Why has the Central Bank of Nigeria (CBN) kept interest rates in single digits over the last three years, even as rising domestic prices continue to challenge the narrative of transitory drivers of inflation?
Look no further than the federal government's domestic debt. This closed June 2021 at US$53.10bn (or ₦21.75trn). It is a little over 11% of the UD$475.06bn estimated size of the economy in 2019 (at the official exchange rate). But it is 300+ times more than the N5.84trn that the federal government expects to earn as gross revenue this year. The latter ratio is scarier than it looks, for a simple reason. What matters is not so much the size of our sovereign debt. But how much it costs to service it. And this is not just a revenue relationship. The lower the proportion of the debt service charge to revenues over any give period, the better. But beyond this, so long as the cost of servicing the sovereign debt is lower than the economy's trend growth rate, then the debt can be borne without distressing the economy.
With the economy projected to grow by around 2.0% this year, and with retail interest rates in or near the same ballpark, one would be forgiven for thinking that all is well. Until, that is, you factor in the federal government's proposal to borrow N5.62trn with which it will plug the gaping holes in next year's budget. Do not also forget that it is reported that the country spent around 98% of its revenue in the first five months of this year just servicing its debts.
Within this context, every 1 percentage point increase in the domestic cost of borrowing (interest rates) cannot but be a burden on the federal government's thin revenue stream. Given how close to anomie the Nigerian state is, one could explain the CBN's action in keeping interest rates below inflation in terms of providing buffers for a beleaguered sovereign. Explain; but not justify. Economic decisions nearly always involve trade-offs. The same way the air squeezed out of a part of an inflated latex balloon is not eliminated, but moves elsewhere, the comforts offered by the CBN to the exchequer through its policy of fiscal repression are at the expense of the health of other parts of the economy.
Low rates hurt savers and tomorrow's pensioners in similar proportion. Large parts of the former are currently eking out a living as swingeing price rises take huge chunks out of their disposable incomes. The more well-off segments have parlayed their wealth into alternative (to liquid cash) investments (including jewellery, real estate, bitcoins, dollars, etc.) bidding up prices in some of the latter vehicles. Tomorrow's pensioners on the other hand were only recently weaned off the defined-benefits pension arrangement with which they were familiar; and moved on to a defined contribution scheme.
The new scheme invites would-be pensioners to increase their contributions to pension pots managed by pension fund administrators who will, in turn, invest the funds in a portfolio of assets that will guarantee the former liveable pensions upon retirement. In order that the PFAs do not play fast and loose with the funds under management (estimated to have grown to about US$31bn since the scheme was introduced in 2004) the law requires that they invest the larger part of the funds under their management in risk-free government securities. With the CBN keeping the rates on these instruments down, an essential part of this contract frays. Tomorrow's pensioners will surely be that much poorer.
In a qualified sense, then, the CBN's cheap money policy is a far bigger threat to the fabric of our society than we currently acknowledge. It would have been of great help if government's borrowing were improving the economy's competence. Alas, we have ample evidence that this is not the case. Yet, that is not all. The biggest consequence of cheap borrowing has been to whet government's appetite for debt. Over the 12 months to June 2021, Nigeria's public debt rose by 14.4% to N35trn. Not just has the public debt tripled over the last six years. A third of the June 2021 debt number was contracted over the last three years.
What are the implications of a potential rise in interest rates in the developed world beginning next year for the country? Generally, interest rate increases in the advanced economies do not favour heavily-indebted developed economies with weak currencies. I.e. economies like ours. Higher rates will push up our external borrowing costs. And the reallocation of investible funds to safer currencies will push the exchange rates of those currencies up relative to the naira. Alive to this possibility, central banks in countries such as Brazil's have begun hiking their benchmark rates.
Our CBN will get there someday. But not before a perfect storm robs it of all its current options.