• Thursday, March 28, 2024
businessday logo

BusinessDay

Inconsistencies in the macro space

Inconsistencies in the macro space

The Nigeria macro space has been turbulent over the last decade. We have seen inflation go from single digits to as high as 18 percent and back down. We have seen very volatile exchange rates with black market rates moving from 199 per US dollar to almost 500 per US dollar before falling down to 360. This kind of turbulence has not been great for the economy as you can guess.

Growth slowed from around seven percent to recession and is current stumbling along at 2 percent. Unemployment continues to climb and climb. Of course, we cannot ignore the oil price shock that happened over that period with oil prices dropping from a high of above $100 per barrel to as low as $30 per barrel in a few months. Still, lest we forget, the oil price crash was four years ago.  The monetary policy authorities have had to respond to all that by raising interest rates higher and higher. In 2010 the monetary policy rate was 6 percent. It is currently 13.5 percent in principle.

All this has created a dilemma for the central bank. On the one hand the actual macro conditions require that rates remain relatively high. I say relatively for a reason and I will get back to that. The central bank also needs higher rates to continue to incentivize foreign exchange inflows. A policy I don’t agree with but that is neither here nor there. Higher rates are however not great for the economy. Especially an economy that really needs to be growing much faster. Then there is the problem of government debt financing with higher rates implying higher debt servicing costs limiting its non-debt spending plans.

Read also: CBN can try, but banks as financial inclusion champion not happening soon

How have they dealt with this dilemma? Essentially by trying to eat their cake and have it. The market for risk-free securities was essentially split into two with the OMO market on one side and everyone else on the other. The OMO market has chugged along with relatively high rates and securities returning near 14 percent. For foreign portfolio funds, as long as they believe they can repatriate their returns in dollars, then everything continues as normal. For everyone else though, rates have effectively collapsed. As at last week rates for treasury bills were hovering near four percent. Banks have reportedly cut their rates for fixed deposits for some customers to as low as one percent. Effectively, for everyone besides banks and foreign portfolio funds, the options for safe returns have collapsed.

But there is a problem. Earlier on I said rates were “relative” for a reason. In the macro space we do not really care about the nominal rate. We care about the real interest rate. This is the return after accounting for inflation. Think about it this way. You loaned Emeka N20,000, which you could have used to buy one bag of rice today. In one-year Emeka pays you back the 20,000 but the price of rice has increased to N25,000. Inflation happened. In nominal terms you have not lost any money. Emeka paid you back the 20,000 intact. But in real terms you have lost out because that money could buy you one bag of rice when you loaned it out but now it cannot buy it. You would have been better off just buying the rice and storing it.

Real interest rates are what really counts. Once you consider the fact that the current inflation rate is near 12 percent and climbing then interest rates of 4 percent start to look problematic. The implication of such low rates is that people who have money are better off not saving. But it does not end there. The risk-free real interest rate of near negative 8 percent is significantly lower than the equivalent for the United States, Germany, and Japan. Which in essence is saying that Nigeria is a less risky borrower than the United States, Germany, and Japan. Is that really true or are we incentivizing people to find out.

The current macro space is inconsistent with the reality of the Nigerian economy and such inconsistencies tend to create problems. Problems which will mature sooner or later. The interest rate is a price and like every other price problem arise if it is too high or too low. If the central bank really wants to move into a low nominal interest rate environment then the thing to tackle is inflation. But that is easier said than done.

Dr. Nonso Obikili is chief economist at Businessday.