Nigeria finds itself in a familiar predicament reminiscent of 2016 as it navigates the delicate balance between lowering interest rates to spur economic growth and raising them to attract foreign investments crucial for supporting its currency reform efforts.
President Bola Tinubu is determined to reduce interest rates, which he believes are excessively high and detrimental to businesses. However, international investors argue that the rates on Nigerian bonds would need to double, at the very least, to entice the influx of foreign capital required to invigorate the newly liberalized official foreign exchange market.
During the most recent auction conducted by the Central Bank of Nigeria (CBN), one-year Treasury Bills were sold at a yield of 8.2 percent. This rate stands at less than half the May inflation rate of 22.4 percent. Furthermore, it falls below the monetary policy rate of 18.5 percent.
Nigeria has deliberately maintained artificially low interest rates on its local bonds for years to manage the escalating borrowing costs of the government. However, raising interest rates now poses a considerable challenge, particularly since debt service expenses amounted to a staggering 96 percent last year, according to World Bank data.
Consequently, the Nigerian government disbursed N96 for every N100 earned toward repaying creditors in 2022, thereby risking an even greater expenditure if interest rates were to increase. Nonetheless, Nigeria faces the precarious situation of potentially alienating foreign investors by persisting with artificially low rates.
Foreign investors contend that the negative real returns resulting from interest rates below the inflation rate discourage the inflow of new dollars. Moreover, this negative return reduces the competitiveness of Nigerian assets in the competition for foreign capital among emerging markets. Abrdn Investments Ltd, based in London, stated that rates would need to rise to between 15 and 20 percent to prompt the repatriation of their funds.
This predicament bears striking similarities to the choice Nigeria confronted in 2016 when it had to decide between lowering interest rates to stimulate an economy in recession or raising rates to attract foreign portfolio investors. The CBN ultimately chose the latter, leading to a significant spike in interest rates, with the one-year Treasury Bill reaching as high as 18 percent.
Yemi Kale, chief economist at KPMG Nigeria, believes that foreign investors are requesting excessively high real returns on investments before returning in substantial numbers. Kale questioned the necessity for rates above inflation when investors could bring in foreign exchange at a 5 percent interest rate, experience inflation in their own country, and earn an 11 percent interest rate on investments in Nigeria while repatriating their capital with minimal depreciation.
According to Kale, it is the local investors who bear the brunt of the inflation rate, rather than foreign investors.
To attract foreign investors in 2016, Nigeria pursued a strategy of high interest rates, selling Open Market Operation (OMO) bills to international investors at attractive rates. This approach reached its peak in 2018, with the CBN incurring nearly N2 trillion in interest payments after selling approximately N22 trillion worth of OMO bills. This figure was twice the value sold in 2017 and more than three times the value sold in 2016, as per data from the CBN's 2018 financial statement.
The stock of the CBN's OMO bills grew substantially, reaching $55 billion by the end of the year, with average yields ranging between 12.2 and 15.3 percent, and approximately one-third of the holdings being owned by foreigners.
