BUSINESS

Nigeria’s interest rate dilemma: Stability at what cost?

Maureen Ikpeama7 months ago7 months ago14814 mins

In this write- up an Economist, Policy Expert, and Public Finance Consultant, Prof Chiwuike Uba, Ph.D, X- rayed issues surrounding the the Nigeria’s monetary policy and proffered solutions. Read on:

In its July 2025 Monetary Policy Committee (MPC) meeting, the Central Bank of Nigeria (CBN) opted to retain its existing monetary parameters—maintaining the Monetary Policy Rate (MPR) at 27.5%, the Cash Reserve Ratio (CRR) at 50% for commercial banks, the Liquidity Ratio at 30%, and the asymmetric corridor at +500/-100 basis points around the MPR. This decision, according to the apex bank, reflects its continued commitment to taming inflation, anchoring price stability, and preserving macroeconomic balance.

The policy continuity came against the backdrop of a modest decline in headline inflation. According to the National Bureau of Statistics (NBS), Nigeria’s inflation rate dropped to 22.22% in June 2025, down from 22.97% in May 2025. While this downward movement is a welcome development, it does not provide sufficient justification for the continued aggressive tightening stance adopted by the CBN. On the contrary, it opens a much-needed window for strategic recalibration.

While the high MPR is intended to discourage excessive borrowing and suppress aggregate demand, the broader question is whether demand-driven inflation is indeed the primary inflationary pressure Nigeria is facing. In reality, much of Nigeria’s inflation is cost-push, driven by persistent exchange rate volatility, insecurity-induced food shortages, high energy prices, logistics inefficiencies, and structural constraints. These are factors beyond the reach of conventional monetary tightening tools.

While a high Monetary Policy Rate (MPR) is designed to discourage borrowing and reduce aggregate demand—thereby curbing inflation—its effectiveness in Nigeria’s context is highly questionable. This is primarily because Nigeria is not a consumer credit-driven economy. Unlike advanced economies, where households and businesses heavily rely on credit for consumption and investment, most Nigerian consumers operate on a cash-based, informal financial system, with minimal access to structured lending.

According to the CBN and EFInA Access to Finance Surveys, over 40% of Nigerian adults are still excluded from the formal financial system, and less than 4% of Nigerians use formal credit channels. The vast majority of micro and small enterprises (which employ most Nigerians) operate outside regulated financial frameworks and rely on personal savings, cooperatives, or informal lending groups. As a result, changes in interest rates—no matter how drastic—have limited transmission to actual spending behavior in the economy.

This structural peculiarity means that a higher MPR may tighten credit for the formal sector, especially for manufacturers, exporters, and large businesses, without achieving a proportionate effect on inflation. In fact, it may do more harm by choking supply (through reduced investment and production) and exacerbating cost-push inflation, particularly when the underlying inflation drivers are not demand-side but structural and supply-based: insecurity, exchange rate volatility, food shortages, and energy costs.

Thus, by applying a textbook tightening policy in a non-credit-driven, structurally challenged economy, the CBN risks undermining growth without addressing the root causes of inflation. This calls for a paradigm shift—one that combines cautious monetary policy with bold fiscal, trade, and structural reforms to enhance supply, reduce costs, and improve productivity.

The CBN’s retention of a 50% CRR for commercial banks—the highest in Sub-Saharan Africa—further constrains the liquidity needed for productive lending. This policy not only limits banks’ ability to extend credit to the private sector but also discourages risk-taking in a fragile economic environment. Meanwhile, the liquidity ratio, though intended to strengthen financial resilience, has the unintended effect of sterilizing a significant portion of banks’ balance sheets.

The asymmetric corridor of +500/-100 basis points around the MPR theoretically provides operational flexibility. However, with an already elevated policy rate, this corridor further pushes effective lending rates into the mid-30% range, making borrowing prohibitively expensive for small and medium-scale enterprises (SMEs), mortgage seekers, and large-scale manufacturers alike. The tightening has made credit inaccessible for most sectors that drive real growth and employment.

