MPC and interest rate: The hawks have it!

The decision by the Monetary Policy Committee of the Central Bank of Nigeria to hike its policy rate yesterday did not take many market observers by surprise. If anything, the market would have priced that increase into its valuation of securities and allocation of resources. So, the initial impact of the decision on investors’ actions, I expect, would be minimal. This is because of the obvious hawkish stance of the committee and the leadership of the CBN right now.

The 200 basis points increase in the Monetary Policy Rate to 24.75 per cent, therefore, adds to the ongoing push to make credit as costly as possible to weaken demand for credit and reduce flying about in the economy. This comes about a month after the committee raised the rate by 400 basis points. Interest rate is the bank’s prime tool now for dealing with the twin challenges of runaway inflation and a troubled naira. These two rates – interest rate and inflation rate – are the prime targets of these hikes in the MPR. And the CBN has not hidden its inclination towards this.

It is not clear now how long this tightening would go on for both objectives to be achieved; not just being achieved, but that being done cost-effectively. The hikes in interest rates have obvious costs that might be quite visible now. But the costs or effects will begin to manifest soon: in the form of downtime in factories, especially those belonging to small-scale enterprises, some of which might not be able to access capital at the high effective interest costs that banks will soon begin to charge.

Part of the force driving the interest rate hike is CBN’s desire to achieve a positive real interest rate. We have been in the negative region for some months, which got even wider earlier this month when the National Bureau of Statistics announced that the inflation rate for February 2024 rose further to 31.7 per cent, up from 29.9 per cent in January. So right now, we still have a negative real interest rate of 6.75 per cent, quite a huge cost for anyone to bear just because they earned money or want to save at this time.

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We might, therefore, expect a change in the tightening position when the inflation rate begins to decelerate. But the reality now is that ours is still a high-cost environment. The price of everything, relative to what they were a year ago, for instance, is still high. Food items are beyond the reach of many Nigerians right now. 

As for the naira, which is the other objective of the monetary policies, the story is quite different now. The naira has strengthened against other currencies since it was receiving so much bashing just last month.  The naira has surprised most people. It has gone up within such a short time, almost at the same speed at which it came down. The story of the rise of the naira is the mirror image of its fall since its flotation in mid-June last year. From a rate of about N462 to the dollar on June 14, our currency crashed to N755 to a dollar at the start of the floatation on the same day. It was later to an all-time low of about N1700.

Yet, it is quite clear that this meteoric rise or recovery by the naira came via a change of tactics. From the blanket floating of the currency, the authorities have realised their fundamental mistake. This was the very point that many economists pointed out; that Nigeria cannot afford the liberty of a truly, free floating exchange management system.

It also took a combination of market interventions by the central bank and even some physical interventions, with security agencies being deployed to check currency speculation. CBN market intervention has taken different dimensions. By the latest directive from the Central Bank of Nigeria to BDCs, the central bank said that each BDC will get an allocation of $10,000 at N1,251 per dollar. However, this comes with a condition that the BDCs will in turn sell the dollars to “eligible customers” at a maximum rate not exceeding 1.5 per cent above the purchase price. This in effect brings the retail price of the dollar from a BDC to N1,269 per dollar.

This will happen simultaneously across the country wherever there is a CBN-licensed Bureau de Change, the circular said. Considering where the naira has been in recent weeks, this is a notable achievement. 

The current exchange rate of the naira to the dollar and other major currencies of the world must quickly begin to be reflected in the other prices in the economy. Since part of the recent spike in the prices of most commodities occurred because of the depreciation of the naira, this means that price increases should also begin to decelerate.

Prices of goods and services must begin to climb down from their current high positions. How soon this will happen depends on the turnaround rate or production cycles in the economy. The dollars that will be accessed at the current lower rates will not enter the production and supply equations until two or three months, or even much longer.

Whether and how much the naira will benefit from the interest rate hike is not clear now. First, the increase in interest rates and the increase in the Cash Reserve Requirement (CRR) to 45 per cent will make the naira more expensive. The higher CRR, raised in February, will hamper banks’ ability to create credit, so money will be more expensive because banks may “pick and choose” who to lend to.