CBN’s big rate hike hasn’t helped the naira just yet. Here’s why

After months of waiting, the Central Bank of Nigeria on Tuesday delivered what Bloomberg termed as a “jumbo rate hike” in its boldest move yet under new governor Yemi Cardoso to tame Nigeria’s consumer price crisis. But the naira has yet to respond positively to the move.

A nearly three-decade high inflation, at 29.9 percent, has battered the naira and punished Nigerians whose incomes and savings have been eroded, leaving millions struggling to buy food and other necessities.

The price of a staple food like plantain rose 130 percent in the last year while rice, popular in the country, soared 99 percent to an average of N77,000. Meanwhile, the minimum wage remains at N30,000, an amount some state governors have refused to pay.

To keep with popular but contested economic theory that inflation occurs when too much money chases few goods, the central moved to cut back money supply. The most common monetary policy is to increase interest rate, squeezing borrowing by individuals and businesses from banks. With fewer naira notes in circulation, the value of the currency should rise.

Also, higher rates should attract foreign investors to convert their dollars to naira, and invest in Nigerian assets for high returns. More dollars seeking the naira should also strengthen the local currency.

So, as was widely expected, the CBN delivered a huge rate hike on Tuesday, by hiking rates from 18.75 percent to 22.75 percent, beating analysts’ prediction of 21 percent.

Ignoring the hike

But the exchange rate ignored the supersized rate increase. By the close of trading Tuesday, the naira weakened 2.1 percent to 1,615.94 per dollar in the official NAFEM window. It was the lowest the currency traded against the dollar officially.

The currency closed at 1609.51 on Wednesday, a slight improvement for a currency that stood at about 464 last June before the new government of President Bola Tinubu devalued the naira by floating it.

Foreign scramble for Nigeria’s dollar-denominated debt, the eurobonds, did not also happen – at least not yet. The All-Share Index, which measures the performance of the Nigerian stocks, also fell around 1.31 percent to 100,582.89 points, the lowest in a month.

Why has the hike not attracted investors?

So why is the response not as expected? First, it may be too early to expect high returns. Second, analysts believe that years of policy uncertainty has eroded investor confidence.

More importantly, Nigeria’s inflation remains much higher than the current interest rates at 29.9 percent in January.

Therefore, even with the big rate hike, buying a Nigerian asset at an interest rate of 22.75 percent (that is if the whole rate is paid) brings a negative real return considering the inflation figure. The negative spread would be sits at 7.25 percent.

On the other hand, if an investor bought a United States asset instead, they would have a positive real return of 2.4 percent as U.S. inflation stands at 3.1% and the official interest rate at 5.50 percent.

A previously underestimated problem is the widespread use of the dollar for transactions by many companies and individuals in Nigeria in a bid to hedge against naira’s volatility. Many Nigerians now save in dollars, thereby exacerbating the dollar shortage.

“Simply raising rates in Nigeria will not resolve this shortage,” Crispus Nyaga of the investment information platform, Invezz, said.

How to proceed?

To fix the problem, the central bank and the government must still address the fundamental issue of attracting more dollars by exporting more and importing less.

The CBN has indicated it is ready to increase the rates again even at the expense of economic growth. That raises the promise of narrowing the negative yield on Nigerian asset which should succeed in attracting investors.

“There is still lots to do apart from tightening naira liquidity,” Samantha Singh-Jami, Africa strategist at Rand Merchant Bank, told Bloomberg. The bank needs to deal “with the FX backlog, and boosting FX liquidity is key.”