Borrowing cost to spike as CBN hikes rate to 14%

The cost of borrowing for businesses and governments are expected to spike further as the Central Bank of Nigeria (CBN) on Tuesday hiked its Monetary Policy Rate (MPR) by 100 basis points to 14 percent, the second straight increase this year to curtail rising inflation.

This is the highest rate hike since March 2019, when the CBN reduced the benchmark interest rate from 14 percent to 13.5 percent.

The CBN had in May raised the MPR by 150 basis points to 13 percent, for the first time in six years.

After the rate hike in May, Nigerian banks repriced their assets and increased their lending rates but only a few have raised the interest rates on customer deposits.

Godwin Emefiele, governor of the CBN, after the two-day Monetary Policy Committee (MPC) meeting in Lagos, said the apex bank would continue to tighten its monetary policy stance if the rising inflation persists.

The MPC members unanimously voted to retain other parameters. The CBN retained the Asymmetric Corridor of +100/-700 basis points around the MPR, the CRR at 27.5 per cent and the liquidity ratio at 30 per cent.

“As inflation continues to trend aggressively higher, it will no doubt adversely begin to retard growth in any economy. You may have observed that in most economies of the world, both the developed and developing economies have had to embark on very aggressive rate increases so as to dampen the effect on inflation,” Emefiele said.

Nigeria’s inflation rose sharply to 18.6 percent in June, the highest since January 2017 as prices of both food and non-food items continued in an upward trend.

Analysts in the financial services sector told BusinessDay that the aggressive rate hike would lead to higher cost of borrowing, higher yield, and bearish stock market, among others.

Rate hike not enough to curb inflation – Analysts

Razia Khan, managing director and chief economist, Africa and Middle East Global Research, Standard Chartered Bank, said: “We expect Nigerian inflation to continue to rise. Until there are further steps towards FX harmonisation, parallel market depreciation may continue to exert pressure on prices.

“In the absence of FX policy moves, the read on monetary policy intentions becomes more difficult. However, we think that in tightening now, the CBN is reacting both to current pressures, as well as potentially preparing the ground for eventual (maybe post-election) FX policy reforms.”

“The further increase in MPR by 100 basis points from 13 percent to 14 percent is not surprising although it was least expected, given the minimal impact of the previous rate increase on the key drivers of inflation,” said Taiwo Oyedele, head of tax and corporate advisory services at PwC.

He said the recent rise in general prices was driven mainly by supply shortages, especially food items, rising energy costs and scarcity, as well as naira depreciation, which is fuelling imported inflation.

“On one hand, these factors are unlikely to react to a tighter monetary policy stance while, on the other hand, higher interest rates may pose a challenge to economic growth and escalate the cost of capital for businesses,” Oyedele said.

Uche Uwaleke, professor of Capital Market and president of Association of Capital Market Academics of Nigeria, said the hike in the MPR in quick succession could signal panic on the part of the CBN and heighten uncertainty.

“This policy stance may not necessarily curb inflationary pressure given that the pressure is not coming from monetary factors but from high costs of petroleum products, electricity and insecurity. Ditto for rising exchange rate, so, expect to see in the coming months higher cost of borrowing, widening government deficit, slower economic growth, rising unemployment and bearish stock market,” Uwaleke added.

Ayodele Akinwunmi, relationship manager, corporate banking at FSDH Merchant Bank Limited, said the rate hike would lead to increase in lending rates and saving rates.

Muda Yusuf, CEO of Centre for the Promotion of Private Enterprise, said bank lending had been constrained by the high cash reserve ration (CRR), the discretionary debits by the apex bank and liquidity ratio of 30 percent.

According to him, many operators in the sector claim that effective CRR is as high as 50 percent or more for many banks.

“Lending situation in the economy is already very tight. The new MPR hike means that the cost of credit to the few beneficiaries of the bank credits will increase, which will impact their operating costs, prices of their products and profit margins. The equities market may be adversely impacted by the hike,” Yusuf said.

‘Good for fixed income, bad for stocks, govt debts’

On the fixed income side, Ronke Akinyemi, assistant vice-president, global market at Parthian Partners, said yields had been trending higher lately due to dearth of liquidity in the market.

