What a difference a year makes! From 3.13 percent inflation premium at the start of the year, inflation premiums on treasury bill rates in the primary market have crashed by more than 6 percentage points to -3.48 percent.
The sharp drop in inflation premiums occurred as treasury bill yields declined precipitously and inflation rose marginally during the year off the back of aggressive credit expansion policies by the Central Bank of Nigeria (CBN).
With treasury yields now very low, only the Federal Government appears to be the winner in this shocking rate decline as the high borrowing rates on local government debt have been drastically lowered. Banks and other financial institutions that had taken fixed deposits at double-digit interest rate are now forced to continue paying high interest on deposits until the maturity period even though the financial institutions are only making single-digit returns investing in treasury bills and other safer financial instruments.
“We expect to see a sharp decline in our investment income in the first quarter of 2020 and negative net investment return as a lot of money we are currently holding in our books was collected at interest rate between 12-18 percent,” said a top executive in a leading microfinance bank in Nigeria. “As you can see, one-year treasury yields are now barely 7 percent which means that we will be paying out much more in interest expense than we will earn through investment income. The outlook for us isn’t good at all.”
The impact of the reinvestment risk is still reverberating gradually in the private sector as investors who had invested in investment notes with double-digit returns are now forced to reinvest their funds at ridiculously low rates, painfully lower than inflation rate for most retail investors.
“I am not sure what to do with my investments with rates this low,” Joshua Obayan, a retail investor, told BusinessDay. “I am considering all my options with finding investments that will still deliver double digits even though I know that it may be very risky chasing high yields at this time. We all know that treasury yields lower than inflation discourages savings, but I guess we have no choice now.”
The Central Bank of Nigeria spent most of 2019 trying to reduce interest rates in order to increase credit to private sector and quicken economic growth in the country. The CBN cut interest rate by 50 basis points in March 2019 from 14 percent to 13.5 percent for the first time since raising interest rate to 14 percent in 2016. This helped reduce treasury yields slightly as inflation premium dropped to 1 percent in March 2019 from 3.13 percent in January 2019, before eventually dropping to 0.05 percent in July 2019 when inflation fell to a 2019 low of 11.08 percent.
However, the big decline in treasury yields which caused the negative inflation premium occurred between November and December 2019 after a decision to ban non-bank investors from the OMO bill market pushed more than N2 trillion in OMO bill maturities into Nigeria treasury bill market. During the treasury bill auction held on November 27, treasury yields had dropped to 8.37 percent while inflation rose to 11.85 percent in November.
It is unknown how long the money market can survive with negative inflation premiums but many analysts believe that the negative impact of declining treasury yields and rising inflation could only end badly for the country which could lose billions of dollars in foreign portfolio investments due to the unreasonably low yields on government debt.
IFEANYI JOHN
