CBN action will lead to drop in consumer demand, escalate production costs, say experts

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Finance and economic experts yesterday expressed concerns over the decision of the Central Bank of Nigeria (CBN) to raise the benchmark interest rate by 150 basis points to 26.25 per cent.

Analysts predicted that the decisions of the Monetary Policy Committee (MPC) will not only lead to drop in consumer demand, but would escalate production costs for businesses.

Chief Executive Officer, Centre for the Promotion of Private Enterprise (CPPE), Dr. Muda Yusuf, said the apex bank should have held down the rate hikes for a number of reasons.

He said: “First, previous rate hikes have been quite aggressive, hurting output and real sector investments. Most economic operators with credit exposures to the banks have not recovered from previous hikes. Interest rates were already around 30% threshold.

“Secondly, extant CRR of 45 per cent has profound liquidity effects on the financial system.  Both measures have dampening effects on financial intermediation, which is the primary role of banks in an economy.

“Thirdly, the monetary policy transmission channels are still very weak, given the level of financial inclusion in the economy. This limits the prospects of monetary policy effectiveness.

“Meanwhile, the new rate hike is an additional cross to be borne by investors who have exposures to bank credit facilities. Naturally, a rigid monetarist disposition by the Central Bank is expected.  But we need to reckon with the costs to the economy.”

He expressed the hope that with the positive outlook for domestic refining of petroleum products, there may be a moderation in energy cost and a pass through effect on general price level.

“This is one silver lining that is on the horizon at the moment.  Necessary fiscal policy support are urgently needed to compensate for the adverse impact of extreme monetarism on the economy,” Yusuf said.

Head of Research at Commercio Partners, Ifeanyi Uba, said the current “hawkish” stance by the CBN-led MPC was designed to combat soaring inflation and stabilize the naira.

Uba said: “While the recent moderation in monthly inflation figures offers a glimmer of hope, the persistent rise in headline inflation remains a significant concern. Despite the challenging economic climate, the CBN’s steadfast stance against inflation carries potential risks, including businesses struggling with rising production costs, diminishing demand, forex crises, and other pertinent challenges that may lead to the gradual erosion of economic vitality,” he said in emailed note to investors.

During the 295th MPC meeting held on Monday through yesterday, the committee also voted to maintain the asymmetric corridor at +100/-300 around the MPR, retain the Cash Reserve Ratio (CRR) for commercial banks at 45.00 per cent, and keep the liquidity ratio steady at 30.00 per cent.

Other analysts disclosed that Nigeria’s relationship between interest rates and inflation is anything but straightforward.

According to them, conventional wisdom suggests that higher interest rates should curb borrowing, reduce available credit, and ultimately lower inflation. However, the empirical evidence in Nigeria, as highlighted in the accompanying graph, tells a different story.

They said: “The connection between interest rates and inflation in Nigeria is complex and unpredictable. While rate hikes are intended to control inflation, their impact can be slow and uncertain. Various other factors, such as supply chain disruptions and global food price increases, also play significant roles in driving inflation.

“In the short term, the effectiveness of rate hikes would be directed to attracting dollar inflow and strengthening the currency, as Nigeria is import-dependent. When the exchange rate strengthens, inflation should reduce.”

The analysts insisted that in other economies, higher interest rates typically lead to increased borrowing costs, which in turn reduces consumer spending and business investments, leading to lower inflation.

However in the Nigerian context, the transmission mechanism of monetary policy may be impaired by structural issues within the financial sector, such as limited access to credit for small and medium enterprises (SMEs) and a significant informal economy.

By raising interest rates, Nigeria aims to attract foreign investment, which can increase the demand for the Naira, thereby strengthening the currency.

A stronger naira can make imports cheaper, potentially reducing imported inflation. However, this effect is contingent on stable global commodity prices and effective foreign exchange management.

The apex bank’s rate hike is expected to exert increased strain on the economy, particularly on businesses. The economy, already grappling with numerous social and economic challenges, may face further destabilisation.

An increase in the minimum cost of borrowing could slow down the corporate sector, potentially leading to a decline in the stock market.

Additionally, the recent interest rate hike is expected to stimulate activity in the fixed-income market by making new securities more attractive.

New bonds will be issued with higher yields to reflect the increased policy rate. Investors will demand higher returns to compensate for the elevated interest rate environment.

As a result, long-duration bonds, which are more sensitive to interest rate changes, are likely to experience greater price declines compared to short-duration bonds as rates rise.

On the macroeconomic front, the increased interest rate may slow Gross Domestic Product (GDP) growth and hinder stock market appreciation.

Furthermore, this policy could exacerbate the unemployment issue facing the Nigerian economy. Despite these challenges, there is a slim possibility that inflation rates may ease somewhat by the end of the year.

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