The Central Bank of Nigeria (CBN) in its bid to control the inflationary pressure in the economy has over the months implemented monetary policies directed toward managing money in circulation. One of the major tools used by the CBN over the years has been the Cash Reserve Ratio (CRR). According to Naijaonpoint with data retrieved from CBN money and Credit Statistics, N7.02tn and N8.04tn were debited from 10 prominent banks in 2020 and 2021 respectively.
Nigeria’s economy continues to bear the brunt of arbitrary deduction of Cash Reserve Ratio (CRR). The continuous CRR debits have been limiting banks’ ability to plan and increase credit extension. Several rounds of debits in connection with CRR keep threatening liquidity and making it difficult and more complex for banks to support the economy.
Nigeria, like most economies, has been operating a deficit budget with the government always benchmarked to finance its budget with heavy borrowings both locally and internationally. It is every government’s objective to ensure they finance the budget deficit by borrowing at a low cost. In the case of Nigeria, a large part of the borrowings are carried out through the issuance of bonds and bills via Primary Market Auctions. Notably, Banks are the major investors in bonds and bills with over 70% of total bids submitted during auctions received from banks.
With inflation on a continuous rise and the government need to borrow heavily to finance its budget deficit, the CBN and Debt Management Office (DMO) are in a dilemma of managing the trade-off between the Monetary (Inflation) and Fiscal (borrowing & Spending) issues.
Contractionary Monetary Policy amidst Increased Borrowing
In the central Bank’s bid to curb the rising inflation, the government has embarked on policies that aim at reducing the volume of money in circulation. Policies such as increased Monetary Policy Rate (MPR) and Increased Cash Reserve Ratio (CRR) have been implemented.
The persistent and increased CRR debits in recent times has reduced bankability to participate in activities such as lending and extending credit to the economy. This policy is aimed at protecting banks’ cash reserve for depositors and at the same time preventing excess cash in terms of lending and credit into the economy to ease inflation.
On the flip side, the government is also a borrower and depends on investors including banks to lend to them by subscribing to their various security (Bonds & Bills) issues.
Blessing or a curse?
With rising inflation, the CRR debit is a means to reduce banks’ ability to extend excess cash into the system and control the volume of money in circulation. This policy in the short run reduces the amount of profits banks can make from excess credit extension and ensure banks will always have the right amount of cash and not fall short of funds when depositors require funds for their personal needs.
However, with the high CRR and constant debits, the liquidity in the financial system continues to be low. With the banks being the major participants in the bond and treasury bills space, the low liquidity facilitated by increased CRR debits dampens their participation in the bond and treasury bills market leading to increased demand for higher yield in the markets. The government, in need to borrow, has no choice but to issue these notes at higher costs (rates) to meet their borrowing needs.
Notably from the image above, we could see the impact of dwindling liquidity on average yields in the fixed income space. The fixed income for most of the year has been characterized by low liquidity fueled by excessive CRR debits thereby leading to an increase in yields in the market. At the last FGN Bond Primary Market Auction in July, we witnessed a total subscription of N142.30bn against the N225bn on offer leading to an increase in yields on the various maturities on offer by over 60bps. This low subscription and increase in yields were triggered by depressing liquidity in the system.
In times of rising inflation, contractionary monetary policy is required to control the circulation of money in the economy. However, in an economy faced with a heavy budget deficit and high borrowing need, an excess contractionary policy might just be an issue despite the benefit that comes with it.
Innocent Otokpa is a Fixed Income Trader at Revent Global Finance.
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