By Babajide Komolafe
Every good or service has a price. So also is the service of lending money to others, a service which is critical to the survival and growth of businesses, households and individuals. The price of this service is called interest rate.
Like every price, interest rate is determined by the law of demand and supply of the commodity, which in this case is money. In the economy, the level of interest rate is chiefly determined by the amount of money or funds available for lending and borrowing.
On the supply side are businesses, households and individuals that save. On the demand side are the individuals, households businesses, including government that borrow either to augment income or invest in income generating projects.
Between these groups are the banks and other financial institutions that mobilises savings in the form of deposits and investment products and lend the funds mobilised to those who want to borrow.
As in the determination of other prices, those who supply the funds, the savers desire and demand for high interest rates, while those who borrow desire low interest rate. Meanwhile the banks also want to ensure that the lending interest rate covers the cost incurred for their operations, and adequate profit for their shareholders.
If the interest rate is too low, especially lower than the rate at which prices of goods and services are increasing (inflation), it would discourage people from saving, and it can make them to take their money out of the country to where the interest rate is high. But if the interest rate is too high, a lot of households and businesses would find it unprofitable to borrow or pass the high interest rate to consumers of their products.
Also, where the nature of the funds available for lending are short term, that is below one year, businesses would not be able to borrow to fund projects that have long gestation period. In this situation, the manufacturing sector and the agricultural sector would be at disadvantaged while the services sector would be at advantage. And that is the case in Nigeria, where 80 per cent of bank deposits are for tenures below one year.
In every country, the role of ensuring that the interest rate is not too low to discourage savings or too high to discourage borrowing for activities that indirectly increase investments and employment is entrusted to the central bank.
The primary objective of central banks is price stability or stable prices of goods and services. This they do by regulating the money supply in the economy. If the money is too much it can cause a situation where too much money chases few goods, and hence cause prices to rise persistently leading to inflation.
But sometimes in an attempt to ensure this does not happen the central bank introduces measures that reduce volume of money in supply, and this indirectly reduces money available for lending and thus increased the price of money, which is interest rate.
Consequently, central banks, especially in developing countries, also play development roles under which they introduce measures to forestall or ameliorate the unintended impact of such concomitant high interest rates on businesses, and investment in the critical sectors of the economy, to ensure these sectors have access to loanable funds at relatively low interest rate.
In Nigeria, the Central Bank of Nigeria (CBN) have played these two roles aggressively in recent times.
It had to tighten money supply in a bid to curtail inflation. In the process, it has raised its interest rate (monetary policy rate) severally. For example, the MPR was raised six times last year from 6.5 in January to 12 per cent in December.
Also the banking crisis occasioned sharp decline in banks lending to the economy especially businesses in the real and agricultural sector.
On the other side, the CBN has played developmental roles to ameliorate the impact of its tight monetary policy and stimulate bank’s lending to the critical sectors, by creating special funds which can be accessed at relatively low interest rate. This it has done in line with its development mandate. Some of these include:
N500bn Real Sector Intervention Fund
The CBN established the N500 billion Real Sector Intervention Fund, comprising N300 billion Power and Airline Intervention Fund (PAIF) and N200 billion Refinancing and Restructuring Facility (RRF)for Small and Medium Enterprises (SME).
The PAIF was for lending to fund investment in the power sector to enhance on-going power sector reforms and to the aviation sector to revive ailing airlines. The RRF was to help refinance or restructure bank loans to SME and manufacturers that have gone bad.
The interest rate for lending under the scheme is 7.5 per cent. Under the PAIF, the CBN had released N120 billion for on-lending to 23 projects out of which N106 billion has been disbursed to 13 projects. N82 billion was disbursed to ten airlines while N23 billion was to three power projects.
Under the RRF, N191 billion has been disbursed to 539 beneficiary companies. This has enabled SME/manufacturing companies that have closed down to reopen and thus restore jobs that had been lost.
Commercial Agricultural Credit Scheme (CACS)
Also, the CBN, in collaboration with the Ministry of Agriculture and Water Resources, established the N200 billion Commercial Agricultural Credit Scheme (CACS) to enhance lending to agricultural sector to finance value chains from input to marketing.
Among other things the scheme was designed to reduce cost of borrowing (interest rate) in agricultural production so that farmers can exploit more untapped potentials of the nation’s agricultural sector. It is also aimed at boosting output, generate employment and diversify the nation’s export base.
Since inception in 2009, the CBN has released the sum of N151.015 billion for disbursement to 190 beneficiaries made up of 163 private promoters and 27 State Governments that accessed N1.0 billion each (apart from FCT which accessed N16.0 million only).
The analysis of number of projects financed under CACS by value chain showed that out of the 163 CACS private sector sponsored projects, production accounted for 44% and dominated the activities funded while processing accounted for 41.1%.
These activities were distantly followed by marketing and storage which registered 8% and 6.75% respectively. With regards to the value of funds released, processing accounted for 55.6% followed by production which accounted for 29.1% of the value of enterprises financed.
These were followed by marketing and storage which registered 10.4% and 4.9% respectively. In terms of job creation, the scheme has facilitated the creation of 20,826 new jobs; 185 skilled, 231 semi-skilled and20,412 unskilled jobs.
A key component of these initiatives is the single digit interest rate of 7.0 to 7.5 per cent interest rate for loans granted under each of them. Compared to the average interest rate of about 22 per cent charged by banks, this translates to 15 per cent interest rate discount for businesses in these critical sectors.
Without this discount, many of the businesses would have collapsed or reduced operations and production. In the process they would lay-off staff, thus increasing unemployment and reduction in national productivity.
The implication of the above is that while interest rate likes every other price is determined by market forces of supply and demand, similarly, its determination rate and hence access to loanable funds if completely abandoned to market forces would ultimately hurt critical sector of the economy.