CBN Cuts Benchmark Rate: What It Means for Nigeria

Last week, the Central Bank of Nigeria (CBN) decided to lower its benchmark interest rate by 350 basis points to 23 percent. This move has people looking closely at how it will affect government borrowing. Normally, a lower rate allows the government to issue treasury bills and other local debts at a cheaper cost. While this does not change the total amount of existing debts, it opens the door for the government to take on new debts at lower rates to pay off older, more expensive ones. But this debt restructuring will not really ease the heavy burden of public debt on the government's finances.

CBN explained that the rate cut and the narrowing of the corridor around its policy rate are meant to recalibrate operations, not to relax monetary policy. The new rates stand at 23.5 percent for banks borrowing from the CBN and 20.0 percent for banks keeping surplus funds. With domestic banks' funds costing 20.0 percent, the government must still convince banks to purchase government securities.

If fiscal policy assumes that the lower rate is a green light to borrow more money, it may face even bigger problems. The CBN warns that spending related to the upcoming elections could increase inflation risks. More borrowing, especially if it goes towards consumption instead of investing in productive efforts, could push government borrowing rates back up, increase domestic prices, and weaken the monetary policy.

Looking at inflation numbers from August, the CBN's choice to cut the benchmark rate seems to align with the consumer price index. Last month, inflation dropped to 15.39 percent year-over-year, while month-on-month inflation fell to 0.71 percent. The core inflation rate also went down slightly to 13.29 percent. Despite this decrease in overall price pressure, there are still strong reasons to be cautious and not assume that the economy is entering a period of relaxed monetary policy. Food inflation remains high, staying above the overall inflation rate in August. There are also differences between inflation rates in rural and urban areas.

The CBN has a lot of work ahead. It is sensible for the bank to try to align its benchmark rate with the market. The key question is whether raising the Monetary Policy Rate (MPR) will help improve the flow of money through the Nigerian Overnight Financing Rate (NOFR) system. Past attempts by the bank to adjust its policy have been challenging, and success depends on proper implementation. Right now, the CBN's decision to keep high reserve requirements, 45 percent for deposit money banks and 75 percent for non-Treasury Single Account public sector deposits, supports its claim that its policy stance is tight.

The bank's ability to put its plans into action will depend on what happens with interbank rates, government securities, lending, and foreign exchange rates. If these rates drop because market players see the new policy rate as a sign of relaxed conditions, then the CBN's decision may end up being seen as easing, even if that was not the plan.

Several economic indicators make the CBN's goals seem more achievable. In the second quarter, Nigeria recorded a balance of payments surplus of $3.51 billion. The current account surplus reached $7.54 billion, and gross external reserves sit at $55.25 billion, covering about 11.3 months of imports. A stable exchange rate also reduces the risk of the CBN's new framework disrupting inflation expectations.

These positive numbers also raise expectations for success. Unlike before, the economy is now growing instead of shrinking. Output growth for the second quarter was 4.43 percent, and recent purchasing managers' index figures indicate increasing economic activity, though you might not see this reflected in everyday life. This context suggests that monetary policy should not signal relaxed conditions until the country can stabilize inflation expectations, moderate food prices, and ensure exchange rate stability.

The role of fiscal management in this situation is clear. However, getting the government to grasp this has proven more difficult than getting a horse to drink water from a stream. Addressing food security, logistics, storage, transport, energy costs, and providing support for vulnerable households are all key to maintaining stable prices. But managing these areas is not the job of the central bank.

While I agree with the CBN that adjusting its policy tools is a technical fix for the country's monetary policy, it is crucial that the CBN keep regularly publishing clear operational indicators. This should include the NOFR, interbank rates, domestic liquidity conditions, lending rates, and inflation expectations. This transparency will show that the CBN is indeed improving monetary flow without losing its grip on monetary policy.