Raging Debate over Nigeria’s Interest Rate Regime

30 Jan 2013

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CBN Governor, Sanusi Lamido Sanusi

Considering inflation which has stubbornly remained at double digits and other macroeconomic factors, the Monetary Policy Committee (MPC) last week left the benchmark interest rate and other monetary policy instruments unchanged. Obinna Chima highlights the argument that followed the committee’s decision
Mixed reactions have continued to trail the decision by the Monetary Policy Committee (MPC) to maintain a restrictive monetary policy position.

While some financial market analysts, economists and industrialists that expected the Central Bank of Nigeria’s (CBN’s) MPC to commence gradual reduction of interest rate at its last meeting, expressed disappointment over the committee’s decision, others welcomed it.

A country’s benchmark interest rate is one of the major drivers of any economy as it sets the pace for investment.

The MPC has the operational independence in determining interest rates and other monetary policy instruments. Thus, as the committee raises or lowers the benchmark interest rate, commercial banks may raise or lower the interest rates they charge borrowers, even the prime rate.

Nigeria’s Monetary Policy Rate (MPR), which was retained at 12 per cent last week, is one of the highest in the world, experts have argued.
CBN Governor, Mallam Sanusi Lamido Sanusi, however explained that the MPC considered calls for reduction in the MPR because of the benign inflation outlook. But he pointed out that the increased sub-national government spending and federal government high expenditure in 2013, higher benchmark oil price in the 2013 budget and the United States debt ceiling with possible impact on commodity prices were some of the factors that influenced its decision.

“In view of the foregoing, the Committee decided that it was prudent to hold and monitor developments between now and the next meeting of the MPC. The committee, therefore, decided by a majority vote to maintain the current policy stance,” he added.

Similarly, the cash reserve ratio and the liquidity ratio were also left at 12 per cent and 30 per cent respectively.
The apex bank has never hidden its disdain for double-digit inflation, which is one of the reasons while it has left interest rate and other tools at the current level in the past one year. Latest figures by the National Bureau of Statistics (NBS) showed that inflation dropped to 12 per cent in December, from 12.3 per cent in December.
Other Committee’s Considerations
The committee also observed that the performance of the global economy remained largely subdued and was characterised by uncertainty and contraction in the Euro zone and Japan, as well as lower-than-expected growth in the large emerging and developing economies. With regard to the budget of the federal government, the committee cautioned against complacency over government revenue, despite the high level of oil prices.

It also noted the uncertainty in global demand and supply of crude oil, and weak performance of non-oil and value added tax (VAT) revenues.
It also noted “with satisfaction, the efforts by the federal government aimed at keeping deficits within the threshold prescribed by the Fiscal Responsibility Act,” and advocated sustenance of the effort.

On expenditure, the committee noted that there was still the need to continue to drive down recurrent expenditure in favour of capital expenditure in view of the infrastructure deficit that continued to constrain growth performance.
The Argument

Analysts at Financial Derivatives Company Limited noted that a declining interest rate environment is subject to expectations of a fall in inflation.
FDC in a report stated that the CBN had adopted a monetary policy framework of implicit inflation targeting, with interest rate as its nominal anchor.

“It has also implemented its strategy using the discretionary rule. This means the CBN is proactive and is more aggressive in the execution of its strategy of maintaining price stability. Even though it talks of inflation targeting, the CBN’s body language reveals a near obsession with maintaining a strong naira with a tendency towards overvaluation.

“The CBN through its comments has alluded to the fact that it believes, the exchange rate is a major factor in the consumer inflation equation. This is because with a marginal propensity to import of 0.63, any movement in the exchange rate is pivotal to the general price level and by implication, its index,” the financial advisory firm added.

To the FDC, a strong naira policy is “symptomatic of a Dutch disease syndrome,” saying that it ties the hands of the CBN and limits its options in the use of interest rates and other money market instruments.
“The reality is that monetary policy strategy is not a zero-sum game. That is, it is not either the exchange rate or the MPR, but any combination of both,” added.

But a senior lecturer, at the Department of Economics, Lagos State University, Dr. Odubunmi Sunkanmi, expressed displeasure over the prevailing interest rate regime in the country.

