The Central Bank of Nigeria (CBN) has recently raised its benchmark interest rate to an unprecedented 26.25% from 24.75%.
This move is aimed squarely at tackling the country’s skyrocketing inflation rate, which stood at a worrying 33.69% in April.
In this explainer, we’ll dive into what these numbers mean for everyday Nigerians and the economy at large.
Why Did the CBN Hike Interest Rates?
The primary reason behind this significant increase in interest rates by the CBN is to combat inflation. Inflation represents the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.
By hiking the interest rates, the CBN hopes to make borrowing more expensive. This should theoretically reduce spending and slow down inflation.
The Impact of High Interest Rates
While raising interest rates might sound like a straightforward solution, its effects can be felt across various sectors of the economy.
For starters, when borrowing becomes more expensive, businesses may cut down on investment since loans cost more.
This can lead to slower economic growth and potentially higher unemployment if businesses decide to scale down operations.
For the average consumer, high interest rates mean higher costs to finance loans for homes, cars, and other purchases.
This can lead to reduced consumer spending, which while helpful in controlling inflation, can also dampen economic growth.
ALSO READ: CBN’s Approved List of Deposit Money Banks & Financial Institutions
Positive Real Rates: A Double-Edged Sword
A key concept to understand in this scenario is the idea of ‘positive real rates.’ This occurs when the interest rates earned on investments exceed the rate of inflation.
For instance, with an interest rate of 26.25% and an inflation rate of 33.69%, Nigeria currently has negative real rates. This scenario can discourage investors from keeping their assets in Naira, as the inflation erodes the value of their returns.
Structural Challenges Remain
While high interest rates might help temper inflation to some extent, they don’t address the root causes. Nigeria’s inflation is not just driven by high demand but also by significant structural issues such as increased production costs and supply chain disruptions.
These factors contribute to the high cost of doing business, influencing the prices of goods and services upward.
To genuinely tackle inflation, Nigeria needs more than just monetary policy adjustments. Structural reforms are crucial. These include enhancing agricultural productivity, improving infrastructure, and reducing bureaucratic bottlenecks that raise business costs. Such reforms would help stabilise prices more sustainably than merely adjusting monetary policies.
A Holistic Approach Is Needed
While raising interest rates is a tool to combat inflation, without addressing the underlying structural issues, the battle against inflation may be prolonged and painful for the common citizen.
Although CBN’s move aims to stabilise the economy and protect the value of the Naira, a holistic approach that combines both monetary and structural reforms is essential.
This will ensure that the fight against inflation is not just effective but also conducive to long-term economic stability and growth.
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