Evaluating the Central Bank of Nigeria’s Monetary Policy Response to Inflation and Economic Troubles
As Nigeria faces rising inflation and a sinking currency, the Central Bank of Nigeria (CBN) has responded with a series of aggressive interest rate hikes. This article dives into the underlying causes of Nigeria’s economic troubles, the CBN’s efforts to battle inflation, and the country’s likely future monetary policy path.
The Central Bank of Nigeria’s decision to raise short-term interest rates to 26.25% at the most recent Monetary Policy Committee (MPC) meeting in May 2024 has prompted many economic experts to question the CBN’s policies and when the central bank will cease to raise rates.
Many have argued that it is overdue for the CBN to stop raising the cost of capital on Nigerian households and businesses, while others believe that too much damage had already been done ahead of the MPC meeting in May. Naturally, higher interest rates would result in much higher interest payments on sovereign debt, which would require Nigeria to make higher debt payments in the future for little gain today.
That being said before we can discuss the possibility of the CBN suspending the present rate hike cycle, we need to look at what has caused high inflation in Nigeria, what efforts the Apex Bank has made to battle inflation in Nigeria, and whether the solutions have worked or even gone far enough.
The Story of Inflation in Nigeria
Headline inflation in Nigeria surged from 22.22% in April 2023 to 33.69% by April 2024. Much of this inflation can be linked to the high cost of food and energy, with Food Inflation standing at 40.53% according to the Nigerian Bureau of Statistics (NBS)’s most recent report, released in May this year. Additionally, high energy and electricity costs are significant contributors to inflationary pressures in Nigeria. Following the removal or relaxation of energy-related subsidies by the new government in Nigeria, fuel prices have nearly tripled since the current administration took office in May 2023. Electricity tariffs for some businesses and households in Nigeria have tripled since the start of this year.
Not to be outdone, the Nigerian Naira has lost more than 22% of its value against the dollar this year. This has resulted in the currency obtaining the unimpressive accolade of being the best and worst-performing currency within a short few months in 2024, highlighting new levels of volatility in the currency exchange rate. At the official exchange rate, the Naira has fallen by around 50.4% against the dollar over the past 12 months.
Local currency devaluation and depreciation increased the cost of imports, which is especially noticeable in Nigeria, which relies on imported machinery to power its industries, and has no operational oil refineries, so it imports petrol and diesel from outside the country. Due to poor farm yields, low mechanization and insecurity in northern & central parts of the country, Nigeria has lacked the capacity to meet food demand within its borders, as evidenced by Nigerians spending nearly N1.9 trillion on food imports in 2022.
All of these issues have resulted in greater household costs of living in addition to high costs of doing business for big and medium-sized enterprises, turning most operating models upside down and causing the economy to shrink and lose purchasing power across the board. Making Nigeria’s inflation more cost-push than demand-pull.
The Whips Used to Control Inflationary Pressures
After years of inadequate management and a lack of a cohesive monetary policy strategy, the Central Bank of Nigeria (CBN) initiated a series of dramatic raises in interest rates and other key policy benchmarks in a deliberate attempt to restore relative pricing control.
Guided by the Monetary Policy Committee, the CBN has utilized various tools, including the Monetary Policy Rate (MPR), Cash Reserve Ratio (CRR), Liquidity Ratio, and Asymmetric Corridor, to control the flow of funds, reassess the cost of capital, stabilize the naira against foreign currencies, and foster long-term economic growth. In addition, the CBN has attempted to harmonise its exchange rate policies and transition to an open market using a ‘willing buyer, willing seller’ framework.
For a more detailed discussion and examples of what all these tools are and how they affect the money supply and inflation, I recommend reading this thread on X (previously Twitter) by Habu Sadeik, a highly regarded analyst.
Since the CBN began this rate hike cycle in late February this year, MPR has increased by 750 basis points or plus 750bps (+7.5%) to 26.25%, the CRR is now 45% from 32.5%, the Liquidity Ratio has been retained at 30% while the asymmetric corridor which is a range from which qualified financial institutions can borrow money from or lend to the CBN has been adjusted and maintained to a range of +100/-300 basis points around the MPR.
