Home Column Low interest rate or high inflation: Which is better for the economy?

Low interest rate or high inflation: Which is better for the economy?

by Business News Report

NigeriaEconomics is a science of choice. Decision making involves making a choice. Among competing wants, preference has to be put on scale and selection made on the best alternative. Every being on earth makes economic decisions. House wives in particular make several choices based on available resources. It is the same at national levels. Nations make choices just as individuals do. One of the choices nation makes is between inflation rate and unemployment – the two side of a coin. Unemployment arises when resources available to a nation are not fully employed. In classical economics, at full employment, those willing to work are fully engaged.

This is not the case with Nigeria of today. Both human and natural resources available are not fully employed. With the resources available to government, head or tail, it has to make a choice. In Nigeria today, there is massive unemployment, which requires extra-ordinary economic action to get many youths to work. The extra-ordinary action needed is massive investment to create job opportunity. The government does not have the resources to do so for now and in the near future, it will not be in position to do so.

It is the private sector that holds the key, but as it stands, the sector is perennially deprived of access to funding that would enable companies to expand as well as set up new businesses.

Interest rates have become very high and it will amount to suicide to take bank loan to start a business in Nigeria. As of today, interest rate stands between 16-30 percent. High interest rate is a reflection of the cost of funds in the country. For those into agriculture, it is almost impossible for them to survive with such high rate of interest. Basically, the source of fund is a big issue arising from the tight monetary policy of the CBN.  The channel of fund is also very short because you cannot get long term loan in Nigeria. The longest you can have is may be six months or one year.

For real sector investments or production investments, longer term loans are needed. Let’s say five years, ten years and preferably at single digit that is the way nations encourage entrepreneurial development.  Without access to long term loans at an affordable interest rate, the real sector cannot grow, but Nigeria needs to grow the real sector to transform the economy, which at the moment is not a productive one. Today, the economy thrives on trading or what economist described as rent-seeking activities of middle men acting as brokers, commissionaires that make easy money through acting as agent to foreign companies. They just fly to China, bring in some consumer goods, pay customs and get it into the market, make money and off they go.

Banks’ high cost of operation and short term deposit of 90 days tenure has also been blamed for the high interest rates in the country. The irony of it all is that the structure of investment in Nigeria today is positively skewed toward foreign investors such that they are taking better advantage of the market than home based investors. It is a situation where Nigerian investors have been turned to spectators in their economy because other investors from other parts of the world come with very cheap funds as many of their home governments are encouraging them to invest and sell products in other countries. As part of incentives, they even get grants to embark on such investment.

But in recent times, the organised private sector has said that the tight monetary policy pursued by the CBN is responsible for high interest rate. The apex bank has retained its monetary policy rate at 12 percent for about nine months now. The CBN in its pursuit of single digit inflation rate policy and a stable exchange rate has continued to ensure that money in circulation meets with available goods and services so that there will be no too much money pursuing too few goods and services.    
While reviewing the economy in the first five months of the year, CBN Governor, Sanusi Lamido Sanusi, said that headline inflation increased from 8.6 percent in March to 9.1 percent in April. Sanusi said the inflation rate still remained within the target range for the fourth consecutive month. He said food inflation was 10 percent year-on-year in April compared with 9.5 percent in March, while core inflation declined further to 6.9 percent from 7.2 percent in March.

He noted that the inflation outlook remained relatively stable and attributed the feat to a combination of a base effect and the success of tight monetary policy. He said that the high level of spending on military operations might increase the rate of inflation, “even though inflation is projected to remain at single digit in the next six months.’’ The governor said most sectors of the economy showed improved performance in the first quarter when compared with what was recorded in the first quarter of 2012.

If the CBN has succeeded largely in curtailing inflation to a manageable level, interest rates should be declining. The apex bank is not steering the money market toward a decline in interest rates, rather it continued to maintain the status quo. Many businesses suffered the increasing difficulty of access to credit and high cost of fund. Rates are between 16-28 percent. This gives clear advantage to offshore investors, high cost of government borrowing as reflected in the yield on treasury bills and Federal Government bonds worsened the credit crisis through the crowding out effects on the private sector and erosion of liquidity in the banks.

If this government is serious about its transformation agenda, the point to start would be access to long term funding and single digit interest rate to entrepreneurs. However, will Nigeria business owners prefer high inflation and exchange rate to lower interest rate? At what point is the needed trade off between interest rate, unemployment and inflation?  Can the government, CBN and organised private sector work this out? It will be better for the economy.

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