The Central Bank of Nigeria (CBN) is walking a tightrope in its decision to increase the benchmark interest rate by 400 basis points from 18.75 per cent to 22.75 per cent.
Experts were cautious yesterday on the outcome of the meeting of the Monetary Policy Committee (MPC) of the apex bank.
The aggressive inflation-targeting stance could help to engender price stability and stimulate foreign exchange (Forex) inflows but it could worsen the high cost of production and spiral effects on the overall economy.
The MPC increased the Monetary Policy Rate (MPR), otherwise known as the benchmark interest rate from 18.75 percent to 22.75 percent. It also raised the Cash Reserve Requirement (CRR) from 32.5 percent to 45.0 percent but retained Liquidity Ratio (LR) at 30.0 percent.
The MPC upped the asymmetric corridor to +100 basis points-700 basis points from 100 basis points and -300 basis points.
Experts said the apex bank could have adopted a gradual middle-of-the-road approach considering the peculiarities of the Nigerian economy and a widely held belief that the spiralling inflation is more fiscal than monetary.
Without aggressive fiscal support and cautious implementation of its policies by the apex bank, there could be more adverse consequences on the economy.
Experts who spoke yesterday include Managing Director, Arthur Steven Asset Management, Olatunde Amolegbe; Chief Executive Officer, Centre for the Promotion of Private Enterprise (CPPE), Dr Muda Yusuf; President, Association of Capital Market Academics of Nigeria, Prof. Uche Uwaleke; Investment Research Associate, Comercio Partners, Ifeanyi Ubah and economy and finance think-tank, Cordros Research.
The reaction at the stock market was immediate as investors scrambled to realign their portfolios in favour of the high yields at the fixed-income market. Nigerian equities lost N773 billion in an extended bearish trading that most analysts expected to continue in the days ahead.
Amolegbe said while the response by the apex bank was a signal of intent on its aggressive stance on inflation, it could adversely impact banking and real sectors of the economy.
“It’s clear the MPC has decided to attack inflation aggressively by reducing liquidity through raising interest rates as well as limiting credit within the system. Increasing MPR by 400 basis points is unprecedented and it is a show of intent,” Amolegbe said.
According to him, the increase in MPR could lead to a rise in the inflow of Forex through foreign portfolio investments (FPIs) and also redirect liquidity that would ordinarily be chasing forex speculation. This could lead to further stability in the forex market.
“On the other hand, higher MPR means higher borrowing costs for corporates that are already carrying significant forex revaluation losses. The possibility of increased loan defaults and rising non-performing loans (NPLs) could result for banks. For the equities market, there is likely to be a significant price correction as investors look toward the fixed income market,” Amolegbe said.
Uwaleke described the MPR increase as an “overkill” saying there were no empirical justifications for 400 basis points in one fell swoop.
“Why not by not more than 200 basis points since they have another opportunity to meet next month and review the impact? They didn’t stop at MPR, they also jerked up the CRR to 45 per cent which at the previous level of 32.5 per cent was among the highest in Sub Saharan Africa. The CBN Governor had assured that the policies of the bank would be evidence-based. Which empirical results support this aggressive move?” Uwaleke said.
According to him, the implication of the new development is that for every deposit in the bank, CRR takes 45 per cent, while the Liquidity ratio takes 30 per cent, with only 25 per cent of the deposits that banks can lend.
“This has negative implications for access to credit, cost of capital for firms, cost of debt service by the government and asset quality of banks. Expect banks to quickly reprice their loans with negative consequences for non-performing loans and financial soundness indicators,” Uwaleke said.
He pointed out that output is bound to shrink with lower Gross Domestic Product (GDP), especially from the agriculture and industry sectors, with the potential for a surge in unemployment levels.
Yusuf said the decisions of the MPC would hurt the real sector of the economy which is already contending with numerous macroeconomic challenges.
According to him, the decisions pose a major risk to the financial intermediation role of banks in the Nigerian economy as the increase would constrain the capacity of banks to support economic growth and investment, especially in the real sector of the economy; because the increases are quite significant.
He noted that although the decision was consistent with the typical policy response of the central banks globally, the CBN failed to reckon with domestic peculiarities.
“The key drivers of Nigeria inflation are largely supply-side variables, and the CBN ways and means financing. Over the last two years, there has been persistent monetary policy tightening, yet there has not been any significant impact on the inflationary pressures. If anything, the general price level had been continuously on the increase.
