The Central Bank of Nigeria maintained its aggressive stance in fighting inflationary pressure using its monetary tools by raising the benchmark interest rate to 17.5% during its first MPC meeting for the year 2023.
The tightening stance of the CBN is aimed at aggressively reining on the rising rate of inflation, which is already at a nearly 17-year high.
Also, the increased rate aims at bridging the wide real return gap, which had deterred the level of foreign investments in the country. This gap is essentially the difference between the interest rate you earn on an investment less the inflation rate.
However, the high-interest rate regime has a significant implication for borrowers, as it seeks to discourage more borrowing in the economy, which consequently has a contracting effect on economic growth.
Following the move by the CBN to further raise the monetary policy rate, is imperative for Nigerian investors, businesses, and particularly borrowers to understand how this affects them going forward.
It is worth noting that access to credit by the real sector, helps in stimulating growth in the economy. However, with interest rates at a 21-year high, Nigerian businesses now have to pay higher interest to service their loans.
Impact of MPR @17.5%
High interest on loans: According to data from the CBN, the maximum lending rate surged to 29.13% in December 2022 compared to 27.58% recorded in the corresponding period of 2021, following the apex banks’ aggressive interest rate hikes during the year.
- On the back of the recent rate hike, the lending rate by banks to borrowers is expected to increase further, implying more strain on Nigerian businesses and borrowers.
- Paying higher interest on loans also means that businesses face high liability to banks, which could impact business profitability.
- For personal borrowers (those with personal loans), will face much lower take-home pay as banks will charge more interest on loans which will be debited against their salaries.
- A borrower who spoke to Nairametrics indicated his monthly debt repayment has risen from about N200k monthly to N350K since the rate increase started last year.
Risk of default: In an economy where the business environment is still largely not favorable in many of the sectors, high-interest rates without corresponding increases in turnover, could push many borrowers and businesses towards a default risk.
- At a time when the uncertainties surrounding the coming election is still clouding business decision and the outlook for the economy, businesses stand the risk of defaulting on their loans if they must pay higher rates.
- Notably, companies that may not be able to immediately pass this cost to their customers might suffer a reduction in their profits.
- Individuals with personal loans may also struggle to pay back, especially if the interest rates consume a huge chunk of their salaries.
The decline in aggregate demand: Because higher interest rates mean higher borrowing costs, people will eventually start spending less.
- The demand for goods and services will then drop, which will cause inflation to fall, however, to the detriment of the economy.
- Businesses will respond by producing or stocking up fewer goods which means there could be job cuts along the way.
- The potential effect will be on the country’s GDP which could be hit by a decline in aggregate demand.
What a borrower should be doing
A high-interest rate environment is not always good for borrowing especially when your income is not rising in tandem. This is what we would do if we were indebted to any bank.
If we have cash? The decision will be to pay down the loans immediately as there is no point in incurring a high-interest expense when you have the money to pay it off. It is pennywise pound foolish.
If I don’t have cash? We suggest you meet up with your bank first and explore restructuring the loans. This will involve a lot of relationship management targeted at restructuring the loans. Your target will be to get the bank to stretch the loan tenor such that the cash flow payment is compatible with your income.
If I want to borrow now? We will suggest deferring any new borrowing until the interest rate environment cools. Of course, this also depends on the opportunity cost dynamics of what you need the money for. If it is a bridge to buy time before raising equity then it might make sense. But you have to be sure you can refinance the debt.
Opportunity cost? If the current investment that you utilized the loan gives you a return on investment that is higher than the interest on the loan, then you are better off keeping the loan. Otherwise, repay the loan.
Leave a Reply