Monetary Policy & Nigeria's Petroleum Economy

By Ifeanyi Aloh

EFFECTS ON THE ECONOMY

The effects of the MPC monetary decision on the Nigerian economy in the face of the global economic crisis could best be described in the comment made by Sam Ohuabunwa, the Chairman of the Nigerian Economic Summit Group (NESG), as follows: 

“Turmoil in global financial markets is deepening into recession across the world. Our recent gains in economic growth and macroeconomic stability may be threatened by sustained fall in oil prices. There is greater threat of ‘protectionism’ as countries look inward to protect against recession.”[1]

The MPC of the CBN against the background of some factors made certain monetary decisions in the period 2007/2008 to forestall a spiral of the economy into inflation. The factors considered are:

• High downside risks to low inflation during fiscal 2007
• Rising autonomous private inflows which is expected to lead to persistent excess liquidity in the system
• Anticipated high election spending
• Falling prices of crude oil
• Impact of these adverse developments were expected to unwind after the elections
• Risks of over appreciation of the naira/dollar exchange rate
• Stability of the exchange rate and external reserve
• Robust economic outlook expected in the medium term

To achieve or avoid the objects stated above, the CBN embarked on monetary policy formulation motivated by protectionism or domestic economy protection. Thus, there was frequent policy change either to mop up excess liquidity, manage the naira/dollar exchange rate relation; supervise the sale of the foreign exchange; create a buffer against the activities of institutional investors; and to print new currency and push into circulation to fill up the wide gap created by the credit crunch and the stock market crisis. 

During the 2007/2008 financial year, starting from February, 2007, the CBN made the following policies:

• CRR (Cash Reserve Requirement) was increased from 3 by 100 basis points to 4.0 percent
• Liquidity ratio was decreased from 40 percent to 30 percent
• Reduction of interest rate from 7.0 to 6.5, and lending rate from 13.0 to 10.5
• Issuance of primary market instrument to mop up about N100Billion from the system.
• Reduction of the MPR from 10.0 to 6.0
• Participation of the CBN in the sale of foreign exchange
• Issuance of treasury bills
• Reduce bank’s foreign exchange net position from 20.0 to 10.0 percent
• Quantitative easing to bridge up a gap of N500Billion created by the credit crunch and stock market crisis
• Interest rate at 200 basis point above the MPR and 400 basis points below the MPR.[2]

The CBN governor, Sanusi Lamido Sanusi, referring to the above, noted as follows:

“The failure of the economy to respond favourably to the monetary easing measures reflected mainly the under-developed character of the financial market and, concomitantly, the weakness of the transmission mechanism of monetary policy.”[3]   

Suffice it to say that the policy decisions made by the MPC did not succeed completely; as a result of certain institutional and political factors that hindered the accomplishment of these objects.                   

 FOREIGN INVESTMENT:

The Nigerian economy is totally dependent on the oil and gas sector. The sector presently accounts for more than 95 percent of Nigerian’s export earnings and about 85 percent of government revenues. Nigerian’s oil reserve has been estimated at 36.2Billion barrels of proven oil reserve. Whereas the proven natural gas reserve has been estimated at 184 Trillion Cubic Feet (Tcf).[4]

In response to these opportunities, operators and global players like Shell, chevron, ExxonMobil, Total, and Eni/Agip invested in the sector. Recently, Chevron developed an upstream operated field in September, 2008, with expected peak production of 250,000 by the end of 2009. EIA estimates that Nigerian’s oil production capacity could be fixed around 2.7Million barrels per day (bbl/d).

However, as a result of oil bunkering, militants’ attack on oil installations, workers strike action and problem of inadequate infrastructure forced production down in 2008 to fluctuate between 1.8Million and 2.1Million. Note, that non-crude petroleum production stood at 230,000 bbl/d in 2008, bring total oil production to 2.17Million for the year.

Nigeria produced 1,204 Bcf of natural gas in 2007; consumed 456 Bcf, while 749 Bcf were exported mainly as liquefied natural gas (LNG). The breakdown is as follows: 95 Bcf of LNG were exported to US; 447 Bcf were exported to Trinidad and Tobago; and 115 Bcf to Egypt. Whereas in 2008, a greater chunk of the 2.17 Million bbl/d of oil production were exported. Out of the 2.17 Million bbl/d oil production, 990,000 bbl/d (44 percent) was exported to US; 25 percent to Europe, 7percent to Brazil, 11 percent to India and 4 percent to South Africa.

Note, that the trading condition of Nigeria was very stable notwithstanding the disturbances and the insurgence in the Niger Delta region. See graph below for illustration.[5]

 

In the period mentioned above, as a result of the heightened export of oil, there was massive influence of foreign exchange, that it raised monetary control problems for the CBN. Hence, the CBN resorted to direct control and supervision of the foreign exchange market.

