Cardoso’s Tough Love: Will Rate Hikes Cage Nigeria’s Stubborn Inflation?

Obinna Chima

The Olayemi Cardoso-led Monetary Policy Committee (MPC) strongly believes that crushing inflation is the best thing the Central Bank of Nigeria (CBN) can do to boost purchasing power and support economic growth.

That was why at its meeting held during the week, for the fourth time in a row, the committee raised the Monetary Policy Rate (MPR), the benchmark interest rate, by 50 basis points to 26.75 per cent, from the 26.25 per cent it was previously.

Nigeria has been grappling with persistent inflation for several years and in response, the CBN has implemented a series of interest rate hikes. While this is a common monetary policy tool to curb inflation, its effectiveness in Nigeria’s complex economic landscape has been a subject of debate.  

The logic behind raising interest rates is to make borrowing more expensive, thereby discouraging spending and investment. This reduced economic activity can lead to lower demand for goods and services, ultimately putting pressure on prices downward.

Even though the latest numbers increased slowly, all indicators of inflation in the country rose once more in June 2024, according to the National Bureau of Statistics (NBS). From 22.8 per cent in June 2023 and 34 per cent in May 2024, headline inflation rose to 34.2 per cent in June 2024. Currency depreciation, with the official exchange rate presently at N1,599/$, compared to the N769/$ it was in June 2023, and growing food inflation (36.4 percent year-on-year) continue to be the key drivers of inflationary pressures.

Also, food inflation, which increased to 40.9 per cent in June, from 40.7 percent in May 2024 and far higher than the 25.3 percent recorded in June 2023, continues to be the primary driver of headline inflation. Corresponding to this, core inflation increased from 20.1 percent in June 2023 to 27.4 percent in June 2024, up from 27 per cent in May 2024.

However, inflation means different things to different people. For the average person, inflation is the result of having to spend more money in order to buy the same amount of products. In contrast, an economist views it as the overall rise in the level of prices during a given period of time.

Notably, high inflation distorts consumer behaviour. It also destabilises markets by creating unnecessary shortages. Similarly, high inflation, which is not the desire of any economy, leads to income redistribution and brings about weak purchasing power.That is why central banks globally are never comfortable with a rising inflation rate usually seen by them as ‘evil.’

Additionally, as part of measures to control Nigeria’s stubborn inflation, the MPC at its Tuesday meeting, also adjusted the asymmetric corridor around the MPR to +500/-100 from +100/- 300 basis points. It however, retained the Cash Reserve Ratio (CRR) of Deposit Money Banks (DMBs) at 45 per cent and Merchant Banks at 14 per cent, as well as retain the Liquidity Ratio (LR) at 30 per cent.

According to the CBN Governor, the sustained hawkish monetary policy stance was specifically aimed at bringing inflation under control.

Cardoso, specifically noted the persistence of food inflation, which continues to undermine price stability.

He said while monetary policy has been moderating aggregate demand, rising food and energy costs continue to exert upward pressure on price development.

Notably, the CBN governor pointed out that the prevailing insecurity in food producing areas and high cost of transportation of farm produce are also contributing to headline inflation.

He said the committee was therefore, not oblivious to the urgent benefit of addressing these challenges as it will offer a sustainable solution to the persistent pressure on food prices.

He reiterated the CBN’s commitment to its price stability mandate, expressing optimism that despite the June 2024 uptick in headline inflation, prices are expected to moderate in the near-term.

The MPC further doubled down on its commitment to stay on course with its tightening cycle in view of the urgent need to address inflationary pressures to consolidate on the gains achieved so far.

The committee particularly hinged its optimism on monetary policy gaining further traction, in addition to recent measures by the fiscal authorities to address food inflation.

The MPC, therefore, resolved to sustain collaboration with the fiscal authorities to ensure that inflationary pressure is subdued.

According to Cardoso, the MPC further expressed optimism with the recent stop gap measures by the federal government to bridge the food supply deficit.

In particular, he noted that the 150-day duty free import window for food commodities including maize, husked brown rice, wheat and cowpeas, among others, will moderate domestic food prices.

The central bank stated that these measures would not lead to direct injection of liquidity into the economy as to cause further inflation.

The apex bank boss also noted that while the measure was a welcome development and may prove effective in the short run, “it is expedient that it is implemented with a defined exit strategy to avert a possible rollback of the recent gains in domestic food production.”

On the Foreign Exchange (FX) segment, Cardoso noted the narrowing spread between the various foreign exchange segments of the market, which he said was an indication of price discovery and improved market efficiency, thus reducing opportunities for arbitrage and speculation.

He said, “Inflation really and truly is having a major impact on our economy. Purchasing power is getting eroded. People are being pushed into different categories of poverty, and it is in their own interest that we are able to take the scourge of inflation.

“If not, the ramifications will also be for them. It’s not on the average man alone. We understand the need for growth and we also understand that it is relatively challenging when you have high-interest rates.

“We also understand that quite frankly. My belief is that it is so fundamental to the long-term future and stability of our economy that inflation should be brought under control, that in the short term these are pains which ultimately will be able to help our economy and help the manufacturing businesses as well.”

However, to analysts at Cordros Capital, while the modest rate increase primarily reflected their anticipation of moderating inflationary pressures in the near term, the MPC members’ decision was also swayed by concerns over escalating borrowing costs for both the government and corporations, following the previous aggressive rate hikes.

“Additionally, the MPC’s decision to narrow the asymmetric corridor around the MPR to +500bps/-100bps (previous: +100bps/-300bps) appears to be driven by its move to further tighten monetary conditions without significantly raising the policy rate.

“Furthermore, the MPC highlighted that the still tight financial conditions in the global economy and the ongoing geopolitical tensions continue to pose an upside risk to domestic inflation. Whilst the MPC’s view on a sustained disinflationary trend aligns with ours, we highlight that inflation is settling within target in the UK and approaching target level in the US and the Euro area.

“We posit that inflation may have peaked in June and should start to moderate in July as the price shock from the subsidy removal and the currency devaluation in June 2023 begins to fade. In this vein, we expect the MPC to lean towards a neutral monetary policy stance, that is, a wait-and-see approach, in its next monetary policy meeting in September, allowing the impact of previous rate increases to permeate the economy.

“Additionally, the surge in the government’s borrowing cost following the uptick in fixed income yields is expected to underpin the MPC’s decision to pause its policy rate hikes. Consequently, we expect the MPC to “HOLD” the MPR and other parameters constant at their meeting on the 23 and 24 September,” they added.

Clearly, the Nigerian economy is challenged due to the fact that its inflation is largely driven by structural factors such as supply-side constraints, infrastructure deficits, and insecurity, rather than just demand-pull inflation. Also, the naira’s persistent depreciation against the dollar also fuels inflation. While higher interest rates can attract foreign investment, it might not be enough to stabilise the currency in the face of other economic challenges. This, therefore requires more push from the fiscal side to achieve economic stabilisation as interest rate hikes are not a silver bullet. To truly support efforts of the Cardoso-led CBN in addressing the root causes of inflation in the country, a multifaceted approach is required.

Investing in agriculture, infrastructure, and security can boost supply and reduce inflationary pressures. The government also needs to control its spending and avoid inflationary fiscal policies. In addition, providing support to vulnerable groups can help cushion the impact of rising prices.