The Central Bank of Nigeria (CBN) has adopted an aggressive two-pronged attack on inflation by increasing both the interest rate the cash reserve ratio for banks. As if that is not enough, the CBN has gone after state governments, businesses and individuals owing it in order to mop up liquidity in the system. Assistant Editor NDUKA CHIEJINA reports on the CBN’s latest move to tame inflation
For many keen watchers in the country’s volatile economic firmament, it was not unexpected that the Central Bank of Nigeria (CBN) increased interest rate at its 287th Monetary Policy Committee (MPC) meeting of September 2022. What was shocking, however, was the aggressiveness deployed by the CBN in increasing the rate. For almost two years, between May and September 2022, the CBN raised the Monetary Policy Rate (MPR) three times from to 13.0 per cent to 14.0 per cent and now 15.5 per cent – all with a view to rein in inflation.
Addressing the press at the end of the meeting, CBN Governor, Godwin Emefiele, said “the focus of the MPC was on the aggressive acceleration of inflation globally and how this had begun to retard growth in both advanced and emerging market economies and global economy was progressively weakening due to the various headwinds confronting the recovery.”
In Nigeria, he said output growth had been sustained as a result of the combination of development finance interventions by the CBN and fiscal stimulus by the Federal Government, noting that “in the last three years, the CBN has injected over N9 trillion into the economy in addition to offering two-year moratorium for 10-year long-term loan facilities.” What this means is that both fiscal and monetary authorities have jointly pumped N9 trillion into the economy to sustain growth. Emefiele believes that these interventions “have significantly helped engendered growth.”
Not to be undone, however, inflation persisted rising to 20.52 per cent in August. This development has forced the MPC to mandate the CBN to “maintain a close watch on the inflationary implications of the interventions.” In other words, the MPC suspected that the N9 trillion pumped into the system to address the effects of COVID-19 and other economic headwinds may be pushing inflation to undesirable levels.
Another reason for the interest rate hike was the need to hold on to and attract foreign investment. According to Emefiele, the MPC noted the moderate downturn in the equities market, attributing it to a continued outflow of portfolio capital as investors re-assigned their portfolios to more attractive US dollar-denominated fixed income securities. The Committee, however, called on the Federal Government to continue to improve the ease of doing business in Nigeria to retain the current patronage of foreign investors through sustained investor confidence in the Nigerian economy.
Most importantly, “the MPC was concerned that within a four-month period, inflation had accelerated aggressively by 280 basis point from 17.71 per cent in May 2022 to 20.52 per cent in August 2022. The Committee was thus of the view that given the primacy of its price and monetary stability mandate, it was expedient that significant focus must be given to taming inflation.”
Given these reasons, the MPC was of the view that holding on to the old rate or loosening it by reducing the rate were options not to be considered. According Emefiele, “this is because a loosening will further widen the negative real interest rate gap and worsen the financial market conditions, as savings mobilisation and investment inflows would decline further. The MPC was also of the view that with the aggressive policy normalisation in advanced economies, loosening the stance of policy would result in a sharp depreciation of exchange rate, leading to further hike in capital outflows.”
However, to pursue a hold decision “would mean a continuous deterioration in real earnings of fixed income earners and the livelihood of middle- and low-income households. As a result, the MPC noted that a tight policy stance (increasing rate) would help consolidate the impact of the last two policy rate hikes, which is already reflecting in the slowing growth rate of money supply in the economy. The MPC also felt that an aggressive rate hike would slow capital outflows and likely attract capital,” Emefiele said.
What next after the hike and effect of interest rate hike on banks
By increasing interest rate to 15.5 per cent, the minimum interest rate on borrowing that lending institutions can charge will go up to 15.5 per cent from 14 per cent and the minimum that banks will keep as liquidity is 32.5 per cent of their total deposits. Speaking on the development, Emefiele argued that “as long as we see inflation going upward, MPC cannot give any assurance that we will not continue to raise rates because we have seen rates move up very aggressively.” The MPC also needed to “move in aggressively to rein in inflation. I cannot assure that we will not raise rate as long as inflation continues to trend upward. The easiest way to tame inflationary pressure is to raise interest rate. This is the right way to go. You have to try as much as possible to raise your rates to a level that is equal or higher than inflation.”
