Something uncommon happened last Wednesday. At least that is how anyone who has not been following Nigeria’s financial markets recently would interpret it.
Investors fell over one another to lend to the government at a rate that was materially lower than inflation, which essentially means paying the government to borrow money from them.
The stop rate on the one-year Treasury Bill, which was oversubscribed, was 3 percent. But data released the same week by the National Bureau of Statistics (NBS) show that inflation accelerated to 13.22 percent in August.
Ideally, a rational investor would balk at lending at a rate below inflation, but this time investors were so eager to lend to the government even though it left them with a negative real return of 10 percent.
The same investors lent to the government at 21 percent in 2017, which earned them a real return of around 3 percent at the time.
So what had changed? Had they suddenly forgotten the concept of risk pricing and why were they happy to park their cash in government debt when they stand to lose 10 percent of their money in real terms at the time of maturity?
The answer to that is the low yield environment in Nigeria, which means even though the return on the one-year TB is below inflation; it is about the highest yielding risk-free asset for that duration. There are simply no other alternatives for an investor.
So, the investor must settle for a negative real return that hurts for each of the 20 investors surveyed by BusinessDay.
“It is classic financial repression,” one of the investors who craved anonymity told BusinessDay.
“Left with no other investment options, investors are forced to lend to the government at very low rates that are not market-reflective,” the investor said.
Indeed, the decline in yields in Nigeria is not market-driven. Take the one-year TB for instance.
The big plunge in the yield of the one-year T-bill from 21 percent in 2017 to 3 percent currently is due to a raft of policies by the Central Bank of Nigeria (CBN), which has kept interest rates artificially low. Yields are not down because Nigeria’s risk premium is lower but because some CBN policies have kept them that way, whether it is the open market operation (OMO) policy that bars non-bank investors from investing or the recent reduction in the savings deposit rate.
If anything, at a time when the country’s finances have been hit by the double whammy of the Covid-19 pandemic and the oil price downturn, the country’s risk premium should be higher and investors should demand higher return today than they did in 2017.
Economists surveyed by BusinessDay explained that the artificially low rates in Nigeria were due to the financial repression by the monetary authority.
Financial repression, which includes legal restrictions on interest rates, credit allocation, capital movements, and other financial operations, was widely used in the past but was largely abandoned in the liberalisation wave of the 1990s, as widespread support for interventionist policies gave way to a renewed conception of government as an impartial referee.
The practice has come back on the agenda with the surge in public debt in the wake of the Global Financial Crisis, and some jurisdictions have reintroduced administrative ceilings on interest rates.
A study done by the International Monetary Fund (IMF) that attempted to estimate the impact of financial repression on growth using an updated index of interest rate controls covering 90 jurisdictions over 45 years shows that the practice poses a significant drag on growth, and could amount to 0.4-0.7 percentage points drop in economic growth.
In Nigeria’s case, not only is financial repression a threat to an already flailing economy, it means an additional burden on many Nigerians whose purchasing power is already being eroded by the country’s current stagflated economy.
“Financial repression does have its advantages in the short term as it provides cheap loans to companies and governments, and reduces their burden of repayments but could have damaging long-term implications,” one economist said.
“The problem with Nigeria is that investors and savers are subsidising a government that is largely inefficient in its spending, prioritising frivolous recurrent spending over capital spending,” the economist said.
An investor who lends N10 million to the government for one year will get N10.3 million at maturity. While that is an increase in nominal terms, it is a decline in real terms when inflation of 13 percent is factored.
If the return on the one-year TB matches an inflation rate of 13 percent, the investor would have earned N1.3 million and would have N11.3 million at the end of one year.
However, by getting a return of 3 percent rather than an inflation-adjusted return of 13 percent, the investor has essentially lost N1 million.
The story is different for the government. Rather than pay the investor N1.3 million, it now pays only N300,000 and saves N1 million.
That is brilliant business for the Nigerian government whose debt service cost hit a record high of 99 percent in the first quarter of 2020, according to Debt Management Office (DMO) data, before moderating to 72 percent in the second quarter.
Lower interest rates moderate the cost of borrowing for the government, but the problem is that the government is widely viewed as an inefficient allocator of resources.
Critics say Nigeria has little to show for doubling its debt in five years to N28 trillion. They point to tepid economic growth that has been stuck at 2 percent.
Weak economic growth rate and rising debt levels strengthen the argument made that the government is not an efficient spender.
Investors are not the only ones subsidising the government, savers as well.
By the CBN’s order to commercial banks to slash the minimum interest rate on savings deposit to a minimum of 10 percent of Monetary Policy Rate (MPR), or 1.25 percent per annum, from the previous minimum of 30 percent of MPR, or 3.75 percent, Nigerian savers have lost about N162 billion.
Nigerian savers hold over N6.5 trillion in their savings account with commercial banks, according to NBS data.
Before the CBN policy that reduced the interest rate on savings from 3.75 percent, that amount of money would have yielded additional N243 billion per annum. But with the policy pegging the rate at 1.25 percent, the money yields N81 billion, a difference of N162 billion. That effectively means Nigerian savers would lose N162 billion annually on the back of the policy that took off September 1.
“While savers and investors reel, the government is one of the biggest beneficiaries of the financial repression, especially when it is as indebted as the Nigerian government and needs some breathing room from choking debt service costs,” one economist said, “That is what financial repression is about.”
The CBN has achieved financial repression by its policies on savings deposits and bank lending. The bank’s aim is to incentivise lending to the real sector and pave way for access to affordable loans.
The economists surveyed however said the CBN might not be able to achieve its aim without help from fiscal authorities.
“The problem with low funding of the real sector is more structural than monetary,” one of the economists said.
“Lending to the real sector would continue to dwindle until the fiscal authorities improve the ease of doing business and address the infrastructural deficits that hinder business,” another economist said, “That is not a problem you can solve with monetary policy alone.”
