Last week, and as widely forecast, the Monetary Policy Council (MPC) of the CBN left its monetary policy rate (MPR) unchanged at 11.50%. This came against a background of uncertainty about the timing of Nigeria’s exit from the recession and against a background of headline inflation (for December 2020) of 15.75% year-on-year (y/y).
To have both high inflation and a recession is a painful combination, and the MPC’s official communique acknowledged this with the statement that “the economy is currently in a stagflationary environment.”
To the question as to which to prioritize, price stability or growth, the communique’s answer was, unequivocally, to “continue pursuing price stability in growing the economy,” i.e. growth.
But what is the cost? When we look at inflation we notice that not only is it trending up, but that the rate of increase is also climbing. More importantly for the consumer, food inflation rose from 14.85% y/y in January 2020 to 19.56% y/y in December.
To put this in context, our 2019 study of a low-income household (see Coronation Research: Power to the Price Point, May 2019) estimated that 50% of its income was spent on food and of this 70% (35% of total income) was spent on unbranded goods such as beans, yam and eggs. This suggests that low-income households are feeling the squeeze.
According to the MPC’s communique food inflation is largely a structural issue: “Members reiterated the adverse impact of insecurity on food production, stressing that the current uptick in inflationary pressure could not be solely associated to monetary factors, but due mainly to legacy structural factors across the economy, including major supply bottlenecks across the country.”
But notice, in this sentence, that monetary factors are acknowledged as part of the inflationary problem. (The CBN long-term target of inflation is a range between 6.0% and 9.0%.)
The MPC cut its policy rate as the economy went into recession. But its work in reducing market interest rates both preceded the recession (and the onset of the COVID-19 pandemic) and was much more dramatic.
The yield on a 1-year T-bill fell from 5.40% in January 2020 to 0.15% in early December (and the dramatic downtrend started in October 2019). Bank credit grew strongly in 2020, having flatlined during the first half of 2019. This suggests a large flow of liquidity into a contracting economy.
The MPC’s communique, to be fair, includes some optimistic statements about inflation, notably that it expects it to decline in the near term “as the economy’s negative output gap closes.”
Nevertheless, in our view, there has already been considerable damage done to company balance sheets (erosion of equity through inflation) and household finances. A resumption of GDP growth cannot come too soon.
On the subject of managing inflation, the MPC is undoubtedly right to include monetary factors among its causes, and most people would agree that structural factors are critical, too, especially during times of insecurity.
Depreciation of exchange rates is also an important factor. Another argument against putting a lot of emphasis on monetary factors is that the financial sector in Nigeria is small relative to the economy as a whole, with outstanding commercial bank credit at around 10.0% of GDP.
Therefore, an expansion in credit may not have the same inflationary effect in Nigeria as it would in an economy where credit is much more widespread, to begin with.
Bank credit and Money supply rebased, 1 Jan 19 = 100, and inflation
Commercial bank credit to the private sector did not grow in the first half of 2019, then rose as the loan-to-deposit ratio (which stipulates the percentage of customer deposits that banks must reach in terms of loans) was imposed from mid-2019 onwards.
The LDR was originally set at 60.0% and was later raised to 65.0%. As market interest rates fell during 2020 it became easier to expand credit and companies that were hit by the recession were eager to take it.
It is true to say that the LDR policy has worked, and fair to argue that a combination of the LDR policy and falling interest rates likely prevented the recession from being worse than it has been. However, it would also be reasonable to think that credit expansion has been a contributory factor in inflation.
If this is the case, then the current environment of rising market interest rates may slow the growth of credit over the coming months and, possibly, inflation may then moderate with a lag of between two to three months.