However, he lamented that with inflation rate higher than interest rate, what Nigeria is currently grappling with is a case of negative interest rate “which in itself is a disincentive to investment. It is therefore imperative that you must raise rate to rein in inflation.” The CBN governor admitted that the latest interest rate hike might retard growth and make the cost of borrowing more expensive. “It is important you know that the level of rate is what will help you to slow down the rate of inflation. You raise rate or not, what will happen is that consumption and investment will be affected because purchasing power of the consumer will derail or completely dissipate. You don’t have a choice but to raise rates. This is the best option at this time. We believe it will rein in inflation,” he said.
Adding his voice to the increase in interest rate, CBN‘s Director of Banking Supervision, Mr Haruna Mustapha, said “we should be very optimistic in terms of the forecast for interest rate. We talk about effective interest and if there is a lag, whether we continue to raise those rates to keep pace with inflation, well that is up in the air for now we are very optimistic that some of the measures that have been taken will yield desired outcomes whether it will get to 40 per cent is very speculative at this point in time. But for now, what I think we should focus on is to see how we bring inflation down and achieve our policy objectives.”
Mustapha added that in terms of impact on bank loans and incomes, “clearly you have an impact but it is going to be a bitter sweet experience and this is what is going to happen. Firstly, by the rate hike, banks will expectedly reprice their loans so you expect to see interest rate on bank loans go up, because that is their traditional function; they would expect some impact on their bottom line. Secondly, customers will be at the other end; they will take the heat. But, again, customers of banks will have their loans even though at a higher cost but at least it is not going to be too significant that it will really impact their own bottom line as well. But ultimately what we are a expecting to see, like I said, is to bring the inflation down and the banking system is a veritable channel for the transmission of monetary policy.”
As a result of the current rate hike, “banks will get more income in terms of interest income and indeed based on the numbers that we have shared, interest income have continued to go up for understandable reasons and this will have a positive impact on banks bottom line. Interest on government securities and so on will go up, which will also add to bank’s non-interest income, which is also another important income line.”
In a nutshell, Mustapha insists that “there will be an impact on the banking system like: increase in bank’s interest income; increase in non-interest income especially other arears that banks get their money from and there will be impact on bank debtors because banks will raise their interest on loans and that will also add to the cost of borrowing.” However, “there are other complimentary measures that would moderate the negative or adverse impact on bank customers but the bottom line is we see this as a very important and inevitable decision that will help us to achieve our policy goals which is to rein in inflation.”
With regards to the 32.5 percent minimum cash reserve ratio decision of the MPC, Emefiele said that “what it means is that we expect that all the banks in Nigeria must fund their accounts by Thursday (in 48 hours) because we will debit them for CRR. We will take their CRR to a minimum of 32.5 percent, which means we are going to take liquidity out of their vaults by Thursday. If any bank fails to meet up with this expectation, the decision of the MPC is that we may need to preclude those banks from foreign exchange market on Friday and onward until they meet this 32.5 per cent.”
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As earlier pointed out, the MPC had expressed concerns over the apex bank’s N9 trillion intervention to boost the economy. Two episodes of recession, COVID-19 and global economic downturn, have battered the Nigerian economy, leaving the CBN with little or no choice than to bailout the economy. It is now time to apply the brakes on most of the Development Finance interventions in order to tackle inflation. In this regard, CBN’s Director of Development Finance, Mr Yusuf Philip Yila, disclosed that the CBN will now aggressively pursue beneficiaries of its interventions whose facilities have fallen due. Already, N3.7 trillion of the N9 trillion has so far been recovered while over N5 trillion are still under moratorium especially in manufacturing.