“We recognize that the primary mandate of the CBN is price stability, but numerous headwinds have posed significant risks to this critical objective. Some of these include the surge in commodity prices and impact on energy costs, disruptive effects of insecurity on agricultural output, and global supply chain disruptions. The surge in ways and means of finance also makes the CBN a culprit in the inflation predicament over the past few years. The hike in MPR or CRR would not change these variables,” Yusuf said.
He pointed out that the credit situation in the economy is already very tight, with lending rates ranging between 25 to 30 per cent, with Nigerian banks yet to live up to their financial intermediation role because of these constraining factors.
He explained that the Nigerian economy is not a credit-driven economy, unlike what obtains in many advanced economies which have much higher levels of financial inclusion, robust consumer credit framework and strong correlation between interest rate and aggregate demand.
“The level of financial inclusion in the Nigerian economy is still quite low, access to credit by households and micro, small and medium enterprises (MSMEs) is still very challenging, and the informal sector accounts for close to 50 per cent of the economy.
“Private sector bank credit as a percentage of GDP was 14 per cent in 2022 in Nigeria. It was 59 per cent in South Africa, 30.9 per cent in Egypt, 30 per cent in Botswana, 51.6 per cent in the United States and 130 per cent in the United Kingdom. These underscore the variabilities across economies; thus, policy responses have to be different.
“The transmission effects of monetary policy on the Nigerian economy are still very weak. In the Nigerian context, price levels are not interest-sensitive. Supply-side issues are much more profound drivers of inflation. The new dramatic increase in MPR to 22.75 per cent hike means that the cost of credit to the few private sector that have exposure to bank credits will increase which will impact their operating costs, prices of their products and profit margins, amidst very challenging operating conditions. The equities market may also be adversely impacted by the hike,” Yusuf said.
He urged the apex bank to accelerate the process of increased capitalisation of the development finance institutions to create a concessionary financing window for the real sector and small businesses.
Ubah said the CBN, just like most apex banks in the developed economies has continued on their contractionary monetary policies to combat the global inflation which erupted earlier in 2022 as a result of the war between Russia and Ukraine, which caused global oil shortage.
“Sticking to maintain a hawkish stance amidst the present socio-economic problems confronting the Nigerian economy is a tough but bold move by the CBN. This move reiterates the CBN’s commitment to maintain price stability in the country. It will have been expected that based on recent data such as inflation, unemployment, and GDP, showing signs of weaknesses in the economy, the CBN will have taken a more subtle approach in its fight against inflation,” Ubah said.
He however noted that the country, despite its resilience, might not have enough room to contain the latest hike in interest rates, adding that the economy, which currently faces a series of fluctuating social and economic challenges, may be pushed further into devastation as an increase in the minimum cost of borrowing in the economy may likely cause a slowdown in the corporate sector, leading to a decline in the stock market.
According to him, with this move, it is expected that the fixed-income space may see a sell-off as an increased interest rate makes old fixed-income securities unattractive, causing a fall in their prices and accompanied by increased yield. It is also expected that new issues both in the public and private spaces will attract higher yields.
“Lastly, on the macroeconomic front, despite the increased interest rate likely to cause a slowdown in GDP growth and stock appreciation, the move may exacerbate the unemployment issue confronting the Nigerian economy. Although doubtful, we may see some degree of easing in the inflation figures before the end of the year,” Ubah said.
Cordros said the decision to bring the MPR to its highest level ever was premised on the need to manage inflation expectations, which have been primarily stoked by the constant depreciation of the naira and the low credibility of the institution in maintaining price stability.
Cordros said it expected domestic prices to stay high due to the depreciation of the naira exchange rate, elevated cost of energy products and reduced food supply induced by heightened insecurity in the food-producing middle-belt region.
“The just concluded MPC meeting mirrors the committee’s zero tolerance for further inflation increases and highlights the need to enforce price stability, which, in their view, supports output growth in the medium to long term. However, we are of the opinion that the committee will hold its key policy rate constant at 22.75 per cent at the next policy meeting scheduled for March 25 to 26, 2024 given the need to allow the current adjustment to permeate the economy whilst waiting for more macroeconomic data evidence to signify the path forward,” Cordros stated.