“Yields will go even higher now that MPC has raised rates; however coupon payments on a few bonds are expected within the week which might temporarily assuage the expected hike but we expect the market to react with yields trending higher nonetheless,” she said.

On the implication for equities market, Oluwaseun Dosunmu, head of research at Parthian Securities, said: “The hike in monetary policy rate is bad for the long-term outlook of the equity market as we might start to see more investors leave the equity market to the fixed income market due to the anticipation that yields in the fixed income market would increase further.”

“It is a disincentive to the stock market as investors look more to the money and fixed income market. Admitted, the purpose is to curb inflation, but its effectiveness is another issue for discussion. With hindsight, it is rarely effective in Nigeria because the pass-through process is rather ineffective,” Saheed Bashir, CEO Meristem Securities, said.

Before the first rate hike in May, the market capitalisation of listed stocks on the Nigerian Exchange Limited had appreciated by N5.71 trillion between January and May 2022, translating to a monthly gain of N1.14 trillion.

But the stock market gained just N201.5 billion between May 24 2022 and July 19, 2022.

The rate hike is expected to worsen the country’s rising debt stock.

Nigeria’s domestic debt stock increased by N1.91 trillion from N18.23 trillion in September 2021 to N20.14 trillion in March 2022. The increase came mainly from the Nigerian Treasury Bills, N914.94 billion (47.9 percent), FGN Bonds, N777.64 billion (47.9 percent), and FGN Sukuk, which increased by N250 billion.

Domestic debt services gulped N2.05 trillion from January to December 2021, according to the data obtained from the Debt Management Office. From January to March 2022, domestic debt servicing gulped N668.69 billion.

On July 18, the federal government offered another bond worth N225 billion to investors, thus increasing the future debt servicing cost. In the July 2022 bond auction, the FGN offered N75 billion via the 10-year 13.53% FGN bond maturing in March 2025. It offered the same amount for the 12.50% FGN bond maturing in April 2032, and another N75 billion offered for the 13.00% FGN Bond maturing January 2042.

Based on the auction results, N5.30 billion was allotted to the investors that bid for the March 2025 offer, N17.82 billion for the April 2032 offer, and N100.72 billion allotted to investors that bid for the January 2042 bond.

“Higher cost of borrowing means that consumers are more likely to default now on their borrowings from banks. Higher interest payments by government on new bonds and treasury bills are not good for the authorities,” Tajudeen Ibrahim, a senior analyst with ChapelHill Denham, said.

Read also: Naira appreciates after CBN’s latest interest rate hike

Insecurity, exchange rate problem, others should be tackled

“Even if the CBN increases the interest rate again, we believe it wouldn’t efficiently reduce the inflationary pressures, as we believe they are supply-driven,” said Sesan Adeyeye, equity research analyst at CSL Stockbrokers Limited.

“The CBN is expected to look at other factors driving the inflation other than just increased interest rates,” said Akpan Ekpo, a professor of Economics and Policy. “Supply-side factors are to be addressed.”

According to Ekpo, the CBN is expected to bridge the gap in the foreign exchange rate between the official market and the parallel market which is a contributing factor to inflation.

“Nigeria’s inflation is also influenced by the foreign exchange factor,” he said. “The gap between the official market and the parallel market is too wide.”

BusinessDay findings have shown that the parallel exchange rate is between N590/$ and N620/$ while in the official window, the dollar was sold for N415.9 as of Thursday.

The World Bank has advised the CBN to allow further adjustment of the naira at the official window to reduce the persistent foreign exchange pressure in the country.

The World Bank said in its latest Nigeria Development Update report that allowing further gradual adjustment in the Investors and Exporters window rate, where the CBN manages the price, would help eliminate misalignment and alleviate persistent FX pressures.

“There is a limit to CBN’s intervention to curb inflation as the government is armed with the responsibility of solving insecurity and implementing measures to reduce the cost of production.” Adeyeye has said.

According to Ayodeji Ebo, managing director, Optimus by Afrinvest, inflation in the country is due to structural issues such as insecurity, which have to be resolved.

“Insecurity needs to be tackled to boost food production,” Ebo said. “Infrastructure such as good roads and rail systems should be provided to reduce the cost of transportation.”