Moody’s: Higher Inflation Will Hamper Investment, Economic Activities

•Says lending to households, small businesses risk default

James Emejo in Abuja

Higher inflation and interest rates tend to discourage investments and economic activity, coupled with slower real growth which would in turn weaken banks’ business generation and loan quality in most African countries including Nigeria, according to a report by Moody’s, one of the global rating agencies.

The report noted that since the outbreak of the Russian/Ukraine conflict, inflation had risen sharply in several countries globally, far exceeding most expectations.

Many African countries are grappling with rising prices driven primarily by higher food and energy prices.

In response, central banks have ratcheted up their policy interest rates to try to quell demand.

In Nigeria, the Central Bank of Nigeria (CBN) increased key benchmark rate by 250 basis points to 14 per cent. In South Africa the policy rate has risen by 175 basis points since the end of 2021 to 5.50 per cent while Egypt has increased its rate by 300 bps so far to 11.75 per cent as well as Kenya which raised its policy rate by 50 basis points to 7.50 per cent.

Also, in 2023, Moody’s forecasted real GDP growth of four per cent in Nigeria, 4.5 per cent in Egypt, 1.5 per cent in South Africa, 3.5 per cent in Morocco and 5.3 per cent in Kenya.

The rating agency stated however that interest rate increases have so far not kept pace with inflation, adding that in South Africa, Egypt, Nigeria and Morocco, real interest rates (excluding inflation) remained negative as in many parts of the world.

The report stated: “Some central banks may tighten monetary policy further to keep inflation under control and to forestall local currency depreciation – particularly as interest rates in US rise, drawing capital away from riskier African economies.

“In Nigeria, competition for longer-dated deposits to satisfy Basel III liquidity requirements2 has resulted in growth of price-sensitive term deposit products, which will gradually increase funding costs and moderate margin expansion as those deposits are rolled over at higher rates.

“In addition, regulations require Nigerian banks to pay 30 per cent of the current monetary policy rate (MPR) on their savings deposits, which translates to an interest rate of around 4.2 per cent at the current 14 per cent MPR. This will increase the banks’ funding costs.”

The report also predicted loan-loss provisions to rise across the board, adding that banks that lend heavily to households and small businesses would be more vulnerable to loan defaults than those that focus on large companies.

It added, “Kenyan and Moroccan banks have lent extensively to households and SMEs. South African banks also have large quantities of household loans but these are primarily mortgages, which tend to be more resilient. Nigerian banks will fare better. They have wide exposure to corporates, with a significant number linked to the oil and gas sector, a beneficiary of the current crisis.”

The ratings agency also stated that imported services, charged in dollars, particularly for software as banks protect themselves against cyber threats, would increase across all systems and a weakening local currency would add to the costs.

However, it noted that Nigerian banks have a high cost-to-income ratio despite low staffing costs, which indicates that they face high regulatory charges and branch network expenses, adding that “We expect all these overheads to rise with inflation”.

Essentially, Moody’s pointed out that higher interest and inflation rates will increase loan-loss provisions across the board.

It said, “We expect bank’s exposure to sectors most vulnerable to inflation, such as households, will be a key factor impacting their provisioning costs. Higher inflation will diminish the borrowers’ repayment capacity because income will be needed to meet other competing and rising costs.

“Higher interest rates will also add to borrowers’ debt burdens by increasing the nominal repayments. We expect high inflation and interest rates to increase provisioning needs in all systems.

“In general, we expect banks most exposed to household borrowers will face the highest loan-loss provisioning charges. While inflation will reduce the real value of outstanding debt, household incomes may not increase fast enough to service the rising repayment costs.”

Continuing, the ratings institution stated, “In addition, unlike in some developed economies, most households in these systems did not receive cash handouts from governments during the pandemic which would have eased the debt service burden.

“In contrast, banks with high exposure to corporates may fare better because many companies will be able to pass on some of price increases to their customers.”