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How Nigeria is misusing government policy
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Have you ever stopped to think about why governments exist?
In early civilisation, around 3000 BC, agriculture, the bedrock of the ancient economy, received a boost from the invention of irrigation. But the application of irrigation required people to coordinate the flow of water so that it reached all fields in the region. Someone also needed to create a calendar to let field workers know when floods might be expected.
The people decided they needed a central authority to do that. A subtle history lesson for us, then: to boost agriculture, the policy tool was to create a central government to control the water supply.
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If you follow Nigerian news, you can be forgiven for thinking that mastering agriculture remains our main economic problem. Actually, there are much bigger fish to fry: economic growth, unemployment, inflation, and so on.
As the world has developed, we have found new ways of tackling these issues.
Some countries, like Ethiopia (agriculture) and South Korea (electronics), have wagered their economic success on singular industries. Others have tried to import success; for the last decade, Ireland has set low corporate tax levels to attract technology giants like Google to drive its economy.
When a country faces an economic problem, it has an assortment of tools to choose from; the chosen policy would depend on the specific bottleneck. For example, while a ₦50 per child school meal voucher could boost school attendance and educational attainment in Nigeria, the same policy would have little effect in Norway. The schoolchildren in Norway are not hungry so the free meals program is not fit for purpose.
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POLITICIANS HAVE A TRICKY RELATIONSHIP WITH CENTRAL BANKS.
An equivalent story can be told for how monetary policy is used to tackle inflation, which is a universal economic problem, but one Nigeria has particularly struggled with in recent times. The country’s inflation rate averaged over 11% in 2019, compared to roughly 9% in Ghana and 4% in South Africa.
Central banks use “monetary tools” to combat inflation. These tools are mainly interest rates (the price you pay to borrow money), money supply, and bank regulations.
When the Central Bank of Nigeria (CBN) was created in 1958, it was under the supervision of the government, which needed to approve all policy decisions. A 1991 amendment granted the CBN autonomy but this was removed in 1997. It was not until 2007 that the CBN became a “fully autonomous body in the discharge of its functions”.
Why did this autonomy matter? So that the central bank’s decisions are not influenced by political interests.
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The central bank’s primary objective—as stated in the 2007 CBN Act—is to control inflation, and doing so requires discipline in managing how much money is flowing in the economy. Too much of it and inflation rises: the classic problem of too much money chasing too few goods.
Unsurprisingly, politicians do not always have the required level of restraint and would rather have money flowing freely in the economy at all times to improve their chances of re-election.
And central banks are not mere spoilsports; inflation imposes real costs.
It was this type of political influence that saw inflation skyrocket to 98 billion percent in Zimbabwe—prices basically doubled each day.
In short, ever since hyperinflation in Germany inspired an autonomous central bank, consensus wisdom has been that monetary policy tools can’t be left in the hands of politicians because they will not be used appropriately.
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THE 2008 RECESSION TAUGHT SOME OF US A FEW LESSONS.
The best central banks know how and when to use the right monetary policy tool.
The last financial crisis crippled the US economy. Specifically, financial markets froze as lenders knew that some institutions were exposed to mortgage-backed securities which had become “toxic”, but did not know which ones. So, they stopped lending completely; hence, the famous credit crunch term.
But an economy without lending is like a bicycle chain without oil, movement is restricted.
To solve the problem, the US Federal Reserve Bank (Fed) bought as many of those toxic assets as it could, about $1.3 trillion worth in total. That did the trick of reintroducing trust into the system and easing financial conditions.
The Fed could have opted for one of its other policy tools—for example, forcing banks to lend by issuing a regulatory circular with a new lending target—but chose to target the source of the bottleneck. In doing so, it found the correct approach.
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ALAS, THE NIGERIAN WAY IS THE NIGERIAN WAY.
After the National Bureau of Statistics (NBS) revealed that Nigeria’s inflation had hit 12% at the end of 2019, the CBN came to the rescue by increasing the Cash Reserve Ratio (CRR) by 5 percentage points to 27.5%. In layman terms, the CBN was asking banks to keep a higher portion of their customer deposits protected.
