Four Economic Implications of Nigeria’s Latest Interest Rate Hike

The Central Bank of Nigeria (CBN) has again raised the benchmark interest rate by a half percentage point to 27.25 percent, marking the fifth consecutive rise despite slowing inflation.

The CBN has so far raised the monetary policy rate – a rate set by policymakers to control money supply in the economy – by a combined 850 basis points from 18.75 percent last July, reaching the highest ever recorded in the country.

 

The continued rise in the interest rate, though aimed to combat inflationary pressures and stabilise the economy, has far-reaching consequences on businesses with households grappling with its passthrough effect.

Babatunde Adesanya, an economist with the University of Abuja said raising the lending rates is geared towards slowing rising inflation “going by conventional belief”.

“But the challenge of inflation in Nigeria is not just a monetary problem. Other problems such as corruption and mismanagement in fiscal sector are also causing inflation in Nigeria,” he said.

 

Raising MPR halts soaring inflation

Africa’s biggest economy has been struggling with rising prices for the past 19 months which has led to widespread discontent before beginning to decelerate in July from almost 40 percent.

The National Bureau of Statistics report shows that Nigeria’s headline inflation eases to a six month low of 32.15 percent in August, marking the second consecutive decline in nearly two years.

But with a hike in MPR, the CBN is maintaining a stricter monetary control to rein in the stubbornly high inflation.

Marvelous Ige, a financial analyst at Lagos-based investment firm, Commercio Partners, explained that since inflation is defined as “too much money pursuing few goods”, the goal of high interest rates is to reduce the money in circulation in order to control inflation.

“The CBN raises interest rates to tackle inflation, hence lessening cost of living crisis. The approach also reduces frivolous spending and protect or restore purchasing power,” said Samson G Simon, chief economist at ARKK Economics and Data Limited.

For many analysts, the recent drop in Nigeria’s consumer prices is largely attributed to the decline in food inflation, supported by the ongoing harvest season on food supply and not by monetary tightening.

Reduction in business expansion and loss of jobs

While raising benchmark interest rates helps in slowing inflation and reigniting purchasing power, it could also hamper business growth.

Nigeria is a country where small and medium enterprises (SMEs) account for 96 percent of its business activities and provide more than 80 percent employment opportunities.

But with a tightening monetary conditions, credit will be accessed at higher rates, discouraging business expansion and fueling the already high unemployment rate.

“By hiking inflation rates, credits are discouraged since they are now more costly to obtain. However, what really happens is that certain manufacturers go on with obtaining credits/loans at high costs.

“The increased cost of borrowing will be passed down to final consumers in form of higher prices,” Ige said.

“For consumers, higher costs of borrowing means reduced access to finance to fund their personal demands/projects.” the finance expert added.

According to Simon, cited earlier, the 50 basis points hike in lending rates will lead to higher cost of credit resulting in less business expansion for a country where small businesses contribute almost 50 percent to its GDP.

“It will result in contraction or slowing down economic growth and higher unemployment,” the economist added.

Echoing same sentiment, Adedotun Adesile, a US-based finance analyst said high lending rates may lead to slower economic growth as it reduces business investment and expansion.

“This will invariably lead to increased unemployment as businesses cut costs due to higher borrowing expenses,” he added.

Increased FX inflows and stable naira

A higher interest rate environment is expected to drive in dollar liquidity as investors will be in search for a market that gives higher returns on investment.

This inflows is will ensure the stability of the naira and improves consumers’ spending power.

Nigeria’s naira has suffered a 70 percent devaluation since it was allowed to trade freely and made its value to be determined by market forces last June.

The naira, though predicted to appreciate to between 1,350/1,450 per US dollar before the year runs out, is for the past weeks trading above N1,500 at the official market and N1,600 at the parallel market.

“The continuous hike in MPR should increase FX inflows from foreign investments and improve the value of the naira or at least stabilise its value,” Simon said.

He however added that with an increased monetary rate environment, cases of non-performing loans and payment defaults become higher.

High interest rates gives higher returns

In a high-interest rate environment, individuals with excess funds in savings accounts, fixed deposits, or other interest-earning financial instruments benefit from higher returns.

This means they earn more interest income on their savings, making it more attractive to save rather than spend. However, this can also mean higher borrowing costs for loans and mortgages.

Adesile explained that a high interest rates environment gives higher returns on deposits as savings accounts and fixed deposits earn more interest.

“Bonds, debentures, and other fixed-income securities become more appealing,” the financial analysts said.

“It’s not all bad news, a high interest rate environment means higher interest income for individuals with excess funds. They can fix their monies in financial instruments and earn higher interest income,” Ige, earlier cited said.

Source:norvanreports.com