The Ripple Effects of Elevated MPR on Business Operations & Socio-Economic Dynamics in Nigeria

The Monetary Policy Committee of the Central Bank of Nigeria, implemented an interest rate hike by increasing the rate by 200 basis points to 24.75% from 22.75%. This initiative, led by the Governor of the Central Bank of Nigeria, Olayemi Cardoso, is intended to tackle ongoing inflationary pressures and stabilize exchange rate fluctuations.

This decision ignited extensive discourse and analysis across various social media platforms, underscoring its substantial impact on Nigerian businesses, their customer base, and the economy in general.

Before forging ahead, it is imperative to explain what the Monetary Policy Rate (MPR) entails. The Monetary Policy Rate can be described as a standard interest rate established by the Central Bank of Nigeria in order to govern monetary conditions within the economy. It can also be described as the price tag placed by the Central Bank on borrowing money. The essence of this Monetary Policy Rate is to combat inflationary pressures and maintain economic stability.

The Central Bank of Nigeria also utilizes the Monetary Policy Rate to offer insight into their assessment of the economy’s performance. This Monetary Policy Rate is adjusted by the Central Bank of Nigeria to either mitigate inflationary pressures or stimulate economic expansion. When the Monetary Policy Rate is increased, borrowing becomes more expensive, which can help control inflation. On the other hand, when it is decreased, borrowing becomes cheaper and this encourages spending and growth.

History of MPR in Nigeria

The Monetary Policy Rate (MPR) was introduced by the Central Bank of Nigeria in 2006 in order to replace the Minimum Rediscounted Rate (MRR) due to the ineffectiveness of the latter. This action was taken with the aim of reducing the fluctuation of interest rates in money markets and fostering a transaction rate that would enhance the effectiveness of monetary policy actions, ultimately leading to the stabilization of the domestic currency’s value.

Monetary Policy & Inflation

Inflation can be defined as an increase in prices, which can be construed as a decline in purchasing power over time. Essentially, this means that the prices of goods and services rise. Therefore, one unit of money purchases fewer goods and services. The loss of this purchasing power inadvertently has an impact on the general cost of living which ultimately leads to a decline in economic growth.

Inflation has been defined by the Central Bank of Nigeria as a continuous rise in the price of goods and services and it has been described as when “too much money is chasing too few goods”

The major question now is, what causes inflation? There are two major causes of inflation which are: Demand-Pull and Cost-Push. These concepts will be briefly discussed below:

• Demand-pull inflation can be caused by an increase in demand for a product or service and this could either be an increase in the ability to buy a product or service or the willingness to buy such a product or service. Basically, when the demand for a particular good or service increases, the available supply decreases. Therefore, due to the availability of fewer items, consumers are willing to pay more to obtain the item. This results in higher prices due to demand-pull inflation.
• Cost-push inflation on the other hand occurs when the conditions of supply decelerate. Therefore, this happens when prices increase because the cost of production increases. As a result, the increased production costs are transferred to customers in the form of elevated prices for the final goods or services provided. The demand for these goods does not change. However, the supply decreases due to higher production costs.

Many contemporary Central Banks prioritize the inflation rate in a country as the primary metric for guiding monetary policy. Therefore, a major focus of monetary policy is to ensure price stability, which does not literally connote constant or unchanging price level, but, that the pace at which the general price level changes is such that economic agents do not express concern about it.

When prices outpace their target, Central Banks implement a tightening of monetary policy through measures such as raising interest rates or employing other hawkish strategies. The higher interest rates will make borrowing more expensive thereby hampering consumption and investment which heavily rely on credit. On the other hand, when inflation decreases and economic output diminishes, the Central Bank is inclined to reduce interest rates, thereby making borrowing more affordable, in addition to employing other potential expansionary policy instruments.

The Impact of Increased MPR

An increase in the Monetary Policy Rate may be regarded as a contractionary monetary policy. The aim of a contractionary monetary policy is to increase interest rates and restrict the amount of money in circulation to slow growth and decrease inflation. However, it is trite to note that there is no absolutism in economic theories and it is important to consider the prevailing economic conditions and other contextual factors prior to choosing a suitable economic theory, as it ensures alignment with the dynamic nature of the economy and enhances the effectiveness of policy decisions.

