Why CBN’s interest rate hike will fail to reduce Nigeria’s hyper inflation

Nigeria’s Central Bank has taken a hawkish stance against inflation by raising its benchmark interest rate to 13% from 11.5% (a 150bps hike). However, experts and scholars have stated that the rate hike would not have the desired effects on inflation in Nigeria.

The rate increase was implemented when the assumption of transitory inflation failed and the inflation rate climbed above 16%. In theory, an increase in inflation is intended to reduce the amount of money in circulation, resulting in a decrease in the inflation rate.

However, a cursory examination of Nigeria’s inflation and interest data shows a significant disconnect between theory and practices. Furthermore, econometrics backed literature also depicts the ineffectiveness of monetary policy in addressing Nigeria’s inflation.

What are scientific literature saying

A study on the “Effects of Monetary Policy on Inflation In Nigeria” was undertaken by Nuhu Musa and Odiba David Amuta.

  • According to the report, a higher interest rate will raise inflation in the Nigerian economy, worsening the situation. “The findings indicated that interest rate and exchange rate exerted a positive and significant effect on inflation in Nigeria both in the short run and long run. However, the monetary policy rate was not significant in influencing inflation rate in the long-run but was found to be significant in the short-run” the study said.
  • The study added that MPR was not an effective tool in handling inflation.“It was therefore concluded that while interest rate and exchange rate are potent tools of controlling inflation, the monetary policy rate is not very effective in controlling inflationary pressure in Nigeria.”
  • This narrative is further supported by IB Iya and U Aminu’s 2014 analysis, which has gotten approximately 33 citations. The study, titled “An empirical investigation of the causes of inflation in Nigeria,” concluded that raising interest rates did not affect lowering inflation. The study revealed that “The OLS results revealed that money supply and interest rate influenced inflation positively, while government expenditure and exchange rate influenced inflation negatively.”
  • The study added, “Therefore, a good performance of the economy in terms of price stability may be achieved by reducing the money supply and interest rate and also increasing government expenditure and exchange rate in the country.”

Instead of raising interest rates to combat inflation, the report suggests that the apex bank cuts the benchmark rate and money supply. “A major policy implication of this study is that concerted effort should be made by policymakers to stabilize prices (inflation) by reducing the money supply and interest rate as well as increasing government expenditure and exchange rate; most importantly increasing exchange rate and reducing interest rate.”

What experts are saying

Dr Muda Yusuf, Founder/CEO of the Centre for the Promotion of Private Enterprise (CPPE) gave his insight on why the CBN interest rate hike would not have the desired effect on inflation.

  • He said “The hike in MPR by 150 basis points to 13% by the MPC is therefore understandable.  But whether this would significantly impact inflation is a different matter. Already, bank lending has been constrained by the high CRR [many operators in the sector claim that effective CRR is as high as 50% or more for many banks], the discretionary debts by the apex bank, the 65% Loan to Deposit Ratio [LDR] and liquidity ratio of 30%. The lending situation in the economy is already very tight.
  • He argued that the monetary policy rate’s ineffectiveness in containing inflation was related to the Nigerian economy’s structure and the presence of the informal economy. He said, “The Nigerian economy is not a credit-driven economy, unlike what obtains in many advanced economies which have much higher levels of financial inclusion, robust consumer credit framework and strong correlation between interest rate and aggregate demand.“

He added that “the level of financial inclusion in the Nigerian economy is still quite low, access to credit by households and MSMEs is still very challenging, and the informal sector accounts for close to 50% of the economy.

Dr Omobola Adu, a Research Analyst at GDL stated that the best-case scenario of MPC’s decision to hike interest rates could have a marginal effect in bringing inflation down.

  • He said “The reason is because Nigeria’s inflation is largely driven by structural factors that are beyond the impact of interest rates. However, it would not be surprising if we see less pressure on monthly inflation rate on account of investors taking advantage of new rates. In the last auction, rates on T-Bills increased, and investors could be prompted to invest more, thereby reducing money in circulation.”
  • He also stated that the CBN rate hike was too fast and recommended a gradual uptick. He said “the CBN has done the best it can do in increasing rates to curb inflation. However, it could have been more effective if it was a gradual increase, rather than a one-off 150bps hike the market did not expect. Outside this, the FG needs to work to make the business environment more comfortable. Existing challenges around energy prices and insecurity are major drivers of inflation that CBN cannot control.”

Dr. Godwin Osuma, a researcher and lecturer in the department of Finance, Covenant University also added to the notion that the interest rate isn’t an effective tool.

  • He said, “The Central Bank of Nigeria recently increased the benchmark interest rate to 13% to curb the current inflationary rate in the economy, but the question remains if this interest hike would be effective. I do not think the interest rate hike would lead to the CBN’s desired effect of reducing inflation because the prices in Nigeria are supply-driven and the disruptions in supply create artificial scarcity.”
  • He also advised that economic policy should be tailored to the Nigerian economic environment. He said, “The Nigerian economy shouldn’t treat its financial environment as those of other climes, the Stability of other macroeconomic variables needs to be considered in Nigeria, how can interest rates be increased when unemployment is still on the increase?”

The recent inflation rate of 16.82% increased the pressure on the CBN to take a hawkish posture. It is possible that the central bank is following the global trend of rate hikes as seen in countries like the United States, South Africa, Ghana, and other emerging market countries that have recently raised interest rates.

However, economic scholars and experts believe that the interest rate is inefficient in resolving inflationary concerns, particularly given Nigeria’s supply-driven inflation, import dependency, and massive informal sector.

Therefore, it is paramount that the apex bank pursues a more targeted approach to root out inflation, such as strengthening the value of the Naira, reducing supply bottlenecks, and pushing for financial inclusion.

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