EFFECT OF THE 2007/2008 CRISIS ON THE SECTOR

The financial crisis which emanated initially from the United States of America (USA) sub-prime mortgage crisis and spiralled into other economies of the world; led to a slump in the international oil price. This development had a tremendous effect on the Nigerian economy; which is heavily dependent on its oil as the major source of export earnings.

The fall in oil price led to about 4.5 percent decline in oil contribution to Nigeria GDP between 2007 and 2008. In addition, the persistent decline in oil prices also created a budgetary crisis for Nigeria as the 2009 budget was benchmarked on US$62.0 as against US$44 which the price fell to.

The developments mentioned above, paved way for the occurrence or appearance of certain adverse economic factors such as:

• Commodity price collapse (fall in the price and volume of oil)
• Decline in revenue (Nigerian export fell from US76.3Billion to US$28.2 in 2008)
• Exit and decline in capital inflows
• Reduction of foreign reserves and pressure on exchange rate (the Naira depreciated from N117 to N135 per dollar)
• Pull out of investment by foreign investors and capital market crash
• Limited foreign credit lines.[6]

The factors listed above has grossly reduced macro-economic activities and also occasioned uncertainty amongst Nigerian policy makers. It has also brought about the postponement of projects and unhealthy delays in the completion of ongoing ones. For instance, it has made it very unlikely for the Federal Government to put into force the US$5 billion allocated for JV operations in the 2009 budget.[7]

In response to the global financial crisis and the slump in oil prices, the CBN formulated the following policies to cushion the effect:

• Cut back on the MPR from 10.25 percent to 9.75 percent
• Reduction in CRR from 4.0 percent to 2.0 percent
• Cut down on the liquidity ration from 40.0 percent to 30.0 percent
• Discount window facility was introduced
• Rights granted to banks to restructure margin loans
• Expansion of lending facilities to banks
• Stoppage of liquidity mopping in September, 2008.[8]

Note, that these measures taken by the CBN has however, been criticised as being inflationary. For instance, Nigerian inflation rose from 2.5 percent in January, 2008 to 8.0 percent in January, 2009. 

RECOMMEDATIONS

The chances of using monetary policy formulation to cause real economic changes in a developing economy like Nigeria is very slim. The problem could be attributed to the inherent imperfections in the different markets that constitute the economy, hence, causing monetary policy decisions to pass through to prices without having real effects on the economy. In respect therefore, we hereby recommend as follows:

Expansion of The Financial Market:

Presently, banks are completely responsible for all the loans taken by the private sector. Consequently, the short term interest rate policy of the MPC, which should ordinarily affect the lending rates to the real sector fails in achieving this objective. Thus, bank lending rates remain high as against the deposit rate. To this end, the CBN should work with other stake holders such as NSE, SEC, FIRS to minimise the cost of bond issue, so as to create alternative source of funds.

Interest Rates:  

There currently exists a wide spread between the interest rate and the deposit rate; in most cases giving rise to huge loan losses and financial instability in the medium term. The CBN should persuade the banks to adopt the culture of infrastructure sharing, so as to enhance efficiency and also minimise the cost of operations. This will pave way for moderate interest rates that will eradicate the problems envisaged above.

Financial Stability Issues:

The global financial crisis gave rise to divestment by foreign investors; to remedy the situation, CBN should work with banks to achieve and maintain public confidence in the sector, in other to attract foreign investors to invest in the economy. Consequently, the CBN should put in place a strategically formulated regulatory and supervisory guideline that will facilitate a smooth monitoring of the sector. This will ensure that they are sound and strong enough to sustain the monetary policy decision of the CBN and the macroeconomic objectives of the government.

CONCLUSION

 To achieve an effective and credible monetary policy framework using conventional monetary policy instruments such as: cash reserve requirements, interest rate policy, discount window facilities, foreign exchange market intervention and open market operation; that will have the needed effects on the economy, especially sectors like the oil and gas sector; there is a need to give attention to those factors that engenders instability. Once, those factors are addressed, it will greatly strengthen the ability of the monetary transmission mechanisms of the CBN to affect the petroleum sector towards any direction in line with the macroeconomic objectives of the government.

NUTSHELL:

This paper attempts to examine the effects of the monetary transmission mechanism of the Central Bank of Nigeria on the oil and gas sector. Using an expository approach, Ifeanyi has explored the history and origin of the CBN and its monetary policy arm – the MPC; and the economic variables normally used by the bank to achieve the government’s macroeconomic objective. He has also attempted to connect these variables to the long run economic conditions or the oil and gas sector performance. In the end, he hopes to be able to determine how monetary policy could be used not only to determine results in the oil sector, but also to control the capital inflows normally generated by the sector. What's your take?

