The man whom we all love to hate, Godwin “Meffy” Emefiele, can’t stay out of news headlines. Between his announcement that our big boy naira notes will get a facelift and the actual reveal which turned out to be not what we ordered, the interest rate also rose from 15.5% to 16.5%.
Without mincing words, that’s not great news.
What’s the interest rate and how does it work?
You know how people say, “Time is money”? The idea behind that saying is the value of money you hold today is different from the one you hold tomorrow.
To illustrate this, think of 10 or so years ago when ₦100 could buy you enough chow to fill your belly. To get that same quantity of food today, you’d have to spend at least ₦500. The quantity of food is constant, but the value of money has depreciated over time because of inflation.
Inflation is when there’s a rise in prices which can be translated as the decline of purchasing power over time because your pocket can’t catch up.
To account for this inflation, people who lend money like to charge what’s known as interest. And the biggest lenders in any economy are the banks. The grandfather of all commercial banks in Nigeria is the Central Bank of Nigeria (CBN) and it’s the one that determines the interest rate. That’s where this guy comes in.
The interest rate is the amount banks charge borrowers and is a percentage of the amount loaned. Using Nigeria’s example, with the interest rate at 16.5%, it means anyone who borrows ₦1 million from the bank will have to pay back the original ₦1 million loan plus ₦165,000 as interest at the end of the year. That means the cost of borrowing is quite high. But that’s not just what’s messed up about this.
Nigeria’s inflation rate rose to 21.09% in October 2022. This means even at the high cost of borrowing, anyone lending money will still be doing it at a loss because the inflation rate exceeds the interest rate.
Wow. But why’s the CBN raising the interest rate?
That’s a good question and the answer may surprise you. The reason the CBN is raising the interest rate is to…fight inflation. In fact, this is the fourth time in a row it has raised the interest rate, yet inflation is still doing agidi.
It’s a circular problem. The government wants to mop up excess money in circulation and has been trying various moves. It introduced the Snapchat naira notes and has been raising interest rates while confidence in the naira remains low.
One of the key reasons for the persistent inflation is our foreign exchange (forex) which is highly volatile. We already did a story explaining how the EFCC is going after bureau de change (BDC) operators who the government keeps blaming for causing the naira to depreciate in value.
Another important component of our inflation is food inflation. With the rising cost of obtaining agricultural produce particularly with floods ravaging farmlands, our situation is pretty bad.
How does this affect you?
If you’ve been following so far, you can already see how the interest rate and inflation rate are connected and how it affects the cost of food you get at the market. But it goes even beyond that.
Experts have warned that factories will likely shut down which obviously means more unemployment. There’s also what’s known as nonperforming loans (NPL), or simply bad loans. Imagine borrowing ₦10 billion and having to repay that, along with ₦1.65 billion as interest in an economy where everything is upside down. Most businesses will find it hard to repay and that just keeps domestic debts mounting. Already, the manufacturing sector is indebted to the tune of ₦5.1 trillion to Nigerian banks. So don’t expect inflation to ease off anytime soon.
What can be done?
Fixing this challenge requires attending to the fundamentals which includes the government providing more support for farmers. If they can get special interventions and exceptions from the high interest rates, they can get cheap loans that can help them with farming and producing more crops. This can address food inflation.
The CBN can also restore some confidence in the economy by easing off a bit on the interest rate. It’s clear that the continuous hike is hurting more people than it’s helping. We can only hope that whoever comes in by 2023 has a better handle on this issue.