Why CBN’s new 18% interest rate could spell doom for Nigerian businesses

In a move to contain Nigeria’s inflationary pressure, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN), on Tuesday, raised the monetary policy rate (MPR) from 17.5% to 18%, making it the second time the apex bank will be raising the benchmark rate this year.

In January, the MPC raised the MPR from 16.5% to 17.5% to ease pressure on the naira amid an unprecedented cash crunch due to the botched currency redesign policy.

For the uninitiated, the MPC is the decision-making body for monetary policy under the inflation targeting system, while MPR is the baseline interest rate in an economy upon which all other interest rates are based. The CBN had adopted the MPR in place of the Minimum Rediscount Rate (MRR) to control the movement of market interest rates by benchmarking it against the MPR, according to this research paper.

CBN governor Godwin Emefiele, while speaking with journalists, noted that the apex bank’s tightening measures had started to address inflationary pressure. There is no doubt that the MPC rates affect how money is in circulation and, conclusively, the inflation rate.

Nigeria’s inflation has been swinging left and right in recent months, rising to 21.91% in February. “However, on a year-on-year basis, the headline inflation rate was 6.22 percent points higher compared to the rate recorded in January 2022, which was 15.60 percent,” the National Bureau of Statistics (NBS) said in its report.

Read also: CBN increases the MPC rate from 16.5% to 17.5%, aims to reduce inflation.

Raising MPR isn’t the way

Since 2022, the CBN has raised the interest rate about six times. For context, the MPR was raised by the apex bank four times in a row, from 11.5% to 16.5% in 2022. However, the CBN claimed that these earlier hikes had led to a modest decline in inflation, as the rate fell from 21.47% to 21.34% in December. It, however, hit a new high of 21.91%, contrary to industry watchers’ expectations.

This paper argues that the pass-through of MPR into short-term and long-term retail interest rates in Nigeria is sticky, adding that only evidence of the effectiveness of monetary policy can be seen only in the relationship between MPR and interbank rates.

Meanwhile, experts have warned that the increase in MPR could lead to higher borrowing rates and negatively affect businesses that borrow capital for their survival. 

“The CBN should resist the temptation to increase the Monetary Policy Rate further. The deployment of this monetary tightening tool should be put on pause. Prior distortions and contradictions in monetary and foreign exchange, the structural component of inflation in Nigeria, and inflation expectations have blunted the ability of the MPR to control inflation at this time.

Tightening the money supply remains important, but this should be pursued through other means of controlling the rate of money creation,” ex-deputy governor of the CBN, Kingsley Moghalu, and a policy expert, Damian Ude, wrote in a policy paper in January.

Read also: Despite labour shortages, more than 50% of businesses in Nigeria plan local expansion – survey

Where does this leave Nigerian businesses?

Kalu Aja, a financial analyst, told Technext that while MPR is designed to make credit expensive and reduce liquidity, Nigeria’s inflation is caused primarily by high food prices, not just excess liquidity. “Thus, the success of higher MPR will be muted,” he said.

Kelvin Emmanuel, Co-Founder and CEO at Dairy Hills, says that MPR at 18% means the cost of capital in the debt capital markets will keep rising, and the end consumers will bear the rising cost of production, which on its own, is a contributor to demand-pull inflation.

One credible reason the CBN keeps raising MPR is because it knows that the real inflation rate in Nigeria is not 21.9%,

MPR at 18% means the cost of capital in the debt capital markets will keep rising & the end consumers will bear the rising cost of production,

— Kelvin. (@realkelvin07) March 21, 2023

With the rate increase certain to lead to higher borrowing rates, Nigerian businesses — especially micro, small, and medium enterprises (MSMEs) — will bear the brunt as they have to grapple with tougher funding conditions.

A 2021 survey put the number of MSMEs in Nigeria at around 39 million. Jerking up the MPR means banks/lenders will respond by adjusting their interest rates to reflect the hike.

The ripple effect is that MSMEs will pay more to borrow funds needed for their businesses, consequently translating to higher prices of goods and services for consumers. Aja said the small businesses would borrow less and limit their expansion. Over half of the businesses in Nigeria are planning to expand locally, according to a recent survey commissioned by Equinix, Inc.

“We need to pursue short-term monetary expansion by lowering the MPR and increasing the cash supply, not the monetary tightening madness that Godwin Emefiele is dogmatically pursuing. People need to get access to cash et credit; manufacturers, traders, and merchants in particular,” Basil Abia, a research consultant, tweeted on Tuesday.

We need to pursue short-term monetary expansion by lowering the MPR and increasing the cash supply, not the monetary tightening madness that Godwin Emefiele is dogmatically pursuing.

People need to get access to cash et credit; manufacturers, traders, and merchants in particular

— ً (@basilabia) March 21, 2023

With these consistent increases in the MPC rates by the CBN, there are fears that Nigerians might end up with a worsened economy which results in lower investments as banks begin to charge higher borrowing rates. But Aja, the financial analyst, said higher rates are a contributing factor to economic recession but not automatic.