/ 15 November 2016

​How effective are central banks in Africa?

In Nigeria and Japan, inflation has failed to move as expected in response to changes in monetary policy.
In Nigeria and Japan, inflation has failed to move as expected in response to changes in monetary policy.

A central bank is an important institution in any country, playing a crucial role in stabilising or keeping inflation within that country’s targeted inflation band. But some countries fail dismally when it comes to keeping this mandate.

Examples are Nigeria and Kenya, with target inflation at 6% to 9% and 2.5% to about 5%, respectively. But both countries have inflation rates above these figures, at more than 18% for Nigeria and over 6% for Kenya.

Central banks across the world influence interest rates through monetary policy — basically hoicking and lowering rates — to control expenditure in an economy.

High interest rates make access to credit expensive; the opposite holding for lower rates. With expensive credit, individuals and companies have a disincentive to borrow and that has a direct negative effect on expenditure, slowing inflation, together with growth.

In contrast, cheap credit ensures high expenditure, increasing prices (inflation) and growth in gross domestic product (GDP). But is this always the case?

South Africa, Nigeria and the United States have increased interest rates during the past 12 months, while Japan and Kenya have lowered rates.

Inflation in South Africa and the US has come down after rate hike(s) and Kenya seems to be moving in line with expectations, but Nigeria’s inflation has gone up.

After Japan lowered rates, the expectation was for inflation to increase, but it has not done so for some time now. In Nigeria and Japan, inflation has failed to move as expected in response to changes in monetary policy.

Forward guidance is becoming increasingly popular in many economies. This is when central banks provide future estimates and outlooks to keep the markets informed. This helps investors such as fund managers make investment decisions.

If the outlook is good, it helps stabilise markets, allowing businesses to make healthy decisions about the future. But this depends on the quality of the data and many of the least developed countries still struggle to produce accurate and timeous economic information.

African central banks and government statistic offices could play a bigger role by providing economic data of a better quality.

Quantitative easing (QE) is when central banks pump money into the economy, such as through buying government bonds owned, for instance, by the banks.

In Japan, QE has included the purchase of billions of dollars of exchange traded funds. As these funds include stakes in listed companies, the Bank of Japan is, in effect, investing in the country’s stock market.

Besides Japan, the US, United Kingdom and European central banks have used QE. This intervention, which is intended to boost expenditure and growth, is possible with developed countries that have the financial muscle yet impossible with least developed countries, which account for much of Africa.

But the continent has huge growth potential, unlike its developed counterparts, which have achieved high levels of economic growth and are close to full employment.

The amount of money circulating in an economy matters because demand for money has to match supply to avoid creating an inflationary environment. The central bank determines when money supply can be deemed too much or too little. It decides on what actions to take, depending on how capable it is.

Action taken to control money supply includes printing money or setting the reserve requirement ratio. This ratio determines the quantity of money each depository institution has to keep. It is set lower when money in circulation is low and higher when there is too much money in circulation.

The US began its Federal Reserve QE programme in 2008, after the financial crisis. The expectation was for GDP to grow the following year, but the US had negative growth in 2009. It carried out further QE interventions in 2010 and 2012, pumping hundreds of billions into the economy, but still did not achieve high levels of growth.

Least developed countries do not have the financial muscle to do QE; money pumped into the stock markets may only benefit companies, which do not pass this benefit on to the consumer.

Central banks can play a big role in ensuring a stable currency and inflation, but they need the help of the fiscus for growth to be achieved fully. For African central banks to apply effective policy, there has to be a good legislative and fiscal authority to complement their efforts.

Kenneth Ndlovu is an analyst at Johannesburg-based Cloud Atlas Investing