Prof. Jonathan Aremu, renowned economist and professor of International Economic Relations at the Covenant University, began his working career in the Research Department of the Central Bank of Nigeria (CBN) in 1980 as an Assistant Economist, and rose through the ranks to become Acting Assistant Director of Research before he voluntarily retired in December 1992. In this interview with Ibrahim Apekhade Yusuf, Prof. Aremu gives useful suggestions on the fiscal, monetary policy and economic policy tools which may be required by the incoming government to respond to the prevailing macroeconomic pressures. Excerpts:
Setting monetary agenda
Thanks for your questions on this topic of setting monetary agenda for Buhari’s administration. I will focus more on monetary policy and later touch briefly on its mixture with fiscal policy. If I get you right, you wanted to know how the incoming administration will engage its monetary policy to resolve the various problems the country is facing.
It is quite some time I left the Central Bank of Nigeria (CBN). However, the main objectives of an effective monetary policy are still constant. They include the following: full employment, price stability, economic growth and balance of payments.
Over the years, the CBN engages some instruments to determine the availability of credit and its flow; volume of money in circulation; cost of borrowing, (that is, the rate of interest); and general liquidity of the Nigerian economy. The instruments of monetary policy to achieve the above objectives are usually of two types: first, quantitative, general or indirect; and second, qualitative, selective or direct. Both instruments affect the level of aggregate demand through the supply of money, cost of money and availability of credit. Of the two types of instruments, the first category includes bank rate variations, open market operations and changing reserve requirements.
The bank rate is the minimum lending rate of the central bank at which it rediscounts first class bills of exchange and government securities held by the commercial banks. When the central bank finds that inflationary pressures have started emerging within the economy, it raises the bank rate.
Borrowing from the central bank becomes costly and commercial banks borrow less from it. The commercial banks, in turn, raise their lending rates to the business community and borrowers borrow less from the commercial banks. There is contraction of credit and prices are checked from rising further. On the contrary, when prices are depressed, the central bank lowers the bank rate. It is cheap to borrow from the central bank on the part of commercial banks.
The latter also lower their lending rates. Businessmen are encouraged to borrow more. Investment is encouraged. Output, employment, income and demand start rising and the downward movement of prices is checked.
Open market operations refer to sale and purchase of securities in the money market by the central bank. When prices are rising and there is need to control them, the central bank sells securities. The reserves of commercial banks are reduced and they are not in a position to lend more to the business community. Further investment is discouraged and the rise in prices is checked. Contrariwise, when recessionary forces start in the economy, the central bank buys securities. The reserves of commercial banks are raised. They lend more. Investment, output, employment, income and demand rise and fall in price is checked.
Every bank is required by law to keep a certain percentage of its total deposits in the form of a reserve fund in its vaults and also a certain percentage with the central bank. When prices are rising, the central bank raises the reserve ratio. Banks are required to keep more with the central bank. Their reserves are reduced and they lend less. The volume of investment, output and employment are adversely affected. In the opposite case, when the reserve ratio is lowered, the reserves of commercial banks are raised. They lend more and the economic activity is favourably affected.
The selective credit controls aim at controlling specific types of credit. They include changing margin requirements and regulation of consumer credit. They are used to influence specific types of credit for particular purposes. They usually take the form of changing margin requirements to control speculative activities within the economy. When there is brisk speculative activity in the economy or in particular sectors in certain commodities and prices start rising, the central bank raises the margin requirement on them.
Effecting a successful monetary policy
Monetary policy in a relatively underdeveloped economy like Nigeria is expected to plays an important role in increasing the growth rate of the economy by influencing the cost and availability of credit, by controlling inflation and maintaining equilibrium the balance of payments. The incoming administration through the CBN should use monetary policy towards the following areas.
To control inflationary pressures of the instruments of monetary policy, the open market operations are not as successful in controlling inflation in Nigeria because the bill market is fully developed. Banks still keep an elastic cash-deposit ratio because the central bank’s control over them is not totally complete. They are also reluctant to invest in government securities due to their relatively low interest rates. Moreover, instead of investing in government securities, they prefer to keep their reserves in liquid form such as foreign exchange and cash. The banks are also not in the habit of borrowing from the central bank.
Monetary policy is an important instrument for achieving price stability as it brings a proper adjustment between the demand for and supply of money. An imbalance between the two will be reflected in the price level. A shortage of money supply will retard growth while an excess of it will lead to inflation.
As the economy develops, the demand for money increases due to the gradual monetisation of the non-monetised sector, and the increase in agricultural and industrial production. These will lead to increase in the demand for transactions and speculative motives. So the monetary authority will have to raise the money supply more than proportionate to the demand for money in order to avoid inflation.
