The
news cycle is still dissecting Nigeria's latest economic data which shows that
the economy is on a recovery path after
the 2016 recession, and inflation continues to trend downwards.
In older news, commercial banks in the country
are still under fire for failing to lend to many individuals and
businesses.
What ties all these together? Monetary
policy.
In a nutshell, monetary policy describes
the activities through which a central bank regulates the financial and
economic system, usually by setting interest rates. In Nigeria, this function lies
with the Monetary Policy Committee (MPC) of
the Central Bank of Nigeria (CBN).
Nigeria’s
Monetary Policy
Since July 2016, Nigeria's national
interest rate – known as the base rate or monetary policy rate – has
been held at 14%. In contrast, the interest rate in South Africa, Nigeria’s
perennial economic rival, is currently 6.75%. Unsurprisingly, many groups
bemoan the high-interest rate environment, arguing that it restricts bank
lending, which, in turn, impedes economic growth.
Notwithstanding the truth in that
statement, high interest rates serve multiple purposes. Primarily, as is the
case in Nigeria at present, they are used to tackleinflation.
The national interest rate determines
how Nigerians typically spend and consume. On the consumption front,
the lower the national interest rate, the more willing people are to
borrow money. When people borrow more and pay less interest on their debts,
there is more money available for spending and consumption, which
influences national output. However, at higher rates, people are
unwilling to borrow. When higher interest rates are coupled with asymmetric information, banks provide fewer
loans. The tighter lending standards mean that consumers will cut back on
spending and consumption, which affect national spending. This has been the
situation in Nigeria over the last few years.
The effects of such a policy decision
could be dangerous if not well-managed. A consistent slump in national
spending and investment results in a shrinking economy, and ultimately,
economic stagnation or a recession. Many economists would point to Nigeria's
high interest rate environment as a factor impeding the country's economic
recovery.
Where
Commercial Banks Come In
The danger of too-high interest rates
does not stop there. When the CBN fixes a high base rate, the rate at
which commercial banks lend to and borrow from themselves, the interbank lending rate, also becomes high. This, in turn, pushes up the cost
of an individual or business obtaining a loan from a commercial bank (or
similar financial institution). Effectively, banks transfer the high cost of
borrowing from the CBN unto their retail and institutional
customers, making loans expensive and less accessible.
Furthermore, when interest rates are
high, investors and banks are often only willing to invest in government
securities which pay high returns – a phenomenon known as crowding out. How come? Well, if I can buy a
risk-free 180-day treasury bill that pays me a 20% interest
rate, I see little incentive in lending to a risky individual or institution,
and if I do, I would definitely charge an exorbitant rate. Similarly, if I
could get such a risk-free 20% return in half a year, why should I invest in the stock market or
your business? In short, high interest rates on government securities draw
investment away from other areas of the economy.
Interestingly, the government
does not particularly like this situation, either. High interest
rates make the cost of government borrowing and debt servicing high. Again,
Nigeria has experienced this recently – rising interest rates in the
country have bloated the country's debt bill to the point that debt repayments
now constitute as much as 60% of federal revenues, according to the
International Monetary Fund. Unsurprisingly, wary of a debt crisis, Moody's recently reduced
Nigeria's credit rating.
Clearly, the CBN's interest decision
has a significant effect on the economy.
No
Cause for Legislative Alarm
So should we be worried about
Nigeria's high interest rates? Many key stakeholders believe so, with some
calling for a cap on interest rates, similar to what Kenya implemented in 2016.
However, this will only worsen the nation’s monetary equilibrium. Although
the CBN can alter its base rate, actual interest rates are determined by
forces subject to the national and global markets, thus cannot be regulated by
fiat. Therefore, there is a need for restraint and an adherence to market
principles for the management of the nation’s monetary policy.
Just a year after the Kenyan
parliament enacted its interest rate cap, the Central Bank of Kenya (CBK)
is already pushing for a repeal of the law because of
the negative effect it has had on the Kenyan economy. Caution must be applied
to ensure that mistakes made in other countries are not replicated in
Nigeria.
Moreover, the biggest determinant of
interest rates in Nigeria will always be the level of inflation. Until the CBN
is able to arrest inflation, perhaps through its interventions in the agriculture sector, high
interest rates will be Nigeria's norm.
Follow this Writer on Twitter @LanreRufai_.
Source: Stears Business
