CBN May Continue to Hawkish Amid Fears of Dwindling Reserves

The times remain very tersed for the Central Bank of Nigeria (CBN) as acting apex bank govenor, Sarah Alade faces her first test as the chairman of the Monetary Policy Committee (MPC).
As bad as the interest rates is, and no matter how much the real sector operators rage over high cost of funds Sarah cannot afford to be a dove, she must remain a hawk as her predecessor, Sanusi Lamido Sanusi.
Razia Khan, analysts with Standard Chartered Bank, London, in her possible outcome of the MPC meeting believe, although inflation rate is comfortably single-digit, she is afraid that food prices remain a threat.
Although headline inflation has remained in single digits, core inflation has been trending higher in recent months. With the approach of the planting season, food prices are expected to start rising more significantly. The sharp rise in the FAO food price index year-to-date, suggests that global trends in commodity prices may soon be transmitted to Nigeria. Should this trend continue, our inflation projections see Nigerian headline inflation in low double-digits by July 2004. Maintaining faith in the ability of the CBN to stabilise the foreign exchange rate, by adjusting to market levels now rather than drawing down further on reserves, will be important to inflation expectations and outcomes.
On fiscal side, she sees no possible succour either. In fact, she is optimistic that, re-accumulating the depleted foreign reseves is almost an impossibe task.
Nigeria’s ability to accumulate greater foreign exchange reserves will depend in the short term on an improvement in oil earnings, as well as a more supportive fiscal stance. The trend in oil production suggests that augmentation of fiscal revenue will still be needed, given current output levels. Moreover non-oil revenue continues to be pressured, in part because of a shortfall in receipts from import tariffs, as official channels for food imports are circumvented. Spending pressures remain, but with retained revenue under pressure near-term, it is unlikely that an improved fiscal stance will be able to boost savings, and therefore foreign exchange reserves meaningfully.
By adjusting the foreign exchange trading band now, the CBN would be doing no more than recognising where the market is currently trading. The inflation advantage of a strong Retail Ducth Auction System (RDAS) foreign exchange rate is already in question – as the interbank and parallel market rates are more likely to influence inflation. Although some stability has been restored to the exchange rate, through increased CBN selling, it has been costly for Nigeria’s foreign exchange reserves. With pressures likely to persist as investors exit Nigeria, the CBN should act early, and more flexibly, to safeguard reserves.
Monetary policy has already been tightened considerably, but significantly more tightening may not be the answer. Given Nigeria’s fundamentals, and investor concern about oil receipts, each tightening episode may be less effective in attracting new inflows as time progresses. The CBN’s commitment to foreign exchange stability has been commendable, and has played an important role in the achievement of lower inflation. But to make a credible commitment to ongoing foreign exchange stability, in a manner that continues to shape inflation expectations, foreign exchnage reserves will also need to be safeguarded. Recognising this, we expect a shift in the foreign exchange band, to encompass current market levels.

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