 1.46 per cent from 1.42 per cent over the same period. The consolidated deposit rate declined during the period from 2.42 to 2.30 per cent.

Thus, the spread between the average maximum lending rate and the consolidated deposit rate narrowed marginally from 20.0 per cent to 19.97 per cent during the period. The bearish performance of the stock market continued during the review period as the All-Share Index (ASI) decreased by 15.5 per cent from 24,980.20 at end-June, 2011 to 21,106.67 on September 16, 2011. Market Capitalization (MC) decreased by 15.7 per cent from N7.99 trillion to N6.73 trillion during the same period. Despite the bearish performance, the equity market was more or less fairly valued as reflected in the NSE Price-Earnings (PE) ratios of 10.82 in August 2011, which was close to the 10-year 8-month median of 11.57.

Moreover, the performance of the NSE during the review period is consistent with the performance of other stock markets around the world, and reflects lingering risk aversion and deleveraging on the part of foreign institutional investors who are key players on the NSE.

External Sector Developments

At the wDAS, the exchange rate, during the period (July 27 – September 15, 2011) opened at N150.00/US$ and closed at N153.52/US$, representing a depreciation of N3.52 or 2.35 per cent. At the inter-bank segment, the selling rate opened at N151.80/US$ and closed at N156.30/US$, representing a depreciation of N4.50 or 2.96 per cent during the period.

The exchange rate recorded a modest appreciation at the BDC segment where the selling rate opened at N163.00/US$ and closed at N158.00/US$, representing an appreciation of N5.00 or 3.07 per cent. The appreciation recorded in the BDC segment of the market was attributed to the increased supply of foreign exchange by the CBN and the removal of ceilings on DMBs’ sales to BDCs.

The Committee noted that the premium between the rates at the WDAS and the interbank stabilized towards the end of the review period, while that of the BDCs narrowed significantly, suggesting the need to sustain existing measures to improve the efficiency of the market.

The Committee also noted the modest accretion to external reserves during the period. Gross external reserves stood at US$34.85 billion on 15th September, 2011, representing an increase of US$1.12 billion or 3.32 per cent above the level of US$33.73 billion attained on July 21, 2011. The increase was mainly accounted for by increased inflows of royalties into the federation account, reflecting the upward trend in international oil prices and stable oil production in the Niger Delta.

Besides, foreign direct and portfolio investments increased over the last eight months. Foreign capital inflows for the first eight months of 2011 stood at US$5.66 billion which is US$1.06 billion or 23.04 per cent higher than the US$4.60 billion recorded in the corresponding period of 2010.

The Committee’s Considerations

The key concerns noted by the Committee were:

1. Continuing expansionary fiscal stance and high component of recurrent expenditure;

2. Liquidity surge expected from AMCON intervention, following conclusion of bank recapitalization;

3. Sharp rise in month-on-month headline inflation rate despite falling headline inflation rate on year-on-year basis;

4. Need to have positive real interest rates; and

5. Persisting demand pressure in the foreign exchange market, driven by significant liquidity injections and reflecting structural deficiencies that have perpetuated the import dependence of the economy.

The Committee considered that given the difficult and uncertain international environment, it is important to ensure that the current trends in growth are sustained and price stability is maintained. The recent data on inflation showed that the headline inflation rate has been maintained within single digit for two consecutive months.

However, concerns remain about sustaining the present inflation trend. The Committee viewed the rise in the monthly headline inflation rate in August which, while justifiable from the point of view of the large household expenditures on account of festivities, was sharp and out of line with the trend in the preceding 11 months. Besides, the anticipated high liquidity in the near future would have a bearing on inflation. The fiscal stance continues to be expansionary. The announcement of a target of one (1) per cent annual reduction in government recurrent spending when viewed in the context of the anticipated injections associated with the implementation of the new national minimum wage, suggests that the fiscal retrenchment is likely to be drawn-out. In addition, there is the weight of structural factors such as the announced hikes in electricity tariffs and the expected removal of petroleum subsidy. Moreover, the AMCON injection of N3.0 trillion is going to add to liquidity surge with attendant adverse impact on prices. It is for these reasons that the Committee felt the need for further tightening of monetary policy.

On the other hand, the Committee noted that rates have been increased in the last four consecutive MPC meetings and that high lending rates increase the cost of finance for SMEs and this has an adverse consequence for growth and job creation.

However, having considered the arguments for and against tightening, the Committee voted for maintaining the stance of tightening in the short term.

The Committee emphasized that for monetary policy to be effective it would need to be complemented by other policies, both structural and fiscal. Monetary policy can only address the monetary aspects of inflation while fostering growth and financial stability. The need for accelerating fiscal retrenchment and structural adjustment can therefore not be overemphasized.

Decisions:

In the light of the above considerations the Committee decided as follows:

1. A majority of 8 to 3 members voted for a tightening of monetary policy.

2. Seven (7) members voted for a 50 basis-point increase in MPR from 8.75 to 9.25 per cent. One (1) member voted for a 100- basis-point increase in MPR. The 3 remaining members voted to maintain the MPR at the current rate.

3. A Unanimous decision to:

a. maintain the current symmetric corridor of +/-200 basis points around the MPR; and

b. retain the current CRR of 4.0 per cent

Sanusi Lamido Sanusi, CON

Governor

Central Bank of Nigeria

September 19, 2011