As a businessman in Nigeria, you are most likely not pleased with the interest rate hike. Despite the dwindling economy, the interest rates keep growing, making it more difficult to access and repay loans.
The Central Bank of Nigeria (CBN) regulates the activities of banks and other financial institutions and serves as a banker to the government.
Since it started operations in 1959, the CBN sets the interest rate for banks to follow. The Monetary Policy Committee of the CBN voted to hike the interest rate from 11.5% to 13% in May 2022. This was disclosed in the communique of the Monetary Policy Committee meeting.
Other developed countries have also increased interest rates. For example, the Bank of England hiked their interest rate to 1.25%, which is their highest in almost a decade. Let’s discuss the reasons for this current hike in interest rates.
To Lower Inflation
Inflation is a general increase in the cost of goods and services. Inflation occurs when there is an increase in the cost of production, which is pushed on to consumers in form of higher prices (cost push inflation). Inflation could also happen as a result of increased demand of goods and services (demand-pull inflation).
Nigeria has a combination of cost push and demand-pull inflation which has resulted in hyper-inflation. The insecurity in the north has reduced farmers’ output as the insurgents destroy farm produce, and bandits kidnap for ransom. The supply of agricultural products doesn’t meet demand, thereby causing food prices to rise.
Also, the government pumped in money for special projects such as N-power, Government Enterprise and Empowerment Programme (GEEP), etc. This increased the money in circulation but with food supply not sufficient, prices of food items still rose.
According to the National Bureau of Statistics(NBS), the inflation rate in Nigeria has climbed to 17.71%. The hike in interest rate is expected to make it more expensive for people to take loans since lenders will pay higher interest. Those with credit cards will also be compelled to spend less, and live within their means or risk being charged higher interest, for using the card.
On a brighter note, a hike in interest rates will encourage saving because savers will earn higher interest when they keep money in the bank or in fixed deposit accounts. All this is expected to reduce the amount of money in circulation and bring down inflation.
The Minister of Finance, Budget and National Planning, Zainab Ahmed has also said the Executive Council has decided to convene an urgent meeting of the National Food Security council to find ways of lowering soaring food prices
To Make New Treasury Bonds Attractive
Treasury Bonds are government issued debt securities that offer you interest every six months up to the maturity date. It is a low-risk investment that accrues interest semi-annually. When you buy treasury bonds you are borrowing your money to the government.
The coupon rate is the interest you receive yearly. It is also known as bond yield. For example, if you buy N1,000 worth of Nigerian bonds at a coupon rate of 10%, you would receive N100 per year. Since interest is paid twice a year, you receive N50 every six months.
Let’s say the government wants to combat unemployment and create social intervention programs such as N-power, funds would be needed to execute them. If the government issues out new bonds, they would carry a higher coupon rate due to hike in interest rates.
, and raising the needed funds would be easier.
Holders of old bonds who want higher bond yields would be forced to sell their securities at a lower price to purchase new bonds or to keep their old bonds and buy the new bonds. Investors receive higher coupon rate for new bonds making them more attractive and oversubscribed.
Examples of oversubscribed bonds in the past were the N250 billion SUKUK bonds oversubscribed by 346% and January 2022 FGN bond oversubscribed by 185%.
By hiking interest rates, government is able to create a market for its new bonds and raise enough capital to fund necessary projects.
To Attract Foreign Investments
Interest rate hikes favour the exchange rate as Nigeria offers a higher rate of interest compared to some foreign countries. Investors from abroad would be drawn to buy assets in naira. Once the demand for the naira increases, it becomes stronger compared to other currencies.
A strong naira would cheapen the cost of imports and make exports more expensive abroad.
Appreciation of the Naira would enable the federal government to settle her external debts easily. For example, if the USD/NGN exchange rate is N600, and the interest rate increases to 13%, the Naira gains value and the exchange rate can drop thus requiring less naira to buy one dollar.
Payment of external debts would also be easier as the government would pay less per dollar borrowed. When Nigeria’s interest rate is high, foreign investors will want to engage in carry trades. Carry trade is a trading strategy that involves borrowing from a country with a low-interest rate and investing it in a country that offers a higher rate of return.
For example, you borrow N1, 000,000 worth of Ghanaian Cedi from a Ghanaian Bank at a 2% interest rate and invest in a Nigerian bond offering a 10% coupon. The interest received from the bond is N100, 000 while the interest paid for the loan is N20, 000. At the maturity period, you make a profit of N80, 000.
When the interest rates are raised, it attracts foreign investments. A higher interest rate relative to other countries makes such a country an investment haven.
For example, with an increase in the Nigerian interest rate to 13%, investors worldwide would want to pump in money since they are guaranteed a higher rate of return relative to other countries.
For this to happen, you have to convert the foreign currency into Naira. Higher demand for the Naira makes the currency more valuable. The exchange rate rises in the favour of a country with higher interest rates.
The balance of trade is an analysis of how a country is faring. The difference between exports and imports is expressed in the country’s currency, in this case, the naira. Higher exports than imports indicate that the country’s products are competing favorably in the foreign markets.
Effect on the Capital Market
A higher interest rate makes borrowing more expensive and reduces the earnings of the company. This can also bring about a fall in profitability and a fall in stock price. Investors jump ship from stocks to bonds because the interest rate hike is in their favour; giving them more returns on investment.
This causes a general loss of confidence in the capital market and could cause new startups to raise funds from oversea venture capitalistsinstead of coming to the capital market to raise the needed funds. Already we have seen new startups like SeamlessHr raise $10 million, and Flutterwave have raised $250 million from oversea venture capitalists.
Higher interest rates also makes shorting of stocks more expensive for short sellers. Shorting is the process of borrowing stock, selling it at the current market price, then waiting for the price to fall to re-buy and return to lender. Your profit is the difference in the sell and re-buy price.
Short sellers are important in the capital market because they provide the needed liquidity in the market. Without short sellers you may not be able to find buyers for your stock when you want to sell.
To borrow stock you need to open a margin account which is a loan account. You are charged interest every day till you return the stock. Higher interest rates means short sellers will be discouraged and capital market liquidity will be reduced.
Nigeria also has over 300,000 retail forex traders who patronize foreign online forex brokers since retail forex trading isn’t regulated In Nigeria. Forex trading is mostly carried out using contract for difference (CFD) which entails borrowing funds from your broker to trade.
Karan Singh from Safe Forex Brokers says that the current outflows to US Dollar globally are still high & this could lead to more stronger dollar in 2022 against weaker currencies. This means that most EM currencies could depreciate further affecting traders & businesses.
He further explained that if your trading account is in Naira, then depending on your broker, higher interest rates could mean Nigerian traders will pay higher when borrowing or margin trading via CFD contracts.
This is true because currencies change in small amounts and so to trade very large currency sizes most traders borrow i.e. use leverage. Some brokers offer Naira denominated accounts and higher interest rates will mean higher cost of borrowing to trade forex.
The Bottom Line
With the hawkish approach to the Nigerian monetary policy, Godwin Emefiele & Governers of other central banks maintain that it is a necessary step to curb inflation. The outcome of the 142nd MPC meeting despite its advantages does not sit well with some stockholders and SMEs. It is hoped that this new change would boost the Nigerian economy.
(New Telegraph)