With the CBN’s contractionary or hawkish monetary policy stance, Mr Yemi Cardoso, the current CBN Governor, hopes to provide some semblance of stability to market participants, build trust and attract foreign investors, stabilise, and restore fate in the local currency, and mop up excess liquidity in the economy.
Is Monetary Policy A Silver Bullet & Has it Worked?
Most economists understand that relying solely on monetary policy cannot bring about stable pricing and long-term economic growth to a struggling and debt-ridden economy. Monetary policy is closely linked to fiscal policy, which is primarily administered by the executive branch of government, notably the Minister of Finance, this function is outside the purview of the CBN. The benefits of sound monetary policy cannot be fully realised unless fiscal policy is clear, consistent, and complementary. On the contrary, it is becoming evident that fiscal officials are more concerned with making lavish declarations about potential foreign direct investments (FDIs) even as multinational companies are closing shop in Nigeria and leaving the country due to harsh economic fundamentals.
Monetary policy is on some occasions a means to buy time for hard work and clear-cut economic plans to come into effect and result in sustained price stability and productivity. Given the circumstances faced and the limits confronting the incoming CBN Governor, the CBN has done its best so far, using clear textbook macroeconomic strategies backed in some cases by communication and actions.
To some extent, the aggressive interest rate hike cycle by the CBN has yielded positive effects. This is evidenced by a recent increase in Foreign Portfolio Investments (FPI) and an improved performance of the naira. The official exchange rate appreciated from N1,650/$1 in February to N1,100/$1 by mid-April before normalizing around N1,500/$1 levels at the time of this report.
On the inflation front, it may be too early to assess the effectiveness of the actions of the CBN as monetary policy often has a lag effect on inflation, the decelerated growth of month-on-month inflation does show some signs of responsiveness. Month-on-Month (MoM) inflation in Nigeria increased slower from February to April 2024 than before the new rate hike cycle began.
Are We at The End of This Rate Hike Cycle?
The simple answer is NO!!
It is unlikely that we are at the end of this rate hike cycle simply because inflation remains higher than the MPR and structural economic hurdles, especially on the fiscal side of economic policies, have yet to be addressed. Nigeria has just begun to close the gap between headline inflation and MPR; further rate hikes will likely be required to manage rising prices.
While the CBN may not need to increase MPR above inflation, there is still room to cover before it can hold interest rates steady. The only question is if the Nigerian economy and the CBN have the stomach for it (30% MPR anyone?).
Nigeria is late to the game when it comes to the ‘…higher for longer’ credo preached by most monetary policymakers in advanced and developing economies of the World. However, due to errant monetary policymaking that preceded the new administration at the CBN, Nigeria has largely failed to follow suit. To remain relevant in the global markets, the CBN is more likely to keep up with the rapid pace of interest rate increases, as it aims to meet the demands of foreign and local investors and attract much-needed investments. Until such a time when advanced economies cut their cost of capital (thereby easing inflationary pressures on import-dependent countries like Nigeria), it is difficult to see how the MPC might rationalize deviating from this current trajectory of more rate hikes.
In a previous piece, I discussed how aggressive monetary policy, particularly by the U.S Federal Reserve Bank, was causing a chokehold on the global economy:
While it is understandable that some may believe that higher interest rates will increase the burden on the real economy, we must recognise and accept that runaway inflation and exchange rate volatility pose additional risk and cost burden to both homes and businesses, so decisive action must be taken to create a sustainable playing field despite the trade-offs that will exist from such contractionary monetary policy.
Ultimately, sound economic policy aims to solve problems through viable solutions, each solution involves trade-offs that create dilemmas or even trilemmas for policymakers. The Central Bank of Nigeria (CBN) and the MPC are tasked with finding the best solution that minimizes difficulties over the long term and that is what it must do.