This reduces the amount of money available to banks to generate loans for customers, which in turn reduces investment and consumption in the economy.
The policy has had mixed reviews. Some believe it will have little impact as banks already have an effective CRR higher than 27.5%. Others expect that the CBN will raise the CRR for all banks by 5 percentage points even if they are already above 27.5%.
Whatever the verdict, this is a classic example of choosing a policy tool that does not match the problem you are trying to fix.
Let us explain why this solution does not tackle the real problem.
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Inflation could be caused by excess money (liquidity) in the system. This pushes down borrowing costs (as no one is pressed for cash) and encourages borrowing and spending over saving. The result is excess demand for goods without the equivalent supply to match, encouraging firms to charge higher prices.
Alternatively, inflation could be “cost-push”, such as when a rise in global raw material prices forces firms to pass on those increased costs to the final consumer in the form of higher prices.
The CBN’s attempt to reduce the amount of liquidity is supposed to solve the first problem of excess cash and demand in the system. But that is not the cause of Nigeria’s inflation.
The main culprit for the uptick in inflation is a rise in food prices as a result of the border closure which has reduced food supply and also given local producers more power to charge higher prices.
According to the NBS, domestic and imported food inflation are currently at 15% and 16% respectively. Once you strip out food prices, Nigeria’s inflation is actually in line with the CBN’s target of 9%.
But the CBN does not have the power to open the borders to push down food prices so with regards to inflation - its hands are tied.
Worse, this inability to affect inflation or growth is not new terrain for the CBN. In 2014, 11 of its economists wrote a paper on the impact of monetary policy tools like interest rates and the CRR on inflation and growth.
The results were not great.
Their analysis showed that the CBN’s main policy tool, the interest rate, had no impact on inflation. In fact, increasing the monetary policy rate was associated with higher food inflation. A central bank’s nightmare.
The CRR had better luck with inflation but no mention on how it deals with food inflation, in particular.
Another CBN paper in 2014 tried to estimate the impact of monetary policy on individual sectors in the economy and found that a change in the monetary policy rate only led to desired outcomes in the retail trade and services sectors.
Amid these results, the authors recommended the creation of “more special credit schemes by the central bank”.
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NOW WE HAVE FARMERS IN SUITS.
The year after those papers, the CBN began a string of loan-related industry policies, ranging from agriculture loans to funds for the creative industry.
It seems like the CBN has given up on traditional monetary policy tools and is bent on using its ability to cheaply create loans to solve the problems in agriculture. Over ₦200bn in loans have been provided by the bank through just one of its schemes, the Anchor Borrowers Program.
Farmers have enjoyed access to single-digit interest loans that other Nigerians can only dream of, but have the CBN policies had any positive aggregate effect?
The numbers do not show anything exciting.
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Despite its resilience through the recession, agriculture grew by 10% (cumulatively) in the three years after the CBN began its big push in the sector in 2015. From 2013 to 2015, the sector grew by 17%. Generally, the speed of growth in the sector has slowed: from above 4% four years ago to around 2% in the third quarter of 2019.
The reality is that as long as agriculture productivity remains low, infrastructure such as electricity for irrigation is scarce, and transport costs remain high, giving farmers more loans will reap only marginal returns.
The main problem in agriculture is productivity and not loans.
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The government is aware of this and has other programs trying to address productivity, such as fertiliser provision. The problems of technology adoption, which Ethiopia has focused on to provide its economy 10% growth, and infrastructure including such as electricity and transportation, are problems beyond agriculture.
The discussion on the direct government policies to solve those are for another day but the answer is not the CBN.
The problem with the central bank’s focus on agriculture is that not only is it spending resources on secondary issues in the sector, it is also facing the cost of not spending time and resources elsewhere.
It has an objective to provide financial stability and we are still in a shaky situation with multiple exchange rates, a heavy reliance on short term foreign investors for foreign exchange and reserves.
Oil prices have started falling again as the coronavirus hits global demand. If we get in a situation where it falls far enough to scare investors and they begin to exit Nigeria again, the CBN better hope its farmers can get it out of the situation.
See you next week!
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