Interest rate hike eyes inflation, naira stability

…Cardoso says money supply grew by N35trn in eight yrs

The Central Bank of Nigeria (CBN) surprised the markets with its liquidity tightening on Tuesday, raising the monetary policy rate by 50 basis points (bps) and the cash reserve ratio by 200 bps.

Financial analysts and economists say the policy decisions are targeted at heading off the cost-push effect of petrol price hikes while attracting inflows to strengthen the naira.

The monetary policy rate (MPR) represents the benchmark interest rate in the economy, while the cash reserve ratio (CRR) is a fraction of the total deposits which commercial banks must hold as reserves with the central bank.

After the two-day Monetary Policy Committee (MPC) meeting on Monday and Tuesday in Abuja, 11 out of the 12 members unanimously agreed to raise the MPR by 50 bps to 27.25 percent, from 26.75 percent in July 2024.

Olayemi Cardoso, governor of the CBN, who announced the outcome of the meeting during a press conference, said the committee also raised the CRR for commercial banks by 500 bps to 50 percent, up from 45 percent. Merchant banks saw a smaller increase, with their CRR raised by 200 bps to 16 percent, up from 14 percent.

A key consideration at the meeting was inflationary pressures, which moderated year on year in July and August, 2024.

There was a unanimous position however that a lot more was still required to actualise the bank’s price stability mandate.

This is because even though headline inflation trended downwards due to a moderation in food inflation, core inflation has remained elevated, driven primarily by rising energy prices.

“As CBN, we are resolute in our focus on bringing down inflation, and we will use all the tools at our disposal to ensure that happens,” Cardoso said.

Read also: CBN’s interest rate hike will slow economic growth – Analysts

Questionable timing but naira stability

Razia Khan, managing director and chief economist for Africa and the Middle East at Standard Chartered Bank, said: “Following the Fed’s recent easing, with more cuts expected, and Nigeria’s gross FX reserves rising (to a stated USD 39 billion), the hope persists that the NGN may eventually stabilise properly.”

She however expressed concerns about the timing of the decision, noting that this is coming after recent changes to the operation of the CBN’s overnight facility, which might have been interpreted by market participants as an easing.

Khan highlighted that despite the CBN’s consistent approach to tightening, the results appear fragmented when viewed against rising core inflation.

She explained, “More meaningfully, despite the consistent tightening resolve of the CBN, the effort starts to look very piecemeal in hindsight, when core inflation is still rising and the policy rate is still negative.”

She questioned the effectiveness of the successive rate hikes, adding, “With each successive tightening, which looks impressive on the face of it, we have to ask ourselves, ‘Will it really be sufficient this time around?'”

She expressed reservations about the current state of the forex market. “The CBN has pledged to monitor money supply and the FAAC more stringently, but the issue seems to be the absence of meaningful FX inflows as much as it is the seemingly insatiable local demand for FX,” she further said.

Ayodele Akinwunmi, senior relationship manager at FSDH Merchant Bank’s Corporate Banking Group, noted that the MPC aims to maintain price stability and ensure a real positive interest rate in the economy to attract foreign investments while preventing the outflow of domestic capital.

He noted that some proceeds from the banking recapitalisation exercise have begun to flow into the economy, and their positive effects may mitigate the negative impacts of the current tightening measures in the short term.

Tilewa Adebajo, chief executive officer of The CFG Advisory, said the MPC’s decision on is a preemptive strike to head off cost-push effect of the increase in fuel prices.

“This in a bid to sustain the downward trajectory of inflation,” he said.

Read also: CBN increases interest rate to 27.25% on petrol price hikes

High cost of funds

However, Ayodeji Ebo, managing director/CBO, Optimus by Afrinvest, said the interest rate hike will translate into increases in borrowing costs, making it tougher for businesses to survive amidst high energy costs.

According to Cardoso, a substantial source of the money supply is the monthly Fiscal Accounts Allocation Committee (FAAC), which official reports say disbursed as much as N12 trillion to the three tiers of government just within the first six months of 2024.

“Members observed a strong correlation between FAAC releases and liquidity levels in the banking system, as well as its impact on the exchange rate.”

He said that in 2015, for instance, money supply was about N19 trillion but has grown to N54 trillion by 2023, basically driven by Ways and Means.

“That is a huge increase, and a substantial amount of that was through Ways and Means. So, essentially, printing of money resulted in a huge amount of money chasing a relatively small amount.

“And to put it in another way, while the economy, on average, was growing at 1.2 percent during that time, money supply was growing at 12.6 percent, so you can see the inherent distortion there.”

Uche Uwaleke, director of the Institute of Capital Market Studies at Nasarawa State University, said: “I want to believe the members of MPC mean well for the economy and have taken the decision to further tighten monetary policy based on strong evidence of major threats to exchange rate and inflation.

“All said, the task of taming inflation must be jointly tackled by both the monetary and fiscal authorities. So, the government has to play its part by controlling recurrent spending and focusing on productivity, including through ramping up assistance to small businesses.”

Muda Yusuf, CEO, Centre for the Promotion of Private Enterprise (CPPE), said it is quite troubling that at a time when manufacturers, entrepreneurs and other investors in the economy are craving for a breath of fresh air, the CBN chose to tighten the noose on them by resorting to a further tightening of monetary policy.

According to him, the latest policy choice of the apex bank is at variance with the mood of most economic players and the desire to promote recovery and growth.

“What manufacturers and other investors need at this time is some oxygen and stimulus, not policy measures that would worsen an already suffocating situation,” he noted.

Ayokunle Olubunmi, head of financial institutions ratings at Agusto Consulting, said the increase in the MPR and the CRR will further raise the funding cost of banks and intensify pressure on the banking industry.

“These will result in higher interest rates on bank loans and discourage borrowing by businesses, moderate inflationary pressure and reduce economic growth,” he said.