Interest rate hike will increase loan default risk – FDC

The rise in interest rates in Nigeria will increase loan default risk, analysts at Financial Derivatives Company Limited have said.

The Central Bank of Nigeria (CBN) hiked its monetary policy rate to 13 percent in May from 11.5 percent to combat soaring inflation. It further increased the benchmark interest rate to 14 percent in July.

The Bismarck Rewane-led FDC, in its latest bi-monthly report, said the CBN is expected to continue mopping up liquidity in response to its tightening monetary policy stance, while increasing the costs of interbank borrowing.

“As a result, short-term interbank rates will likely remain in the double digits. This will keep interest rates on loans and advances for businesses and individuals high,” it said. “The rise in interest rate will increase default risk. As the risk of default rises, so will the cost of impairment for financial institutions.”

August inflation numbers to be released this month are expected to cross the 20 percent psychological mark, as food and energy costs remain elevated, according to the analysts.

“The expected increased consumer spending impacts of the 2023 general election campaign, beginning on the 28 of September, will further tilt up inflation,” they said.

Read also: Naira maintains steady fall at official, parallel markets

The FDC expects the foreign exchange scarcity in the country to persist in September as the demand continues to outweigh supply while CBN’s intervention in the forex market remains constrained due to the international reserve dwindling.

“As a result, the naira in the parallel market is expected to hover around N680/$-N710/$ in September,” they said.

According to the report, the Nigerian forex market is segmented with multiple exchange rates, with the most important rate being the Investors and Exporters window.

It said: “No less than 55 percent- 60 percent of Nigerian forex transactions are traded on this window. The CBN and most exporters and investors use this window.

“It serves not only as a source of price discovery but also a barometer for measuring potential and actual CBN intervention in the market. Some of the exchange rate determinants are balance of payments, capital inflows, and trade balance.”

The FDC said the country’s external reserves lost 0.49 percent to close the review period at $38.90 billion on August 15 from $39.10 billion at the beginning of that month, adding : “This was due to CBN’s effort to defend the naira supported.”

The analysts said: “The month of August was characterized by mixed economic outcomes, ranging from weak naira and high inflation to strong economic growth. The market sentiment was also mixed, oscillating between bearish and bullish sentiments. Generally, we expect investors to remain tepid, or at best, cautiously optimistic while expecting the outcome of the next MPC meeting scheduled for September.

“While the CBN’s monetary tightening regime continues, we expect the CBN to leave all monetary parameters unchanged in September as it monitors the impact of its restrictive monetary policy on the economy.”