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The false move by CBN against inflation 15 Jun 2022

At its Monetary Policy Committee meeting in May 2022, the Central Bank of Nigeria (CBN) raised its anchor interest rate by 150 basis points, from 11.5 percent to 13 percent. Two rationales have been separately provided for the aggressive hiking of the Monetary Policy Rate (MPR). On its part, the CBN justified the rate hike by declaring the need to stymie inflationary pressure. (Nigeria's inflation rate advanced to 16.82 percent in April 2022). Media reports also suggested that the increase was compensatory for the past policy inaction – for good or bad – of the CBN, by highlighting that it was the first time that the reserve bank has hiked the interest rate in two years.

Uptrend in inflation has become a policy challenge for the major Central Banks. At the outset of the trend of rising inflation about a year ago, it was thought to be a ‘necessity’ in reversing the recessional impact of Covid-19. Following the economic rebound from the pandemic, inflation was expected to return to its long-term targets of around 2 percent. But the reality is complicated. While the global economy returned to strong growth by the end of 2021, inflation has continued to rise. In the United States, annualised inflation reached a 41-year high of 8.5 percent in April 2022, and it was 9 percent in May in the UK, the country’s fastest rate of average change in prices in four decades.

Advanced economies’ inflationary drivers are twosome. One relates to the scarcity of products and services as a result of the supply chain disruption during the pandemic. Added to this now is the rising prices of energy, caused by the geopolitical conflict directly between Russia and Ukraine, and indirectly between President Vladimir Putin’s government and the NATO alliance. The other factor, which is monetary, relates to the liquidity surfeit in response to the pandemic at a time that the effect of the extraordinary monetary policy that lowered interest rate below zero percent, in order to counter the deflationary pressure from the 2008-2009 global financial crisis, had yet to fully dissipate.

Emerging Markets (EMs) are inversely impacted by the monetary conditions in the advance economies. For instance, interest rate hikes in the US would tend to spark financial outflows from the EMs. But they are now more directly affected by the disruption of the global supply chains of both energy and food products. All these conduce to a recent trend in which inflation has been well above the benchmark rates.

Nigeria’s high inflation, on the other hand, has been a persistent, long-term trend. Apart from the brief moment that the Consumer Price Index (CPI) decelerated to 8 percent in 2014, the country’s inflation readings have been in double digits for decades and have tended to defy anti-inflationary policy measures.

As it is currently the case, Nigeria’s inflation is driven by a multiplicity of factors that come under the umbrella of bad political and market governance. In recent years, the economy has tended to decouple from the world’s economy – including the oil-economies – on the upside, while being affected by every external, downside risk.

The country’s productivity challenge is structural, steep, and inflationary. The low productivity of the agriculture sector is driven by low quality inputs, poor value chain development, absence of value-addition, low credit penetration, and lack of technical capacity. And whereas the services sector is vibrant, it is not externally competitive. It has been underperforming in attracting foreign investments, compared to when South Africa’s was at the stage Nigeria services sector is currently in terms of development – and in spite of its superior market potential.

Nigeria is a long-term net-importer of energy products despite being a major producer of crude oil. Combined with high external dependence for food and other basic products, the country is highly susceptible to ‘imported inflation.’ Wasteful politics has also entrenched corruption, ensuring that the hydrocarbon export earnings are misappropriated and used for uneconomic public projects.

Incidentally, the CBN, under its current leadership that is openly political, represents the institutional decay that has damaged the structural fabric of the economy. Thus, fighting inflation through monetary adjustment alone will be ineffectual. Indeed, the new interest rate hike will have significant negative impact, and its potential positive impact is a mirage.

At 13 percent, the MPR will further make bank credit unaffordable to SMEs and worsen cost-pushed inflation. In any case, excessive liquidity in the system is also being driven by the next electoral cycle, which is set to be the longest since 1999 given the adjustment to the electoral calendar in the new electoral law. The ongoing ‘dollarisation’ of the election, in which the CBN Governor was a presidential aspirant, is already causing the depreciation in the value of the naira, leading to further upward pressure on prices.

The CBN’s decision will ultimately prove to be a problem than a solution. Indications of this are its forward guidance on continued use of its so-called development financing and lack of commitment to ending its illegal overuse of Ways and Means Advances to finance the federal government. These interventions are imbued with political patronage and are therefore unproductive.

In light of the above, it does not matter if the interest rate hike had occurred a year ago or how many rate increases are ahead. Monetary adjustments alone cannot solve Nigeria’s inflation. But the real economy can be further damaged by lack of absorptive capacity – due to endemic poverty – to handle the shock of at-once, 150-basis-point increase in the policy interest rate that was already in double digits.