The Central Bank of Nigeria tightened its monetary policy rate to 14% annually in an effort to curb headline inflation which had risen to 16.5%. This rate hike aimed to increase dollar inflows to support the foreign exchange market, reduce external reserve depletion, boost national savings, and reduce regulatory arbitrage between banks and the CBN. In the short term, the higher interest rates were expected to lead to appreciation of the naira exchange rate against the dollar in both the interbank and parallel markets. However, inflation in Nigeria has largely been driven by supply shocks which may not respond to interest rate adjustments. The higher borrowing costs could also increase corporate failures, non-performing loans, and government debt service costs, inflicting

1. MPC TIGHTENS TO 14% P.A.
BETWEEN A ROCK AND A HARD PLACE

2. Rate hike a tactical response to:
Curb the persistent rise in Headline Inflation to 16.5%
Increase dollar inflow into the forex market
Reduce external reserve depletion
Increase national savings
Reduce regulatory arbitrage between banks and the CBN

3. Reduce demand for dollars at the interbank
Naira appreciated to N376/$ from N378/$
Naira already in the REER, 20 year fair value N315 – N320
Will lead to short term naira appreciation
Benefits of move
Reduce cost of imported raw materials and finished goods

4. Benefits of move
Source: Renaissance Capital, Bloomberg

6. Inflation in Nigeria (Supply Shocks)
Dec'15 Jan'16 Feb'16 Mar'16 Apr'16 May'16 June'16
9.60% 9.60%
11.40%
12.80%
13.70%
15.60% 16.50%
 Inflation resulting from supply shocks
 May not respond to interest rate hikes
 Rate hikes good for money supply induced inflation

7. Disadvantages – Limited policy options and hard choices
Higher cost of borrowing a peril to SME’s
Increase corporate failure and bankruptcies
Higher non-performing loans (NPL) 11% – 15%
A spike in government debt service approx. N1trn
No matter the decision, more pain before gain

8. Sub-Saharan Africa Perspective
Nigeria Angola Ghana
16.5%
31.8%
18.4%
14%
16%
26%
-0.4%
4.1%
4.90%
Inflation
Interest Rate
GDP
Nigeria negative
growth

9. Outlook
Naira will appreciate and stabilize in the interbank to N300/$ - N305/$
BDC rates will appreciate to N370/$
Gains will depend on oil production
Market transparency and liquidity
Tactical moves do not solve structural problems
Only consistency, time and patience will do