How Did Nigeria’s Treasury Bills Drop From 18% to 3% in 3 Years?

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How did Nigeria’s treasury bills drop from 18% to 3% in the last three years and why earnings on savings, investments and pensions are now peanuts. In today’s thread, we will talk about interest rates in Nigeria.

On Wednesday, the CBN held an auction to sell treasury bills on behalf of the Federal Government (FG). A one-year treasury bill was sold at an interest rate of about 3%.

Why do we care? Well, it turns out that this auction-formally called a Primary Market Auction (PMA)-has a big say in determining interest rates and investment returns in Nigeria: on your savings account, your loan, your pension, and so on. Here’s how.

Let’s start by explaining interest rates. An interest rate is essentially the cost of borrowing money or the reward for saving/investing. How are interest rates determined? Well, if I think lending you money is risky, then I charge you a higher interest rate and vice versa.

But other things determine interest rates in an economy. One of them is inflation. If I lend you money today, I want to make sure that what I get back in return is greater than inflation.

This principle also applies when we lend money to the government by buying treasury bills. If inflation is 10% a year, I don’t want to buy a treasury bill that gives me a return under 10% else my money is losing value over time.

Interest rates are also determined by demand and supply. When an investment opportunity is scarce, people accept a lower interest rate. Demand works the other way: if more people want to lend you money, you can haggle for a lower interest rate.

Now that we know how interest rates work, let’s go back to the government and its PMA.

The FG borrows money to fund its budget and one of the ways it does this is by selling treasury bills at the PMA. At the auction, banks, foreign investors, pension funds, and others come and buy these bills as a form of investment.

Back in 2017, revenues were still pretty low so the government needed to borrow to get the economy growing again. One of the ways it did this was by holding Primary Market Auctions.

The problem is the oil price crash and foreign exchange crisis made the government a higher risk borrower. At the same time, inflation was as high as 15% during that year. Putting all this together, investors demanded a higher interest rate on treasury bills.

The government obliged. In one PMA held in July 2017, the one-year treasury bill was sold at 18%.

Fast-forward 3 years and the same thing is happening. Oil prices tanked earlier in the year, exposing our exchange rate and increasing inflation. Going by precedent, interest rates on treasury bills should be pretty high-to reflect the greater risk and higher inflation.

But, as we said earlier, the one-year treasury bill was sold at 3%, way lower than current inflation of 12% and the interest rate of 18% from three years ago. That is a huge difference!

Why is this happening? To explain, we need to introduce one more thing: OMO bills. An OMO bill is essentially a treasury bill, but it is sold by the CBN (not the government) and is mainly used to control the supply of naira.

Why are OMO bills important? The CBN needs to manage the supply of the Naira. If there is too much naira in the economy, inflation will rise and the naira will depreciate against the dollar. Think about it: when something becomes more abundant, it becomes cheaper.

Over the years, the CBN sold OMO bills at high-interest rates to attract foreign investors. They did this to support the exchange rate: OMO sales became a good dollar source as investors had to change dollars to naira to buy them.

It was a match made in heaven: Foreign investors would give the CBN their dollars, and, in return, would enjoy interest rates as high as 16% in 2017. To ensure these investors didn’t leave after a year, the CBN kept on selling OMO bills at high rates.

The CBN tried to keep these investors (and their dollars) in town but knew that increasing the interest rate (or keeping it as it was) would be expensive. So, it hatched a plan.

It decided to bar all non-bank domestic institutions from partaking in OMO auctions. This meant that pension funds and all the others could no longer buy OMO bills. The high-interest rates were exclusive to banks and foreign investors.

Unfortunately, the move did not quite work. Foreign investors began to exit the country late in 2019, worried that the CBN would be forced to devalue the naira at some point and scared of losing all their returns when they converted back to dollars.

Meanwhile, starved of their most lucrative investment option, local investors started looking for other places to put their money.

They tried the Nigerian stock market, but the market had performed poorly two years prior to that time. They would try other (possibly riskier) investments too, but an investor like a pension fund cannot afford to lose money. So, they play it safe.

All these investors that cannot buy OMO bills have to make do with buying the regular FG treasury bills. What do you think happens next?

Yes, you are right! We mentioned earlier that increased demand would reduce interest rates. As more people are willing to lend the FG money, they can give each person a lower interest rate.

All of this is why we are in the unusual position where a one-year treasury bill has an interest rate significantly lower than inflation.

So, how does all of this affect you? Chances are that the returns on your savings and investment have fallen.

How come? There are a few ways this can happen. If you save/invest in a mutual fund or Fintech investment, a lot of these funds/businesses ultimately invest in FG treasury bills and similar investment products.

As the interest rates on these have fallen, your mutual fund of Fintech products will give you a lower return!

More importantly, they know that you can’t go and put your money elsewhere-basically everyone uses the government’s treasury bill rates as a guide for interest rates on other investments.

There is a silver lining for you though: you may be able to get loans at a cheaper rate from your bank or other financial institution.

As treasury bills are less attractive to banks, they are more willing to give out loans to individuals and businesses, particularly as the CBN has basically been forcing them to do so in many ways.

Don’t get too excited though. Banks know how volatile the economy is at the moment and will pick and choose the borrowers they deem less risky. Still, you might as well try and take advantage of lower interest rates.

– Proshare.

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