What is particularly concerning is that this policy posture is taking place amid a tepid economic recovery and acute supply-side disruptions. The latest Q1 2025 GDP growth data released by the NBS shows Nigeria’s economy expanded by a modest 2.98%, down from 3.46% in Q4 2024. Agriculture and manufacturing, which collectively account for over 35% of employment, have remained subdued due to insecurity, currency depreciation, and rising input costs. These sectors desperately require access to affordable credit—credit that the current monetary stance effectively chokes.

The latest drop in inflation to 22.22% may provide some validation for the CBN’s hawkish posture. However, this decline is still modest, and inflation remains alarmingly high—well above the 6–9% long-term target band. Core inflation, which strips out volatile food and energy prices, has remained sticky and structurally entrenched. This suggests that the drop in headline inflation may be seasonal or statistical, rather than reflecting any durable improvement in fundamentals.

Pix: Prof Uba

To deepen the policy conversation, it’s important to recall that Nigeria’s MPR has never been this high in over two decades. In 2011, when inflation averaged around 12%, a policy rate of 12% was sufficient to stabilize the macroeconomic environment. This sharp divergence between inflation dynamics and the current extreme monetary response underscores the need for a broader rethink.

International comparisons offer useful perspective. Kenya, for instance, with inflation around 5.7%, has maintained its policy rate at 13.0% as of June 2025. Ghana, battling similar inflation challenges (20.9% in June 2025), has begun a cautious policy easing to support private sector recovery. Egypt has adopted a hybrid approach of gradual tightening while also providing targeted concessional funding to critical sectors. Nigeria’s singular focus on brute-force tightening without fiscal, trade, and sectoral coordination stands in contrast.

Another layer of complexity lies in the disconnect between monetary and fiscal policies. While the CBN tightens, the Federal Government continues expansionary fiscal practices—borrowing heavily at high yields, maintaining subsidies, and engaging in deficit financing. These contradictory actions dilute the efficacy of monetary policy. In fact, the elevated MPR also raises the government’s debt service burden, worsening fiscal sustainability risks.

Moreover, the impact on employment and poverty is profound. Unemployment remains elevated, with youth real unemployment above 40%. Informality is growing, as businesses downsize or operate outside the banking system to escape high borrowing costs. The net result is a rise in economic precarity and a potential erosion of social cohesion.

From a currency perspective, the MPR appears aimed in part at attracting foreign capital inflows and defending the naira. However, the naira remains volatile, closing at ₦1,453/$1 on the official I&E window on July 22, 2025. Without structural reforms to boost non-oil exports, reduce import dependency, and improve forex supply, high interest rates alone cannot deliver exchange rate stability.

Looking ahead to the second half of 2025, the risks are clear. If the current policy stance is maintained, Nigeria may face an economic slowdown, contraction in private investment, and mounting non-performing loans (NPLs) in the banking sector. A sustained tight money regime in a structurally weak economy can become self-defeating.

The CBN must therefore consider a recalibrated strategy. Gradual easing of the CRR—from 50% to around 35%—could inject liquidity without undermining inflation control. Similarly, introducing targeted concessional credit windows for agriculture, manufacturing, and export-oriented sectors could drive growth while keeping speculative demand in check. Liquidity forecasting should be improved to avoid erratic Open Market Operations (OMO) interventions.

Furthermore, forward guidance is essential. Market players and investors need clarity on the CBN’s medium-term trajectory. Ambiguity creates uncertainty and stifles confidence. Transparency in forex operations and clearer communication on monetary goals would improve credibility.

Finally, there is a need for institutional humility and engagement. The CBN should establish regular dialogue with organized private sector groups, academia, and independent economists to inform its decision-making. The complexity of Nigeria’s inflation challenge demands a collaborative, data-driven, and multi-sectoral approach—not a technocratic silo.

In summary, the July 2025 MPC decision reflects consistency, but not necessarily effectiveness. Stability, while important, must not become an excuse for inertia. The Nigerian economy requires a balanced, pragmatic, and context-sensitive monetary policy—one that supports investment, protects livelihoods, and lays the foundation for inclusive growth. God is with us!

Prof. Chiwuike Uba, PhD is an Economist, Policy Expert, and Public Finance Consultant. He is the Chairman of the ACUF Initiative for Policy and Governance.