Despite a call by the Minister of Finance, Kemi Adeosun for the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) to cut interest rates, Godwin Emefiele, Governor of the CBN announced on 20 September that the CBN will not reduce its benchmark interest rate from 14%. This basically means that banks will continue to charge high interest rates despite the fact that many manufacturers need low interest rates to prosper.
But the government also suffers from high interest rates which is why Adeosun has sought lower interest rates because she said that the cost of government borrowing was too high and was hoping that a lower interest rate will enable the government to reduce its cost of borrowing.
The Federal government has been borrowing heavily from banks and other financial institutions to support its operations due to a sharp drop in revenues brought about by low oil prices and militancy in the Niger Delta. The refusal by the CBN to cut interest rates means that the cost of government borrowing will remain high.
However, the CBN governor ignored Kemi’s request because the CBN needs the high interest rates to attract inflow of dollars into the Nigerian economy. With the CBN managed external reserves on a free fall, Emefiele needs high interest rates to attract foreign investors to come and invest in Nigeria debt instruments in a bid to ensure that the country does not run down its external reserves. A lower interest rate would not do the magic.
Data released by the National Bureau of Statistics (NBS) shows that since the CBN began to raise interest rates in March and moved for a flexible exchange rate, there are signs that foreign investors are getting interested in the Nigerian market again. The NBS data shows that the country recorded capital inflow of $1.04 billion in the second quarter of 2016, 46.58% increase over the inflow recorded in the first quarter of the same year. In deciding not to cut rates, Emefiele cited the increase in capital inflows in the second quarter as a sign that the purpose of using higher interest rates to attract dollar inflow into the country is working.
But analysts at United Capital disagreed with the CBN governor in a note to investors released after the CBN made its announcement.
“Since the last MPC meeting, we do not think the desired foreign exchange (FX) impact expected from the further rate hike has come to fruition, at least not yet. Broadly, from June when the new FX policy was announced till date, FX reserves have declined by 6.1% to US$24.8bn. Even more instructive is the still disappointing turnover figures at the Official FX market both on year on year and sequential basis. Total turnover from June to date is N4.6trillion, 35.0% lower than the comparable period in 2015. So it is not surprising that foreign portfolio flows into naira assets have been muted, despite attractive yields on naira FI assets (one of the highest amongst frontier markets) which is a direct consequence of higher interest rates from a tight monetary policy stance and aggressive OMO issuances. A similar pattern is evident in the equities market. While FPIs were net buyers of naira equities in the month of July (N2.6bn), the quantum of month on month inflows declined 44.8% to N23.4bn.”
The investment firm also notes that the decision by the CBN will negatively impact on the government and also questions the CBN’s decision not to listen to the finance minister.
“Recent comments by the Finance Minister suggests the fiscal authorities intend to continue to pursue its strategy of reflating the economy via higher spend on capital projects, with plans to raise money from the foreign debt market as well as domestic pension fund industry now in the pipeline. This, together with recent downgrade of Nigeria to junk status by S&P, suggests the government debt service ratio is set to rise further and raises questions about the appropriateness of further monetary policy tightening at this time especially seeing that the FPIs still appear unconvinced about the strength of the underlying macro fundamentals as well as the pricing of the naira and will likely remain on the sideline in the near term.”
The CBN has one last opportunity to cut interest rates before the end of this year in its last MPC meeting slated for 20 and 21 November. United Capital notes that the last meeting should provide the CBN with an opportunity “to make the crucial decision of whether to continue to jettison growth concerns by maintaining a tight monetary policy stance in a bid woo the foreign money managers and stabilize the FX market, or return to a monetary easing mode which will align more with the fiscal objectives of the government, effectively completing a one-year cycle of monetary policy flip-flop.”
But for now, the analysts at United Capital say “The equities market will likely continue to oscillate between the bulls and the bears in the near term, with investors likely to continue to lean more towards short term tactical play, pending further clarity on the domestic macro and policy fronts. Also, yield in the FI market is set to remain elevated, with trajectory to be shaped by system liquidity gyrations, pace of OMO issuance by the CBN and inflation expectations.”
Kemi, like manufacturers, will now have to cope with the higher cost of borrowing despite the slowdown in economic activities.
