The National Bureau of Statistics show the average interest rate charged by the commercial banks on a loan at 17.09% in Q3 2016 up from 16.82% in Q1 2016.
The high interest rate reflects pressures from the spiraling inflation rate to generate a real return for the banks’ investors. The 10 year high cost-push inflation rate of 18.48% in November 2016 is driven by supply constraints in the foreign exchange market that has devalued the Naira.
The rate is also driven by the high base rate and maximum interest rate set by the CBN. The recent 2016 CBN auction of 1 year T-Bills was yielding 18.5%, while the max interest rate of 24%.
Traditionally, monetary policy is the most important tool for maintaining low inflation, as central banks increase interest rates if inflation is forecast to rise. Increased interest rates will help reduce the growth of aggregate demand in the economy. The slower growth will then lead to lower inflation.
However In these cases of cost-push inflation, it is harder to reduce inflation, and it is maybe better to let the temporary inflation factors come to an end. This was shown in 2008 and 2011/12 in the UK where cost-push inflation at 5% above the 2% target range.
The reasons for the inaction of monetary policy are similar to the current economic situation present in Nigeria at the moment. It was because the inflation was driven by supply side constraints and the economy was in recession. As such any interest rate increase would reduce aggregate demand and further entrench the recession. The UK learnt their lesson during the ERM crisis when the interest rate increased to 15% to control inflation, contributed significantly to the recession.
The high interest rate creates a barrier to credit for sectors that may provide sustainable growth to the economy but are unable to meet the high cost of capital.
As noted structural supply side policy rather than monetary policy is the tool to address Nigeria’s rampant inflation and promote access to credit.
Supply side policies such as development of the manufacturing sector and deregulation would reduce costs and increase productivity, thereby reducing inflationary pressures in the long term for the Nigerian economy.