How risk of Nigeria’s artificially low interest rates exceeds policy gain
Aimed at diverting liquidity away from risk- free instruments to the real sector, Nigeria’s lowinterest rate policy may have achieved its purpose but its side effect could mean more challenges for Nigeria’s already troubled economy.
The financial repression tactics by the Central Bank of Nigeria (CBN) have eroded the high returns on savings and investments, and an additional burden to Africa’ most populous country faced with the double challenge of Covid-19 and lower oil prices.
Described by analysts to mean negative return on savings and investment in real
terms, financial repression implies that Nigerians no longer have many choices when investing their savings, as yields on investment instruments are lower than the inflation rate.
From 2019 to date, the interest rate on government short-term instrument has plunged by 8 percentage points from 12.27 percent in January 2019 to 3.45 percent in the same period of 2020.
The stop rate on the 364day T-bill instrument now stands at around 3 percent, the highest rate across the three government instruments.
“Savers who have to earn below inflation rate return on their savings would see the value of their money eroded. Thus, by the time repayments are made, the purchasing power of the saved money would be lower, which implies lower income, lower demand and lower output,” Ayorinde Akinloye, a research analyst at CSL Stockbrokers Limited, says.
While interest rates have always been high in Nigeria due to the monetary system in vogue since 2009, which sought to use FGN bonds/tbills and OMO bills as means of attracting US dollar to stabilise the naira, the recent OMO policy by the CBN, which prevents domestic investors from participating in the auction, has sent yields to its worst record. The apex bank banned non-bank locals (individuals and corporates) from participation in its Open Market Operations (OMO) at both the primary and secondary markets last October.
“The government uses this policy as an opportunity to reduce borrowing cost, but the major risk of financial repression is that it discourages savings, which will have major consequences in terms of capital permission on the economy and could increase pressure on the exchange rate and external reserves,” Omotola Abimbola, a macroeconomist at Chapel Hill Denham, notes.
While the low- interest rate policy means cheap borrowing cost for both government and corporates, as they have both tapped into the domestic market for capital, it does not translate into a low cost of credit for the ordinary Nigerians who are still accessing bank loans at a double-digit interest rate.
Data analysed from the Debt Management Office ( DMO) show the Federal Government domestic debt has increased by 10 percent in one year, from N13.11 trillion in the first quarter of 2019 to N14.53 trillion in 2020.
Akinloye believes financial repression related policies in themselves are aimed at driving the cost of borrowing lower with the aim of driving investments via access to cheap debt capital, “however, in the case of Nigeria, most of this cheap capital goes to the public sector, which is grossly inefficient. Thus, this misallocation of capital impedes growth.”
Meanwhile, Nigerian companies as of August 7, 2020, have raised more than N559.77 billion through commercial papers, 103 percent higher than the N275.37 billion raised in March 2019. They issued the notes with an average interest rate of 7 percent, much better than the average 15 percent offered by commercial banks.
“It is worth noting that the market forces that should eventually push up the rates in the fixed income space are not doing so. Institutional investors seeking to combat the subdued levels of business activities as a result of the pandemic are taking up government securities despite low-interest rates,” Desmond Abbey, research analyst at Arthur Stevens Asset Management, states.
A lower interest rate means Nigerians have no return on their savings and investment as the inflation rate has accelerated to12.82 percent in July, the highest in 27 months.
“Nigeria needs Nigerians to save and invest in the economy, and this requires a positive rate of return. This is particularly critical for the BOP, as they have fewer options to save and invest,” Andrew S. Nevin, partner/ chief economist at PWC, says.
The impact of financial repression means an additional burden to many Nigerians whose purchasing power is already being eroded by the country’s current stagflated economy. With the first contraction in three years at -6.1 percent in the second quarter of 2020, the largest economy in Africa can now be best described as one that is stagflated.
The condition, described by slow, declining or contracting economic growth and relatively high unemployment, or economic stagnation, which is at the same time accompanied by rising prices (i.e. inflation), tips Nigeria into top six most miserable countries globally.
Nigeria’s current economic position means deeper dwindling of consumers’ purchasing power, which implies that incomes of many Nigerians can only buy less of their usual consumption basket, a situation of the poor getting poorer in real terms, and the middle class getting thin out.
According to Nevin, the easiest way to exit “this situation is for the Nigerian economy to grow faster in a sustainable and inclusive way. If we have sustainable, inclusive growth of 6-8% annually for GDP, interest rates would rise and the stronger economy would ensure a fair return for savers.”