By Babajide Komolafe

…Rewane highlights interest rate outlook for H2
The amount of funds in the inter-bank money market fell sharply by 89 per cent last week, prompting a sharp increase in cost of funds.

From N187 billion the previous week, the balance of funds in the market fell to N19 billion at the beginning of  business on Friday.

In response short term inter-bank interest rates rose by about 300 basis points. According to the weekly inter-bank newsletter of Kakawa Discount House interest rate on Overnight borrowing and Collateralised borrowing (open buy back) rose to from 14.5 per cent and 14 per cent to 18 per cent and 17.5 per cent respectively.

The sharp drop in liquidity might not be unconnected to the measures introduced by the CBN to reduce money supply and also the restrictions imposed on banks that borrow from the apex bank.

In the previous week, the apex bank increase the cash reserve requirement (CRR) of banks to 12 per cent from 8.0 per cent. This effectively reduces the amount of funds that banks can lend reduces by about N823 billion.

In addition to this, the apex bank banned banks indebted to from lending to other banks in the inter-bank money market. It also banned banks that lend funds in the interbank market from accessing its lending facilities.

Also on Wednesday, the CBN prohibited banks from borrowing from it and purchasing foreign exchange from the official foreign exchange auction on the same day. “Authorized Dealers are henceforth NOT allowed to access the WDAS window throughout the term of a Repurchase or SLF (standing lending) transaction with the CBN”, the apex bank said in a circular.

Interest rate outlook for H2
Commenting on these developments, Bismarck Rewane, Managing Director/Chief Executive, Financial Derivatives Company Limited said that the resulting high interest rate will reduce the net interest margin of banks by about 1.5 per cent and this cannot be effectively transferred to borrowers.

“We expect interest rate margins to remain pressured by high cost environment.  The further tightening will affect bank loan growth and the cost of funds. We believe that Tier 1 capital of banks will remain insulated due to the cheap funds available to them.  Manufacturing companies also face challenges as their cost of borrowing increases.

“There will also be sharp increase in NIBOR rates and we expect a further rise in bond yields. The higher interest expense squeezes the net-interest margins (NIM) of Banks, which NIM’s are expected to shrink by 1.50% and cannot be effectively transferred to borrowers.”

In his outlook for the interest rate in the second half of the year, Rewane said the trilemma of maintaining low inflation, interest rates and exchange rate stability remains a challenge.

“The CBN will maintain its “wait and see approach” with limited interest rate hikes, while the use of open market operations and other policy tools will increase but monetary policy easing is expected in 2013 as inflation outlook improves”, he said.

“The CBN is faced with three possible scenarios. It could reduce the MPR or maintain it at present level or increase it
He said a 50 bases points (bpts) reduction  in the MPR  11.5 per cent will lead to further weakening of the exchange rate to N165 per dollar at the official market, depletion of external reserves to $32 billion. But it will prompt decline in borrowing cost and growth in credit.

But an a 25 per cent increase to 12.25 per cent will lead to stable exchange rate, increase in external reserves to $40 billion and slow down inflation to 9.7 per cent. But this would tighten liquidity in the system and stunt economic growth.

Leaving the MPR unchanged at 12 per cent on the other hand would lead to slow down depreciation of the naira to N157 per dollar and slow growth in external reserves to $37 billion. Though inter-bank rates would remain flat at 14.5 per cent, the measure would tighten credit to the private sector, increase yields on government bonds, and the CBN will have to Use of other monetary policy tools to stem inflation.