Although increasing the Monetary Policy Rate can assist in tackling inflationary pressures and fostering long-term economic stability, it may concurrently yield short-term adverse impacts on economic growth, investment, and consumer spending.

The Nigerian Association of Chambers of Commerce, Industry, Mines and Agriculture, and the Nigerian Association of Small Scale Industrialists characterized the interest rate hike as a decision fraught with unintended adverse effects, and asserted that the increase in the Monetary Policy Rate was an inevitable cost for businesses, considering the prevailing economic conditions. They also stated that the rise in the Monetary Policy Rate would further hinder the private sector’s access to cost-effective credit.

According to the President of the Nigerian Association of Chambers of Commerce, Industry, Mines and Agriculture (NACCIMA), Dele Oye, the increase of the interest rate bears several repercussions specifically on the private sector such as:

• An uptick in borrowing expenses, inadvertently discouraging entrepreneurial endeavors and expansion initiatives, both pivotal for fostering economic growth and generating employment opportunities.
• The transfer of expenses to consumers via elevated prices for goods and services may fuel inflation rather than alleviate it.
• The possibility of stifled economic growth based on the fact that tightened monetary conditions could trigger a decline in both investment and consumption, which are critical drivers of economic growth.

Faith Iyoha, an economist at the Nigerian Economic Summit Group stated that the frequent Monetary Policy Rate hikes are an ineffective measure for addressing the country’s inflationary challenges. This is based on the fact that a relationship between prices and productivity exists and inflation cannot be properly tackled without leaning on productivity. Additionally, she stated that this may lead to overheating of the economy and the tightening measures might prove excessive for productivity, potentially resulting in a decline in GDP.

The Director/ Chief Executive Officer of the Centre for the Promotion of Private Enterprise, Dr, Muda Yusuf, stated that the increase would limit the ability of the banks to bolster economic growth and investment. He averred that while the decision aligned with the standard policy approach of Central Banks worldwide, it overlooked unique domestic circumstances.

Does an Increase in MPR effectively Control Inflation?

Several Central Banks have utilized an elevated Monetary Policy Rate to mitigate inflation in their respective countries. Some of these countries include Brazil, Turkey, and Chile. In the 1970s and 1980s, Chile had high inflation that reached over 300%. The Central Bank of Chile successfully reduced inflation by increasing interest rates as well as implementing a monetary policy rule that linked the money supply to the pace of economic growth. In the 1990s, the Central Bank of Brazil successfully mitigated inflation by employing tight monetary policies such as the increase of interest rates. Turkey also achieved this in the early 2000s by increasing the interest rate and decreasing money supply.

While it may seem that increasing interest rates effectively combat inflation, it is important to acknowledge that the success of a monetary policy hinges greatly on the specific dynamics of a country’s economy. A crucial question to consider at this point is whether the rise in the monetary policy rate can effectively address inflation in Nigeria.

There are various reasons why the elevation of the Monetary Policy Rate may not effectively address inflation in Nigeria. Some of these reasons are highlighted below:

• The Nigerian economy is not a credit-driven economy, whereby credit plays an important role in facilitating consumption, investment and economic growth. Therefore, the Nigerian economy is not like advanced economies such as the United States, Switzerland, Australia etc. that have higher levels of financial inclusion, robust consumer credit framework, and a strong correlation between interest rate and aggregate demand.
• The inflation in Nigeria is largely supply-driven and any disruptions to that supply chain can result in artificial scarcity.
• Despite consistent tightening of monetary policy over the past two years, there has not been a significant impact on inflationary pressures in Nigeria. In fact, the overall price level has continued to rise steadily.

CONCLUSION

In order to tackle inflation in Nigeria, the Central Bank of Nigeria should not view the financial landscape through the lens of other nations; rather, it should prioritize considering the stability of additional macroeconomic variables within Nigeria. The Central Bank of Nigeria needs to adopt a more focused strategy to combat inflation such as efforts to bolster the value of the Naira, alleviate supply constraints and promote financial inclusion.

In addition, addressing forex liquidity challenges can involve implementing suitable policy measures and incentives to encourage foreign investments while also tackling structural issues such as security to enhance the productivity and competitiveness of local businesses.