Blurb
Analysis: Why CBN’s interest rate hikes may not bring down inflation
Nigeria’s central bank monetary policy committee will announce to the world on Tuesday, May 21, 2024, whether they will continue with their hawkish monetary policy of raising rates or shock everyone by leaving it untouched.
At 24.75%, Nigeria’s benchmark interest rate is at an all-time high and very few people will bet against keeping it unchanged. The apex bank has made it clear that combating Nigeria’s sticky high inflation rate is its primary objective in 2024.
It also hopes higher rates will also help stabilize a battered naira which many consider a natural pass through to high inflation.
For context, the idea is to create an economy with positive real rates (whereby interest rates earned on investment exceed the rate of inflation).
For example, if inflation is 20% and the interest rate is 25% then there is a positive real rate of 5%. This means investors are seeing the value of their investment grow by a net 5% per annum.
However if inflation is 30% and interest rates are still 25%, then you have negative real rates. This negative real rates scenario discourages investors from keeping Naira assets.
In economic reality, positive real rates are a key reason why central banks continually adjust interest rates to ensure folks continue to keep assets in their currency. In our case, interest rates higher than inflation will encourage folks to hold Naira assets.
The issue however is that to achieve positive real rates, both interest rates and inflation need to be addressed simultaneously. Whereby the Central Bank will advise its preferred inflation target and consequently its likely interest rate target.
For Nigeria, the central bank is yet to announce an official inflation target or what actions are required to arrive at an inflation rate target. Neither has it communicated an interest rate target. Thus far it has simply said it will adopt an “inflation focused monetary policy”. Thus zero specific AND measurable objectives communicated by the CBN.
As the famous quote goes, ‘ A goal without a plan is just a wish’ – Antoine Du Saint Exupery.
A brief recap of recent actions shows that the apex bank started raising rates in May 2022 when the Emefiele MPC raised rates from 11.5% to 13%. At that time Nigeria’s inflation rate had risen from 15.6% at the start of the year to 17.7%.
Rates were again moved from by 100 basis points every other month until they hit 16.5% by the end of the year. But by that time inflation rate was at 21.3% a 500-basis point disparity with the monetary policy rate.
As the MPC meets this week, the disparity between the MPR and the inflation rate stands at a staggering 8.9% ( approximately 900 basis points). No surprises here, the apex bank is seemingly chasing an inflation shadow with no clear target.
Nigeria’s current approach to attaining positive real rates by only raising interest rates, as currently being implemented by the Central Bank of Nigeria (CBN), is reactionary at best. This is because as mentioned both inflation and interest rates need to be tackled simultaneously and not in silos as is currently the case.
To effectively tackle inflation, the CBN’s monetary policy must be complemented by addressing the underlying supply issues that drive up the cost of doing business. Simply raising interest rates makes borrowing more expensive, thereby slowing down economic activity and demand which is ok if consumer demand is driving inflation. However, for Nigeria, the key issues driving inflation are being completely ignored.
Notably, the last time the MPR was higher than the inflation rate was the period between March 2018 and May 2020 (just before the end of the Covid-19 lockdown). This was a period characterized by a stable exchange rate and a moderate money supply.
However, when Covid-19 struck in 2020, Nigeria just like most countries around the world embarked on an expansive monetary policy that ushered in the growth in the nation’s money supply.
Nigeria’s inflation is driven by increased costs of production and disruptions in supply chains. This is further compounded by an extraordinary spike in monetary policy with an incredibly anaemic GDP growth rate. In other words, too much money chasing too few goods and not enough goods being produced for a variety of reasons ranging from insecurity to logistics to power to human capacity to technology and velocity challenges.
However, a deep dive into issues driving inflation has been addressed in other articles on Nairametrics.
In fact, Nigeria’s current inflation is heavily driven by rising food prices…this food inflation is markedly getting worse in urban areas compared to rural areas reflecting the rising challenges in transporting and preserving food to our cities—sectors that require more investments at affordable rates of borrowing.
Thus, while the CBN’s intent to control inflation through higher interest rates is understandable, it overlooks the structural issues plaguing the economy.
Addressing Nigeria’s inflation problem requires a holistic approach that goes beyond monetary policy. Structural reforms are crucial to resolving supply-side constraints.
This includes investing in infrastructure, improving agricultural productivity, enhancing supply chain efficiency, and reducing bureaucratic bottlenecks that increase the cost of doing business. Only by tackling these fundamental issues can the inflationary pressures be alleviated in a sustainable manner.
The previous central bank administration overstepped its role by taking on ultra large interventions in pursuit of a development finance mandate. Thus exploding the money supply by financing federal and state government deficits through monetary policy.
Research reports by the CBN itself have noted that the efficacy of interventions was muted at best and in some cases unsuccessful.
The current central bank administration has clearly stated that it will not follow this approach, preferring to collaborate with organizations and institutions better suited to economic development through fiscal policy and budgets.
This emphasizes the crucial role of the Minister of Finance who is also the coordinating minister, as well as, other key government ministries.
The government must actively seek foreign direct investment alongside the central bank’s monetary policies, which need to be tapered. Additionally, the government’s large fiscal deficits need to be curtailed.
The central bank cannot pursue higher interest rates to curb inflation while the government simultaneously adds tens of trillions in fiscal deficits, largely funding recurrent expenditure and accumulating more debt. Recent borrowings are now at current interest rates of over 19%.
The government should focus more on public-private partnerships, leveraging capital markets as the ideal conduit for capital formation. Projects that have an immediate impact on economic growth and inflation reduction should be prioritized, with the president providing the highest level of executive backing.
Finally, the CBN’s strategy of raising interest rates to combat inflation is one-dimensional and short-term in nature. Especially as higher interest rates without end-state targets simply add to borrowing costs which companies will need to recoup through pricing to consumers. Thus a vicious cycle of pass-through costs.
Nigeria’s inflation requires a multidimensional approach: while some level of interest rate adjustment may be necessary, it is imperative to simultaneously address the structural supply-side issues that are the real drivers of inflation.
Without these comprehensive reforms, Nigeria’s inflation battle will remain an uphill struggle, and the cost to businesses and consumers will continue to rise.
