You are hereby directed to cut interest rates. Really?

By Rafiq Raji, PhD

Unrepentant beggars?
Nigerian authorities are set to launch a US$1 billion Eurobond, could be by late September or October though. Just last week, the country’s vice president, Yemi Osinbajo, announced capital spending of over US$300 million, to be deployed as early as this week. The plan: spend, irrespective of the source, until the economy recovers. Good news is; the government would probably get the funds it needs. But at what price? Foreign financiers and multilateral institutions have been impressed by the authorities’ adoption of a treasury single account (TSA) and the free-floating of the naira (such as it is). Market participants, initially sceptical, have begun to come around. Even so, there are still worries. Would the reforms be sustained? These concerns are not unfounded. Last week, Nasir El-Rufai – an influential member of the inner circle of Nigeria’s president, Muhammadu Buhari, and governor of a state bordering the capital territory – hinted that the central bank’s independence may be attacked yet again. This time, it could be ‘directed’ to cut interest rates. So to speak. His desire is for a law to be enacted giving the executive branch the legal power to do so. Mr El-Rufai’s comments coincide with recent action by Kenyan lawmakers, who passed a law capping interest rates. Regardless, talk like this riles foreign investors. Not that it surprises them anymore. And since African sovereigns are increasingly reliant on foreign capital, unwise though that is, external investors’ views matter. Add to that: they are now not shy of punishing erring ones; Ghana lately.

Populist policies often fail
In late July, the Kenyan parliament passed a revised banking law that included a cap on interest rates, effectively setting the maximum price for a commercial loan by fiat. Banks would be required to cap interest rates at 4 percentage points above the Central Bank of Kenya’s (CBK) benchmark rate, currently 10.5 percent. At no more than 14.5 percent, banks would still make a decent profit. Smart people that they are, the bankers didn’t put up a fight. And really, why should they? You want to set the price for another person’s money? “We go see now,” to use a popular passive-aggressive Nigerian expression of defiance. They signed a memorandum of understanding with the CBK, pledging to cut interest rates. The lawmakers are not fooled. They have threatened to approve the law if the country’s president, Uhuru Kenyatta, witholds his assent. It is probably just political grandstanding: Mr Kenyatta’s handwriting is all over the law. It is a key campaign promise of his, one he would be all too eager to show-off to voters ahead of a likely keenly contested presidential election in 2017. I’ll be frank. The policy would probably fail. In Kenya. In Nigeria. And anywhere else. True, bankers are some of the meanest people you can find. Even so, the way to get them to reduce interest rates is not to force them but to create the type of environment that makes them want to.

Leave them with little choice, tap into their greed
Block the means for banks to deploy as much funds as they currently do to government securities. True, the government needs to borrow money. But it has to make a choice, strike a balance at least. It could make the cost to banks for not lending to small and medium-sized enterprises (SMEs) very high. For instance, the Central Bank of Nigeria (CBN) could boost the capital and capacity of the Bank of Industry (BoI) by increasing its stake; to the point where if any viable SME needed a loan, it could get one. When lending to businesses – SMEs especially – becomes the only viable way for commercial banks to make money, and BoI (just one of quite a few government-backed banks: the Nigerian Export-Import Bank is another) proves to be a strong player in the field, they are going to try having the field to themselves, and rates may gradually fall; albeit likely over a long-term horizon. In any case, some of that already happens, competition that is, on the liabilities side. When bankers are looking for deposits, you would be amazed at the concessions relationship managers and salespeople are willing to offer. What needs to be done is for that type of competition to happen on the asset (lending) side.

The CBN is probably now the wiser. Last week or so, it barred banks and other financial institutions from accessing its discount lending window on the same days they settle treasury bills and other government securities, that is in addition to an earlier directive denying dealers access to the interbank market on auction days to trade foreign exchange. That is a good first step. It shouldn’t stop there. It should apply similar creativity towards encouraging them to lend to the real economy. That first, before worrying about cheaper loans.

Even so, that is, if banks eventually do that which is wished, it may not necessarily lead to a fall in interest rates. Bank loans have to be priced above the inflation rate to be profitable. So yes, the inflation rate would continue to be a floor irrespective of the monetary policy rate (MPR). To ensure policy credibility, the CBN has little choice but to take this into account. Despite this, there is quite a bit that the CBN could still do: discouraging cartel behaviour for instance – banks could decide informally on a floor up and above that which would be considered reasonable. A vigilant CBN could check that. Cheaper loans may still be a pipe dream regardless: the structural issues, if not fixed, will continue to be in the way. Costs from those expensive back-up generators and information technology servers (to mention a few) have to be recouped somewhere. That last bit is not greed. It is simply common sense.

Also published in my BusinessDay Nigeria back-page newspaper column (Tuesdays). See link viz. http://businessdayonline.com/you-are-hereby-directed-to-cut-interest-rates-really/

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