By FASHOLA OLANREWAJU & MUHAMMAD AKANJI

On May 22, 2024, the Central Bank of Nigeria (CBN) raised the monetary policy rate (MPR) for the fifth time in a year by 150 basis points, bringing it to 26.25 percent. This liquidity tightening strategy aims to combat inflation, which has surged to 33.69 percent, defend the struggling currency, and stabilise the economy. The rise in inflation is attributed to high energy costs following the removal of fuel subsidies, large fiscal deficits, renewed weakness in the naira, soaring food prices, and persistent insecurity. Analysts suggest that instead of continually tightening liquidity, the CBN and policymakers should focus on addressing the root causes of inflation. The current strategy of liquidity tightening does not appear to effectively target the primary factors driving inflation in Nigeria.

The CBN’s approach appears to mirror the global trend of significant interest rate hikes seen post-pandemic, aimed at combating price surges. Worldwide, advanced economies have raised rates by an average of 400 basis points, while emerging economies have increased them by about 650 basis points. Despite these aggressive measures and the resilience shown by various economies, core inflation remains high, suggesting that central banks may need to maintain elevated interest rates for an extended period. However, this strategy carries substantial risks, particularly the increasing difficulty for individuals and businesses to service their debts, exacerbating credit risks. Thus, the rationality of fighting inflation using the tool of a continuous monetary tightening strategy in an economy like ours still baffles many.

Business sector analysis

The consecutive interest rate hikes by the CBN have severely impacted the business landscape, especially micro, small, and medium enterprises (MSMEs). These enterprises, already struggling with high electricity costs and foreign exchange scarcity, now face increased borrowing costs. Making debts more expensive is an intended consequence of tightening monetary policy to control inflation. The fact that borrowers are already in a precarious financial situation means that the higher interest rate could amplify their fragilities.

Small business owners report reduced production capacity, lower profits, and a limited ability to expand their workforce due to the higher production costs. This has prompted calls for urgent financial intervention and single-digit interest rates to prevent the collapse of many MSMEs. Meanwhile, large corporations in Nigeria are adapting by reassessing their financial policies and operational efficiencies. Although these corporations are more financially resilient than MSMEs, they too are reviewing borrowing costs and overall financial planning in response to the ongoing interest rate hikes.

Criticism and controversies

Economists and business leaders have voiced various analyses and insights about the recent interest hikes in Nigeria. Many have opposed the rate hikes, arguing that the continuous increase in interest rates may worsen the business environment and worsen the loan repayment crisis. Experts have highlighted that raising interest rates may not effectively address the problems of inflation and could slow down economic development by making it difficult for businesses to access affordable loans for growth and operations.

Furthermore, there are raging concerns about the lack of engagement with the private sector. Business leaders have criticised the CBN for using a one-dimensional approach focused solely on increasing interest rates without addressing the structural issues driving inflation.

Elementary economics explains that inflation occurs when there is “too much money chasing too few goods.” The typical remedy is to reduce the money supply by raising interest rates and the Cash Reserve Ratio (CRR), making funds more expensive and reducing circulation. This strategy works well in the Western world, where access to consumer credit means higher interest rates directly impact spending patterns. However, in Nigeria, where consumer credit is almost nonexistent, increasing interest rates won’t significantly affect consumer spending. Instead, it will harm businesses and the productive sector, which need support to boost production and reduce costs.

“Experts have highlighted that raising interest rates may not effectively address the problems of inflation and could slow down economic development by making it difficult for businesses to access affordable loans for growth and operations.”

Hence, there is a need for a more comprehensive and holistic strategy that addresses the underlying supply-side constraints, promotes investment in infrastructure, enhances agricultural productivity, and reduces bureaucratic bottlenecks to foster sustainable economic growth and stability.

Alternative strategies

One alternative is to focus on supply-side policies that will boost production efficiency and incentivize local content in key sectors of the economy, which include investing in infrastructure, improving technology and skill transfer, increasing supply chain efficiency, and reducing bureaucratic bottlenecks that will increase the ease of doing business.

Another strategy is to implement structural reforms and soft government interventions to assist businesses, particularly MSMEs, in overcoming the high-interest rate environment, such as low-interest loans, tax incentives, or direct financial assistance to help offset the increased cost of borrowing. While this may not directly address inflation, it could help prevent the collapse of many businesses and protect jobs.

Economists have also called for the adoption of an explicit inflation-targeting framework where the CBN communicates its inflation target and the policy actions required to achieve it. This approach provides more transparency and accountability, allowing businesses and consumers to make informed decisions based on the central bank’s objectives and actions.

Ultimately, a combination of monetary policy adjustments, supply-side reforms, targeted interventions, and a clear inflation-targeting framework may be necessary to effectively address Nigeria’s inflationary challenges while supporting economic growth and stability. However, the success of these alternatives will depend on the government’s commitment to implementing comprehensive reforms and the coordination between fiscal and monetary policies.

Recommendations

To combat inflation effectively, the CBN should focus on stabilising the naira’s exchange rate, as its depreciation is a primary driver of inflation. Achieving this sustainably requires policies that boost dollar inflows, such as promoting non-oil exports and addressing inefficiencies in the oil industry. The CBN should provide more funds to exporters and encourage banks to do the same, rather than tightening liquidity, which makes it harder for exporters to access loans at reasonable rates. Increased funding for exporters would lead to higher foreign exchange inflows, stabilise the naira, and curb inflation.

Additionally, the federal government must improve national security to allow farmers to return to their fields and boost food production. Addressing the high fiscal deficit, the second major cause of inflation, is also crucial. The deficit has been exacerbated by the previous administration’s fiscal irresponsibility, which included illegally obtaining over N30 trillion in ‘Ways and Means’ advances from the CBN. The current administration’s continuation of deficit spending, as seen in this year’s inflated budget, needs urgent correction.

To combat inflation, the federal government must significantly reduce its expenditure budget to lower the deficit and cease borrowing from local banks, which crowds out the productive sector from accessing loans.

The CBN should reverse its stance on the Monetary Policy Rate (MPR) and advise the federal government to address the root causes of inflation it has identified rather than penalising the productive sector with higher interest rates due to the federal government’s fiscal mismanagement.

In conclusion, the critical analysis of the structure and dynamics of the Nigerian economy in light of the recent monetary policy changes underscores the importance of a balanced and strategic approach that considers the diverse needs and challenges faced by businesses across different sectors to ensure long-term economic strength and prosperity. (BusinessDay)

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