1. Begg, D., Dornbusch, R., Fischer S., Economics, 9^th Edition, (London, United Kingdom: McGraw-Hill Higher Education, 2008).
2. Lipsey & Chrystal, Economics, 11^th Edition, (Oxford: Oxford University Press, 2007).                                               

3.      Chairman Ben S. Bernanke, The Financial Accelerator and the Credit Channel, (2007): Federal Reserve Bank, Atlanta, Atlanta, Georgia (www.federalreserve.gov/newsevents/speech/Bernanke20070615a.htm) last visited on 10^th January, 2010.

4. Modiglani, F., (1971), “Monetary policy and consumption” In Consumer Spending and Monetary Policy: the Linkages, Boston: Federal Reserve Bank of Boston         

5.      Okigbo Panel Report, Panel On the Reorganisation Of The Central Bank of Nigeria, 1994, www.dawodu.com/okigbopanel1a.pdf  (last visited on 2^nd January, 2010)

6. http://www.cenbank.org/AboutCBN/history.asp   (last visited on 2nd January, 2010).

7.      A Brief On The Central Bank of Nigeria (CBN) Act, 2007,  Legal Services Division, CBN, www.cenbank.org/OUT/PUBLICATIONS/PRESSRELEASE/GOV/2007/PR3-7-07.PDF (last visited on 4th January, 2010)

8.      www.cenbank.org/MoneyPolicy/decisions/2007.asp (last visited on 5th January, 2010).

9.      Mishkin, F., Symposium on Monetary Transmission Mechanism, (1995), Journal of Economic Perspective 9(4): 3-10 (NBER Working Paper series 5464).

10.  Nigerian Economy May Reel Under Financial Crisis. www.twnafrica.org/index.php?option=com_content&view=article&id=83:Nigerian-economy-may-reel-under-financial-crisis&catid=5 (last visited on 10^th January, 2010)

11. The Maiden Press Statement of Sanusi Lamido Sanusi as CBN Governor, www.economicconfidential.com/aug09featurescbngovernor.htm  (last visited on 10^th January, 2010).
12. Nigeria Energy Data, Statistics and Analysis – Oil, Gas, Electricity, Coal. www.eia.doe.gov/emeu/cabs/Nigeria/pdf.pdf  (last visited on 11^th January, 2010).

13.  Jean Balouga, The Global Financial Crisis and The Oil and Gas Sector of the Nigerian Economy,  

(International Association For Energy Economics, Fourth Quarter, 2009), www.iaee.org/en/publications/snewsletterdl.aspx?id=87 (last visited on 12^th January, 2010)

14. Soludo Chukwuma, Global Financial and Economic Crisis: How Vulnerable is Nigeria? January, 2009, www.cenbank.org/OUT/SPEECHES/2009/GOVADD-21-1-09.PDF (last visited on 12th January, 2010).
15. Economic and Financial Review (CBN), Volume 45 No. 4, December, 2009, pp. 91-107; www.cenbank.org/OUT/PUBLICATIONS/COMMUNIQUE/RSD/2009/EFR INNER VOLUME 45 N0 4.PDF  (last visited on 14^th January, 2010)
16. Adedipe, B., The Impact of Oil in Nigerian Economic Policy Formulation, A paper presented at a conference organized by Overseas Development Institute in conjunction with Nigerian Economic Summit Group, 16^th/17^th June, 2004. www.odi.org.uk/events/nigeria_2004/Adedipe.pdf (last visited on 13th January, 2010).

[1] Nigerian Economy May Reel Under Financial Crisis www.twnafrica.org/index.php?option=com_content&view=article&id=83:Nigerian-economy-may-reel-under-financial-crisis&catid=5 (last visited on 10^th January, 2010)

[2] Supra.

[3] The Maiden Press Statement of Sanusi Lamido Sanusi as CBN Governor, www.economicconfidential.com/aug09featurescbngovernor.htm  (last visited on 10^th January, 2010)

[4] Nigeria Energy Data, Statistics and Analysis – Oil, Gas, Electricity, Coal. www.eia.doe.gov/emeu/cabs/Nigeria/pdf.pdf  (last visited on 11^th January, 2010).

[5] See www.eia.doe.gov (supra)

[6] Jean Balouga, The Global Financial Crisis and The Oil and Gas Sector of the Nigerian Economy, (International Association For Energy Economics, Fourth Quarter, 2009), www.iaee.org/en/publications/newsletterdl.aspx?id=87 (last visited on 12^th January, 2010)

[7] Supra.

[8] Soludo Chukwuma, Global Financial and Economic Crisis: How Vulnerable is Nigeria? January, 2009, www.cenbank.org/OUT/SPEECHES/2009/GOVADD-21-1-09.PDF (last visited on 12th January, 2010)