Nigeria policy rate retention may worsen capacity underutilization, as businesses avoid borrowing due to high interest

Financial and economic analysts in Nigeria, offering a postmortem of the central bank’s Tuesday monetary policy decision to retain benchmark monetary policy rate at 14 percent, say they fear a possible adverse effect on capacity utilisation, with its attendant consequence of fueling unemployment. Many businesses they further said have become averse to borrowing following what they consider as unfavourable, the rate at which banks currently lend money in the economy.

The MPC has maintained status quo for the sixth consecutive time since it last changed its benchmark policy rates 12 months ago.

However, some analysts see the decision as counter productive and restrictive as interest rates remain in the high region.

Analysts at Financial Derivatives Company (FDC) said an accommodative policy is necessary this time when growth is paramount, as it would send the right signals to economic agents, while a few see no downsides to the decision.

They argued that a year ago when the MPC increased the MPR to 14 percent, it was in response to a weak currency and dwindling external reserves, a situation that has since reversed. They, therefore, would welcome a reduction in the monetary policy rate to stimulate growth.

However, analysts at Renaissance Capital saw no downsides to the policy rate, saying the risk remains upside because inflation always bottoms out in the early teen region

“We believe the committee’s mention of FX stability and lower inflation in 2H17, on the back of 3Q17 harvests, lowers the probability of a rate hike. So, we revise down our YE17 policy rate forecast to 14 percent, from 18 percent previously.

“Although a rate hike is no longer our base case, we think the risk to the policy rate remains to the upside, because inflation bottoms in the early teens, by our estimate,” they said in a note sent out Wednesday.

But FDC argues that the CBN is of the school of thought that Nigeria’s inflation is driven by demand-pull factors rather than production shocks. Hence, it believes that reducing interest rates could increase liquidity and the demand for forex, thus inducing inflationary pressures.

“As businesses have become averse to borrowing due to high-interest rates, the economy is facing capacity underutilization and higher unemployment. The MPR is an anchor rate that is having less of an influence on market participants, as the rates for T/Bills seem to reflect the cost of borrowing,” the FDC analysts noted in its economic bulletin for July.

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They remarked that the apex bank is of the view that with a high marginal propensity to import, an increase in liquidity will magnify the pass-through effect of imported inflation. Furthermore, with fiscal injections such as the Paris club refund and budget disbursements, the resulting increase in liquidity in the system could stoke inflationary pressures and lead to a buildup of demand pressure in the forex market.

FDC strongly believes that the CBN may be forced to do a rate review in the short to medium term, adding that a ‘do nothing’ approach to monetary policy is only adopted to hedge inflation expectations

“Given increasing political pressure to lower interest rates to encourage growth, we believe that the CBN may yield and thus review the MPR at its next meeting. Nigeria’s increasing debt service burden (70% of independent revenue) is becoming an impediment to fiscal consolidation.

“This is likely to force a review of the interest rate policy in the short to medium term. A reduction in MPR may be more likely if Q2 growth figures released on August 23 are positive,” said FDC analysts.

Other analysts who spoke to businessamlive are also in support of relaxed rate regime, saying the current economic environment need stimulation for growth.

“The CBN governor in his address to the media on the outcome of the meeting indeed point to a fragile recovery of output growth over the remaining part of the year. This shows that we need stimulus for growth,” an analyst said.

Policy responses to inflationary trend in consumer prices are always mixed from country to country. In July alone, not less than six countries have met to alter/maintain their monetary policy stances. Countries such as Angola and Kenya are in harmony with Nigeria as they have maintained status quo on benchmark rates, while Ghana cut rates by 150 basis points, which shocked analysts based on the magnitude of the cut.