To achieve balance of payment, as earlier said, monetary policy through the use of interest rate policy plays an important role in bridging the balance of payments deficit. Many developing countries like Nigeria today, have balance of payments difficulties to fulfil the planned targets of development. To establish infrastructure like power, irrigation, transport, etc. and directly productive activities like iron and steel, chemicals, electrical, fertilisers, etc., we still have to import capital equipment, machinery, raw materials, spares and components thereby raising their import in spite of declining fortune from oil. This is the cause of our imbalance created between imports and exports which lead to disequilibrium in the balance in payments. Monetary policy can help in narrowing the balance of payments deficit through high rate of interest. A high interest rate attracts the inflow of foreign investments and helps in bridging the balance of payments gap.
One of the objectives of monetary policy in developing countries is to create and develop banking and financial institutions in order to encourage, mobilise and channelise savings for capital formation. Such a policy will enhance financial inclusion by monetising the non-monetised sector and encourage saving and investment for capital formation. It should also organise and develop money and capital markets across the country. These are essential for the success of a development oriented monetary policy which also includes debt management.
Debt management
Debt management is one of the important functions of monetary policy in an underdeveloped economy like ours. It aims at proper timing and issuing of government bonds, stabilising their prices and minimising the cost of servicing the public debt. The primary aim of debt management is to create conditions in which countries can finance development programmes and to control the money supply. But public borrowing must be at cheap rates. Low interest rates raise the price of government bonds and make them more attractive to the public. They also keep the burden of the debt low. Thus an appropriate monetary policy, as outlined above, helps in controlling inflation, bridging balance of payments gap, encouraging capital formation and promoting economic growth.
Mixing monetary and fiscal policies
Nigerian economy is currently facing extremely difficult times after having been hit by converging adverse developments, some due poor governance others due to declining fortune from oil revenue. In the past, the Nigerian economy has proven resilient in times when economic circumstances have suddenly changed. While the economy’s flexibility is now being tested, an adequate policy response would help to revamp growth, enabling companies to expand investment and create new jobs. To this end, the domestic in- coming administration should aim at quickly restoring the economy to balance and laying out the foundations for a sustainable recovery. This includes stabilising the exchange rate and inflation, and also implementing a decisive fiscal consolidation programme.
Managing inflation
Inflation had been high and volatile even before the recent problems resulting from the collapse of the oil price. Facing difficult challenges, including the management of the financial crisis and laying the foundations for a sustainable recovery, the monetary authority, under the in-coming administration, should consider the following among others earlier mentioned.
We have to keep capital controls in place until they can be safely removed. Until then, monetary policy should continue to be mainly focused on exchange rate stability, which may limit the scope for further reductions in the interest rate.
Besides, we must take measures to restore the credibility of the CBN. Best-practice policies should be adopted in terms of communication, independence, governance and monetary control. Even more importantly, the conduct of monetary policy should be decisive and the incoming government should respect the independence of the CBN.
A suitably modified inflation-targeting framework can act as an effective nominal anchor for monetary policy and Naira should be allowed to be determined at the market rate without further subsidy.
Fall in oil prices
The collapse of the oil price and the consequent dwindling of economic activity in the country put public finances of the in a dire situation. An aggressive fiscal consolidation programme should be quickly implemented along the monetary policy recommended here.
This will involve significant tax increases and spending cuts, with the latter playing an increasing role over time.
Many of the tax cuts implemented over the boom years should be re-examined and possibly withdrawn.
The tax system should be reformed over time in order to increase revenues in a growth friendly way by widening tax bases, imposing corrective taxes and closing loopholes. For instance, the number of goods and services exempt from the VAT should be reduced.
There is also scope to better target tax allowances. To do that we have to halt all non-essential public infrastructure projects and impose a freeze, or even a cut, on nominal wages in the public sector.
We also must adopt a new fiscal framework emphasising spending control and medium-term sustainability, by requiring public agencies to make up for any over expenditure in the following years and giving public-sector managers greater autonomy and accountability in deciding how to achieve their objectives.
Cost control
Exorbitant remunerations of politicians/administrators must be drastically slashed to reflect the reality of Nigerian economy.
Government Ministries, Departments and Agencies must be pruned down. A time of crisis provides the opportunity for introducing politically difficult reforms (like removal of oil subsidy).
Above all, there is scope to cut a number of inefficient programmes, starting with the unsustainable subsidies and similarly, the consolidation/harmonisation processes among state and local government authorities should be embarked upon.
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