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High Cost Of Borrowing: Who Is Fooling Who?

interest rates
Posted: Nov 30, 2016 at 6:00 pm   /   by   /   comments (0)

BY HENRY BOYO

Question: Why do manufacturers decry high cost of borrowing?
Ans: There is a limit to which you can grow a business with personal savings; invariably, sustained growth and expansion require additional capital, which may be subscribed or borrowed. It is less risky, for example, to borrow, if loanable funds come with cheaper rates below 5%, especially where gestation is necessarily extended; besides, easier access to cheap funds generally stimulates businesses to create more job opportunities. Furthermore, material inputs, similarly financed with low interest loans, will also reduce production cost, and sustain consumer demand with affordable prices.
Conversely, when loanable funds cost 30% plus, as is currently the case, investors will naturally shy away from the risky gamble of providing their own infrastructure and paying N30 interest on every N100 borrowed. The investment climate, and productive sector will shrink, and imported products financed with much lower cost will flood our markets. Ultimately, massive labour layoffs will result, as once viable industries close shop.
Question: CBN has been widely blamed for sustaining high interest rates, how does CBN enforce such rates?
Ans: The CBN has statutory responsibility to ensure that prices of goods and services, as well as cost of funds remain within levels that would successfully drive the economy. So yes, by its actions and policies, CBN has the capacity to induce higher or lower cost of funds. The Monetary Policy Rate (MPR) is the prime instrument for this purpose, as it is the rate at which commercial banks borrow from CBN to cover temporary cash shortfalls. Thus, with MPR at 14%, banks are inclined to lend to customers, including real sector operators, at well over 20%. Conversely, in successful economies where MPR is 2% or below, banks would be encouraged to lend to customers at below 10%.
Question: So, why is CBN sabotaging the economy with high MPRs?
Ans: A low MPR should expectedly stimulate borrowing and consumer spending which would be welcome if the annual inflation rate is sustained, below say, 2%. Conversely, if inflation spirals closer to 20%, stimulating additional spending with easy access to cheap funds will invariably instigate general price volatility. Consequently, with the prevailing high inflation rates, any additional cash injection or easier access to cheap funds may ultimately induce the Zimbabwe experience, where spiralling inflation and unarrested excess printing of Zimbabwe currency compelled an inflation rate that drove the exchange rate to over $1= 1,000,000,000 Zimbabwe dollars.
Question: But some experts have advised that the best antidote to our comatose economy is to spend our way out of the recession?
Ans: Such experts are obviously either wickedly mischievous or regrettably ignorant. Evidently, additional injection of Naira liquidity, where, much too much money already outstrips production output, will spike inflation through the roof, to create serious challenges to productivity, talk less of economic resuscitation. President Buhari will be well advised to be wary of experts who advocate increase in spending as the way out of the current recession.
Question: Are you suggesting that the series of CBN cash interventions and billions of Naira government bailout funds are actually counterproductive?
Ans: Well, the answer is evident; so far, these serial interventions have not arrested the inflation spiral, and it is most certain that future interventions will only worsen matters so long as the undeniable presence of ‘Surplus Naira Liquidity’ continues to be a nightmare for CBN to manage.
Question: How can surplus Naira be a problem, when manufacturers are literally howling that they are institutionally denied access to cheap funds; besides, why should any commodity with a market surplus, become more expensive to borrow?
Ans: The naked evidence of the distortional and oppressive burden of Excess Naira is when CBN regularly pays up to 15% interest rates to restrain private borrowers from easy access to the Excess funds, in order to curtail liberal spending and thereby keep inflation from spiralling out of control and wrecking the economy. Incidentally, commercial banks, primarily, will earn over N500bn this year as interest charges when CBN borrows surplus Naira supply to mop up excess liquidity, by selling Treasury bills to banks with very high yields.
So, inexplicably, the cost of Naira loans will paradoxically become higher when systemic surplus Naira liquidity remains CBN’s albatross.
Question: With such bountiful easy returns from CBN’s Treasury bills, why would commercial banks lend to the real sector; besides, what is the prime cause of excess Naira supply that persistently challenges a more responsible economic management?
Ans: You are absolutely right; it is highly unlikely that banks will service the real sector with cheaper funds, when government itself is borrowing from them at such ridiculously high and oppressive interest rates; it is certainly less risky to lend to government than the real sector. Perennial Excess Naira supply is the cumulative product of CBN’s regular creations of substituted Naira allocations for distributable dollar denominated oil revenue. Thus, as dollar earnings increase, the greater also has been the threat from excess Naira supply and its train of regressive consequences.
Question: Is the Naira exchange rate also a victim of Excess Naira supply?
Ans: Yes of course, Excess Naira supply is the prime cause of a weak Naira, because the Naira exchange rate remains threatened so long as CBN persists in regularly auctioning small rations of dollars in a money market that is, undeniably, embarrassingly suffocated with Naira surplus. Regrettably, the process of reducing the surplus Naira burden from the system attracts a distortionally high interest burden and also crowds out the real sector from access to cheap funds.
Question: Is there a more progressive way of dealing with the Excess Liquidity problem?
Ans: There are two plausible obvious strategies which can work together to reverse the distress in our economy.
First of all, the mandatory Cash Reserve Requirement (CRR) for banks must be gradually modulated to an equilibrium level that would eliminate the need for CBN to compulsively borrow to remove excess Naira supply from the custody of commercial banks. CBN will cease to borrow at such equilibrium level, so that banks will ultimately have no choice but to enthusiastically court the real sector with modest interest rates, if they must stay in business. Alternatively, banks can be directed to pay a token fee below 2% for CBN to warehouse their surplus funds, as is currently the practice in successful economies.
Secondly, the CBN should cease replenishing the pool of systemic excess liquidity by persistently substituting Naira allocations for distributable dollar income to the constitutional beneficiaries of the federation pool.

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