It’s 2016 all over again in Nigeria.
Africa’s biggest economy is once again torn between achieving low interest rates and raising them to attract the badly-needed foreign inflows needed to support the naira in a battle that could make or mar its latest currency reform.
President Bola Tinubu has set out to reduce interest rates, which he deems to be too high for businesses but foreigners say the rates on naira bonds would need to at least double before they bring in the dollars needed to grease the newly liberalised official foreign exchange market.
One-year Treasury Bills in Nigeria were sold at a yield of 8.2 percent at the last auction by the Central Bank of Nigeria (CBN), less than half of the inflation rate of 22.4 percent in May. The yield on the T-Bill is also lower than the monetary policy rate of 18.5 percent.
Nigeria has kept the interest rate on its local bonds artificially low for years to manage the government’s ballooning borrowing costs.
Raising interest rates will therefore not be as straightforward after debt service costs hit 96 percent last year, according to the World Bank data.
That means the government spent N96 of every N100 earned repaying creditors last year and risks spending even more if interest rates went up.
Nigeria however faces the risk of irking foreign investors by keeping the rates artificially low.
Foreign investors say the negative real return, which arise from interest rates lower than inflation rate, is a deterrent to new dollar inflows. The negative return also reduces the competitiveness of naira assets in the battle for foreign capital among emerging markets.
London-based Abrdn Investments Ltd said rates will need to go up to between 15-20 percent for it to bring its funds back onshore.
Nigeria faced a similar challenge in 2016 when it had to choose between lowering interest rates to stimulate an economy in recession and raising rates to attract foreign portfolio investors. The CBN opted for the latter, paving the way for interest rates to go up, with the one-year T-Bill rising as high as 18 percent.
Yemi Kale, chief economist at KPMG Nigeria, thinks foreign investors are asking for too much by seeking real returns on investment before returning in sufficient quantity.
“You bring in FX at 5 percent interest and inflation in your country and get an interest rate on your investment in Nigeria of say 11 percent and you repatriate your capital with little depreciation, so why do you need rates above inflation?” Kale said.
It’s the local investors who are hard hit by the inflation rate rather than the foreign investors, according to Kale.
Nigeria went down the route of high interest rates in 2016 to lure foreign investors, with the CBN selling Open Market Operation (OMO) bills to foreign investors at high interest rates.
At the peak of the practice in 2018, the CBN spent close to N2 trillion in interest payments after selling as much as N22 trillion worth of OMO bills, two times the N11 trillion sold in 2017 and more than three times the N7.8 trillion sold in 2016, according to data from the CBN’s 2018 financial statement.
The stock of the CBN’s OMO bills grew substantially, hitting the equivalent of $55 billion by year-end with average yields at between 12.2‒15.3 percent, with about a third of the issues held by foreigners.
The CBN eventually pulled back after being criticised for racking up such huge interest costs, with the apex bank lowering interest rates to single-digits. The move to lower interest rates as well as the dollar scarcity that followed saw foreign investors shy away from Nigeria.
“It (the high interest rate on offer) was like bribing foreign investors to bring dollars but it was always going to unravel because of the weak structure of the economy which meant we didn’t earn so much dollars and the government’s income was dwindling,” a senior financial market expert said.
Even the brightest experts are not sure whether the government should allow interest rates go up in order to compete with other emerging markets battling for foreign inflows or keep interest rates low to keep the government’s borrowing costs from going any higher.
“It’s a tough conversation to have,” a local fund manager who weighed in on the conundrum Nigeria faces said.
“But I think it will take more than increasing interest rates to lure foreign investors back, the CBN needs to build confidence again,” the fund manager said.
“Ghana and Zambia both have interest rates higher than most markets but investors are not flocking there,” the fund manager said.
The naira float this month is considered a necessary first step in restoring investor confidence but there’s a long way still to go if foreign investors who have had their fingers burnt repeatedly in the last eight years must return.
Investors have over $2 billion stuck onshore in Nigeria, according to the IMF’s estimate, and that will need to be resolved before foreign capital returns.
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Wilson Erumebor, a senior economist at a private sector think-tank, the Nigerian Economic Summit Group, said the end goal should be to ensure stable rates.
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“Stability will provide confidence and Nigeria needs more net inflows to ensure stability,” Erumebor said.
“There is a need for complementary policies to attract inflows of foreign exchange into Nigeria. Fiscal and trade authorities must incentivise growth – production of goods and services for both the local and export market,” Erumebor said.
He said the CBN must implement supply-side policies to cushion the effect of inflationary expectations.
“Doing business and welfare reforms are also crucial,” Erumebor said.
Charles Robertson, an economist, thinks the CBN will need to supply dollars into the market to begin the process of rebuilding investor confidence and achieving a stable exchange rate.
“At root, the CBN collects export oil revenues – some have to be supplied to the market,” Robertson said.
