The Central Bank of every country sets benchmark rates which banks and other financial institutions rely on to determine borrowing cost. Depending on inflation, growth, exchange rate, objectives of the economy, the MPR is a useful tool on guiding the economy to achieve set objectives. For example, when there is a need to stimulate growth the Central Banks cut MPR and when the desire is to stifle inflation to increase it. By cutting the rates Banks can lend at lower rates to businesses thereby growing the economy and creating jobs. By increasing it banks increase lending rate thus discouraging businesses from borrowing more, thus reducing the money supply.
The CBN in Nigeria has for over 6 months held the MPR at 12% as it struggles to reduce inflation which stubbornly sits at double digits (12.7% for May). This off course means banks lend to businesses at rates above 18%pa resulting in many businesses being unable to borrow. At 12% MPR in Nigeria is one of the highest in the world. It is way above that of the BRICS (Brazil, India, China and South Africa) and way above developed economies. It is only matched by countries like Pakistan. See below;
Click in to expand view (Source Meristem Research)
MPR rates, like I mentioned, is directly proportionate to lending rates. Meaning that the higher the MPR the higher the lending rates. The negative effect this has on our economy is that, businesses in Nigeria cannot be competitive hence cannot grow. For example a South African Business like Shoprite can borrow at 6% and for a longer tenor to Invest in Nigeria at a return of 12% (barring exchange rate risk). Meaning, even if their investment is entirely financed by debt they still have a spread of 6% to enjoy as equity returns. A Nigerian business in contrast will not borrow at long term as banks do not offer such here. They also borrow at rates like 18% putting huge investments like that out of their reach. See Interest Rates of other countries compared to Nigeria below;
Click in to expand view
For Nigerian businesses to be competitive, there is a strong need for the CBN to abandon its futile and counter productive policy of hiking MPR to cut inflation. Inflation rate in Nigeria is even mostly influenced by Food Prices which incidentally are not heavily linked to lending. It is in my opinion more influenced by cost such as transportation, storage, spoilage etc. These cost are even out of the direct control of the CBN as they are predominatly purely cash in hand backed and mostly reside in the informal and unbanked sector of the economy, making harsh MPR rates counter productive.
Its time I think the CBN should embrace growth and device a different strategy that ensures banks can lend cheaper to productive sectors of the economy. They have started some of these policies by introducing several intervention funds, however, most are yet to access these funds due to strict and unassailable conditions tied to it. I also do not know why the spread between deposit rates and lending rates are still at double digits. It is as if inflation is only being catered for on one side and abandoned on the savings side. To get us to grow at 12-14% which I believe we need to create jobs the CBN must rethink its present policy of double digit interest rates.
An interesting point, but the CBN doesn’t have much of a choice, price stability is its no.1 objective. Interest rates by definition is the rent collected for lending money and theoretically it reflects two things: the lender’s expectation about next period inflation and the risk premium.
Next Period inflation is an unknown and is often current period inflation + an x-factor which could be positive of negative. The risk premium on the other hand is reflective of the average risk rating of borrowers in an economy. Thus when the CBN fixes MPR it typically targets inflation to do other wise would be imply having negative real interest rates and make the MPR look foolish. And since CBN isn’t really in the business of lending money for profit reasons the MPR always reflects largely inflationary concerns
Furthermore as you showed the NIBOR rates (which are a sort of indicator as to the ‘market’ rate) try to approximate that and u see again its clearly covering for inflation first then the risk banks place on lending to each other which is much lower on average than to their borrowing markets.
CBN cannot do much but prop it up – a losing battle u might say but its entirely out of their hands, monetary policy can only sustain not radically transform. Recently, i was listening to Doyin Salami a member of the MPC and he said inflation rates this year was well within the targets set last year by the CBN – a scary thought. Which perhaps explains why Sanusi stolidly supported the subsidy removal even though the resulting inflation would be his headache.
Again, as u mentioned above the core determinant of inflation is food prices often reflecting transportation and storage (which i interpret as power). So if we really want to bring down inflation to about 5-6%, we have to generate more power and put in place an efficient transport system i.e railways they are efficient on time and being bulk carriers do it cheaper than the individual middle-men transporters who clearly have an incentive to push for cut-throat prices.
Power and transportation clearly imply capital expenditure which is where im driving at – fiscal policy. Which really moves ‘real’ variables. but in Nigeria fiscal policy is often tilted towards consumption ie recurrent and tax policy not really effective due to populace wide tax evasion so not really much to expect
So in summary CBN’s hands are tied really they cannot ignore price stability and worse they will always be behind the curve, firefighting.
Thanks Wale, for your very instructive comment. It basically highlights the challenges the CBN faces with effectively using monetary policy to drive down borrowing cost and off course stabilize prices. The tall and short of this unfortunately is that we are in a cyclical quagmire were the order of the day is just try, try and try again maybe, somehow, things will change. The CBN may not be in the business of lending, but it sure is in the business of guaranteeing loans. It has to use the Bank of Industry more swiftly and effectively if it is to finance real sector business that drive growth and cuts inflationary costs such as transportation and power. I have often said what this economy needs is some bit of out of the box radicalism. A departure away from the norms of inflationary cutting. Perhaps the government needs to get into the business of running business. The advantages of PPP must be explored more as the government can borrow cheap (well…) and hand day to day running of the businesses to Private sector who are co shareholders. This seems like a tall dream…
Fantastic analysis and I think your argument is very valid. But in my opinion, that’s one side of the debate. The question is how sophisticated is Nigerian’s monetary transmission system? I think the business risk in Nigeria is still so high that even if interest rates are a lot lower, Banks may not necessarily lend in such a way that we can see the kind of growth we need. If we are to go by the statements of the MPC meeting, the slow down in growth is as a result of slowdown in non-oil sector (chief of which, I would think, is Agriculture). The question is how much of Agriculture is tied to the money market activities? I hear its something like 2%. I think what we need is more Fiscal activities to deal with the challenges of the business environment (infrastructure decay for example), such that Banks see lending to the real sector as an attractive venture. Right now, the risk of real sector (especially for SMEs) borrowing is extremely high. Will like to get your feedback on this side of the argument.