The manufacturing sector is holding about 31 per cent of the CBN’s loan portfolio, overtaking agriculture. Most of the loans extended to the manufacturing sector are not mature for recovery or repayment because lending to manufacturing takes a long time to mature. “You have to order the equipment, put it in place, assemble them; it takes a long time. In the last two to three years that we’ve lent out quite a significant sum to manufacturing, you will begin to see the net effect of all those investment in a few months’ time.” This was Yila’s explanation for the delay in recovering some facilities given to some beneficiaries of the CBN intervention.
Yila assured that “most of the interventions are quite securitised around the MSMEs and then the anchor borrowers programme; while the best performing interventions is the Commercial Agric Credit Scheme of which we lent around N800 billion. For recalcitrant debtors, especially those under the Anchor Borrowers’ Programme (ABP) for which N1 trillion has been released and about N400 billion recovered, even from smallholder farmers every single person who is taking that small holder farmer loan is going to pay. We have their BVN. In fact, we have started what you call the Global Standing Instruction (GSI); we will continue to probe the account in the bank that they lent through.”
The reason for this aggressive drive to recover due facilities is part of the CBN’s efforts to mop up liquidity in the system and check inflation. Yila also disclosed that those the CBN is targeting are state governments that accessed credit facilities from CBN development finance interventions. Defaulting state governments will be debited every month for six months directly from the FAAC account to liquidate their debt. According to Yila, “We’ve started recovering loans from state governments. We have been doing a loan workout programme with them and we are debiting their monthly Federation Account Allocation Committee (FAAC) accruals directly for the loans.”
Yila stated that “if a state government has taken N1 billion and is already in default, over a six-month period, we are going to be debiting them N150 million every month. So, we’ve started that programme. Every single loan that has been given out through any of our intervention programmes must be paid back. There is absolutely no mercy. We have started; we are in recovery mode. At the development finance department, we have begun to recover the loans,” he said.
Message for the banks
It is not all rosy for the banks too. The Cash Reserve Ratio (CRR), which is maximum amount of liquidity a commercial bank can hold in relation to its deposits, has been increased to 32.5 per cent. The CBN expects that all the banks in Nigeria must fund their accounts 48 hours after the decision was made “because we will debit them for CRR. We will take their CRR to a minimum of 32.5 per cent, which means we are going to take liquidity out of their vaults. If any bank fails to meet up with this expectation, the decision of the MPC is that we may need to preclude those banks from foreign exchange market until they meet this 32.5 per cent,” Emefiele said.
This message, he said, “is meant to underscore the fact that this very aggressive decision to rein in inflation must yield result. We do not want to face Nigerians in the next few months and begin to take the blame for not being able to rein in inflation in spite of all the rates we have raised. So, we have decided to adopt a two-pronged approach: increase MPR and CRR going up because we must mop liquidity effectively out of the vaults of the banks.”
In his analysis, Mr Gbolade Idakolo, Managing Director/CEO SD&D Capital Management Limited, said “the increase of the CRR by the CBN from 27.5 per cent to 32.5 per cent is a move directed at the curbing inflation that has not abated for over four months. Under normal circumstances, these measures are expected to tame inflation; however, there are concerns about its effects on the overall economy.”
The banks whom this measure is targeted will pass the cost to their customers which will see instant increases in interest rate for both existing and new loan request; companies that use bank loans to carry out their activities will definitely pass the extra cost to their customers as well as the consumers of goods and services. This will likely result into spending more to buy less; the effect of this new policy could also affect foreign exchange sourcing, which is in short supply; the measure could lead to further devaluation of the naira if there is limited supply of FX to intervene by the CBN and the 2023 election circle has started and politicians will put pressure on the availability of FX because that is what they typically use for their campaigns.
Prof Uche Uwaleke, on his part, believes that “the decision by the MPC to further tighten monetary policy is justified by the need to tame inflationary and forex pressures and possibly stem capital outflows on account of the hike in policy rates in developed economies, especially in the United States and United Kingdom. The primary mandate of the CBN is to maintain price stability. But, it has grave implications for cost of capital for firms, cost of borrowing by the government, stock market performance and output growth in general. It may also affect the asset quality of banks as they reprice their loans in response to the hike in MPR.”