He urged the banking sector watchdog to commence a gradual reduction in the MPR so that commercial banks could also follow suit.
He added: “Interest rate is too high and when you compare the lending rates with rates on fixed deposits, you will find out that the disparity is just too much. When you want to borrow from banks, they give you as much as 24 per cent. But when you place funds with them, the highest you can get is about 7.5 per cent.

“As such, no country flourishes with high level of interest rates because it discourages investments. For any economy to grow at all, there must be both foreign direct investment (FDI) and domestic investment. But the only thing that can attract investment is the level of interest rate. Hardly will you find any country that attained economic growth with high interest rates.”

Also, an economist, Mr. Henry Boyo, argued that the collapse of some manufacturing firms in the country was a result of high interest rate regime. This, he insisted had resulted to low capacity utilisaton.
“This was triggered and sustained by faulty monetary policy framework of the CBN, which sustains excess liquidity in the system,” he declared.

According to him, “If we are serious about economic transformation, I want somebody to show me any country with interest rate at double digits, and is among the best countries in the world. It is not possible! So, you need a single-digit interest rate and a stronger naira, in order for us to transform the economy.

“High interest rate destroys production because of the high cost of production. So, don’t be surprised when houses are being converted to mosques, churches. As a result of high interest rate and we have uncompetitive local products.”

Meanwhile, while the Director of Research, CBN, Mr. Charles Mordi, concurred that low interest rate regime is desirable for the country, he pointed out that interest rate is largely influenced by demand and supply.
According to Emordi, in a situation where demand outstrips supply, prices go up.

The CBN official explained: “Interest rate is the price of financial instruments. Bringing down interest rate is not something you just do overnight, the right conditions have to be in place for interest rates to come down gradually. The economic environment has to be right for the CBN to deliver low interest rate regime.

“The CBN is also concerned about high inflation and that is why central banks all over the world are obsessed with delivering on low inflation. There is a trade-off between inflation and growth and there is threshold of inflation, beyond which it becomes damaging to growth.
“What people fail to realise is that you do not suddenly move from a high inflation regime to a low regime. It is something that has to be gradual. You walk towards it over time.”

He described achieving low interest rate regime; low inflation and a strong naira at the same time as the “impossible trinity.”
“These are three prices that compete in the market. We cannot have of these three prices moving in the same direction at the same time. So, you cannot have a strong naira, low inflation and low interest rates at same time,” Emordi added.

On his part, Director-General, Lagos Chamber of Commerce and Industry (LCCI), Mr. Muda Yusuf, also noted that high interest rate impedes competitiveness of firms.

Yusuf insisted that last week’s resolution by the MPC would bring about unfavourable economic conditions such as depressed economic activities, which according to him, had manifested in low sales, weak consumer demand, huge inventories by manufacturers, liquidity squeeze and tight cash flow conditions in the economy.

“What is paramount at this time is the stimulation of the economy and that is the norm globally. Affordable and long-term finance may not be a sufficient condition for economic growth, but it is a necessary condition. Cash is the life blood of business! We acknowledge the structural and institutional bottlenecks in the economy and their impact on economic growth.

“Consequently, all policy tools – monetary and fiscal - should be deployed to stimulate the economy. Low inflation and robust reserves are good, but they are not ends in themselves; they are means to an end,” he advised.

Group Managing Director/Chief Executive Officer, First Bank Nigeria, Mr. Bisi Onasanya, had informed THISDAY recently that if the country’s base interest rate was lower than inflation rate, then the economy would not be able to attract foreign investors.
Onasanya insisted that as long as the country was still not able to bring inflation rate down, the interest rate regime of the CBN today was still supportive and in order.

He said: “As a matter of fact, textbook economics would tell you that you interest rate should be above your inflation rate. Today, if the CBN decides to take a factual decision based on available statistics, what they would do is not to bring down interest rate, but to take it up. There are efforts today to bring down interest rate, but the efforts should be concentrated first on bringing down inflation before we start talking about bringing down interest rate.

“I understand the fact that it is desirable for the economy to borrow at low interest rate, but we need to understand that in the context of the Nigerian economy, what is more important today is to make sure that our exchange rate is stable and low enough to sustain the economy.”

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