Nigeria’s Inflation Fighting Interest Rate Hikes Laden with Tradeoffs

Nigeria’s Inflation Fighting Interest Rate Hike Laden with Tradeoffs

Nigeria’s inflation-fighting benchmark interest rate hike that started in the first half of 2022 has been noted to be laden with buckets of unintended consequences – tradeoffs however skew negative and could last longer than consumer price index worries.

Recall that the monetary policy committee, MPC, of the Central Bank of Nigeria has become both fast and furious about the high inflation rate in the country which has resulted in three times upward adjustments to the interest rate.

Monetary authority raised the benchmark interest rate in May 2022 by 150 basis points, booked another 100 basis points in July and sustained a hawkish mood in September where it raised monetary policy by 150 basis points again,

A leading investment banking firm, Cowry Asset Management said the decision to raise interest rates to 15.50% is expected to fight inflationary pressures and give incentives to Nigerians to save, according to a macroeconomic note obtained by MarketForces Africa.

Howbeit, there are bags of unintended consequences, including a possible slowdown in economic growth.  Cowry Asset Management analysts assert that the decision will, for the short-medium term, condense capital flights out of the economy.

On the other end of the curve, a higher interest rate could drive a possible rise in foreign currencies or United States dollar inflows based on the attractiveness of the Nigerian investment environment.

Due to the FX backlog which culminated from the inability of foreign investors to repatriate funds abroad, an approach adopted by the Central Bank of Nigeria to stem the naira from falling, foreigners have moved aside from participating in the local economy.

On the contrary, the upward adjustment to the benchmark interest rate; a liquidity squeeze in the financial system is inevitable, according to analysts’ note.  The investment banking firm sees an increased cost of borrowing to both the public and private sectors which analysts think may bring about a slowdown in the rate of economic activities, and a decline in aggregate spending and consumption.

A combination of these is likely to bring about a sluggish gross domestic product (GDP) growth, according to Cowry Asset analysts note.

“At a time when major central banks in the world are engaging in interest hikes, Nigeria’s apex bank (CBN) maintained its hawkish role play for the third consecutive period this year following the bi-monthly assembly of its highest decision-making committee.

“This time, was for an unexpected 150 basis points hike in interest rates to 15.50% from 14% in a bid to quell accelerating inflation which has found comfort in Nigeria’s economy and is now at a 17-year high of 20.52% since October 2005”, analysts note reads.

CBN’s monetary policy committee also voted to raise the cash reserve ratio (CRR) by 500 basis points to 32.5% from 27.5% while all other parameters stayed constant. READ: Central Bank of Nigeria Hikes Interest Rate to 13%

In its note, Cowry Asset emphasized that  Nigeria’s Central Bank’s aggressive monetary policy tightening measures will see more liquidity crunch in the system as an additional regulatory requirement.

The committee justified its action and said there is the need to consolidate the effects of the previous two rate hikes; stating that it believes that an aggressive rate upsurge would reduce capital outflows, possibly attract capital inflows, and strengthen the naira.

Meanwhile, at its last meeting which was held in July, committee members stressed the need to further tighten policy in order to stop the inflationary trend from continuing unabatedly. As such, committee members voted to raise the monetary policy rate by 100bps to 14.0%.

There was the emphasis, by the committee, on the likely impact of lingering uncertainty from supply chain bottlenecks as a result of the Ukraine unrest and the detrimental effect the decision would have on global trade.

MPC pointed at a sustained rise in inflation across markets in the face of interest rate increases by central banks globally, as well as the likely attendant impact of another recession on majorly fragile economies and emerging markets that are still healing from recession.

“What we can deduce from the hawkish stance of the central bank in the wake of its inflation-served a’ la carte lies in the policy impact of a rate hike to arrest inflation in the short-term period, especially at the point when there exists a disconnect between the nominal anchor rates and the market rates.

“Nevertheless, it is not far-fetched to say that it is a fear that, obviously, high commodity prices in Nigeria are primarily driven by unresolved structural factors such as insecurity, exchange rate fluctuations, and high energy costs”, Cowry Asset stated. #Nigeria’s Inflation Fighting Interest Rate Hikes Laden with Tradeoffs