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Oh yes! Here we go again.

In the time between the post on the exchange rate, a couple of things have happened.

The Nigerian banking system witnessed a terrible loss and tragedy.

Nigeria, sadly, lost the AFCON final.

The inflation figures for January 2024 were released.

I had put a lot of thought into what the next post should be on, and it couldn’t have been clearer that writing on inflation was just the right thing to do.

Ever since I was young, I was always aware of the fact that things were getting more and more expensive, however, it was not until I got to a certain point in secondary school (SS1 to be precise) did I realize that the technical term was inflation. In time, I will tell you all the story of why I came to be fascinated by economics but for now, let’s dissect this juicy topic.

So, what does Inflation even mean?

Inflation is described as the gradual rise in prices of goods and services over a period. Inflation isn’t the increase in price of just one commodity or service, it has to occur across multiple goods and services across numerous sectors to be classified as inflation. What I am saying in a nutshell is, that if the price of just rice increases but everything else stays the same then that is not inflation. However, if we see increases in prices of rice, clothes, dispatch rider services, Uber rates, canned produce, school fees, etc. gradually and at the same time, then this can be called inflation (because as you can see, prices of goods and services across multiple sectors are all rising within the same period.

Last week, the Nigerian Bureau of Statistics released its monthly inflation report which stated that headline inflation has now hit 29.9%, and food inflation at 35.4%. Simply telling us that the prices in the country as of January 2024 are 29.9% higher than in January 2023 and the equivalent for food.

So, what causes inflation?

To understand the drivers behind inflation, it is important to understand the types of inflation.

1. Demand-pull Inflation: This is when prices of goods and services rise because there is a lot of demand in the system, but production capacity cannot meet the existing demand. Think about your Uber and Bolt apps for a second, whenever there is a “surge” it means that there are more people ordering rides than there are cabs available. This is an example of demand-pull inflation. Demand-pull inflation is actually an indicator that the economy is growing because it implies that people have income and are ready to spend on goods and services; this will lead businesses to invest in more staff (driving up employment), investing in more capacity to meet the demand (driving up investment), and increasing salaries and wages (not only because they need to, but also because they can afford to)
2. Cost-push inflation: Now this is the inflation that’s not great. A true indicator that something is intrinsically wrong with the economy. Cost-push inflation occurs when the costs of production generally rise and cause the costs of goods and services in the economy to rise. What are the costs of production? Essentially the costs of production are the costs of all the elements and factors that are essential in producing goods and services.

● The inputs you need for production (raw materials)

● The resources you need to process those inputs (labor, machinery)

● Other supporting costs (transportation and logistics, packaging, advertising, etc)

Of course, this is not a completely exhaustive bucket list of the costs of production, but it should provide you with a clear picture of how costs are categorized.

When there is a general and gradual rise in these costs, it will inadvertently (daily dose of grammar) feed into the cost of the final product and when this happens at an economic scale for all goods and services then you can expect inflation to rise. Cost-push inflation is an indication of inefficiency in the larger economy. An inefficiency that is leading to costlier factors of production. This type of inflation, ladies and gentlemen, is what Nigeria faces today.

There are other types of inflation, and fancy buzzwords like stagflation, hyperinflation, lol you name it, but that isn’t the purpose of this space. The question on everybody’s minds is, why is inflation becoming rampant in Nigeria?

Answering the why

To answer the why, it is important to dissect the elements of Nigeria’s cost-push inflation, and to achieve this, I will walk you through the 3 components of the cost of production (inputs, resources, and other costs). Inputs (raw materials) can be sourced in 2 main ways: locally, and or imported. Let’s start with the imported stuff, shall we?

The Nigerian Bureau of Statistics records the top 15 products based on import value, across the past 3 years the top 8 have remained constant, with number 1 being motor spirit (or fuel). However, what is most interesting to me is numbers 3 and 4 (Durum wheat) and (Cane Sugar). At first, I didn’t know what Durum wheat was, so I did a Google search and you’ll never guess what I found.

“Doughs made from durum wheat tend to have higher extensibility. This means they are more easily stretched into long pieces without breaking, making them ideal to use in pasta.”, Healthline

Sugar, on the other hand, is instrumental in almost every single confectionery, soft drink, and pastry in the country. These two products are essential inputs (raw materials) in Nigeria’s food ecosystem. And what makes their prices gradually go up, year after year? Simple, cast your mind back to The Laws of Economics 101

To import goods into Nigeria requires the use of USD, and as the Naira loses value, the cost of importation becomes more and more expensive. As a result of this, businesses pass on the increased cost to consumers in the form of higher prices. This leads us to the next segment of the cost of production.

Resources and Other Costs

In this segment, I will only show you guys one variable: fuel. Cast another glance at the table of the most imported items in the country. The three-time reigning defending champion is Motor Spirit, or simply Fuel. The logic is quite the same here but with one added variable: the price of crude oil in the international market. A brief explainer, crude oil is priced at 10 USD, then a country (Let’s say the Fire Nation) explores it and sells it to another country (let’s say Earth Kingdom) at this point the crude oil becomes an input. The Earth kingdom then refines the crude oil with a refinery (that consists of machines invested in, salaries of staff who operate the refinery, and the cost of renting tankers that will transport the refined crude) by the time this process is done, Earth Kingdom sells the refined crude back to the fire nation at 20 USD (covering the 10 USD for the crude, and all other costs of production). However, the price of crude oil, i.e., the initial 10 USD is priced globally by the forces of demand and supply. Therefore, increases in the price of crude oil will translate to increased overall costs for the fire nation, while reduction in the price “should lead to lower fuel costs.”

But why is fuel so important in the cost of production?

Well, fuel is important in two phases:

1. Operating
2. Transportation

In every Nigeria vs Ghana thread, there is always one clapback the Ghanaians have, and that is “Nigerians do not have light” and be that as it may, it is the truth. Inconsistent power supply forces businesses to operate with self-generated electricity, which is more often than not, powered via diesel generators.

As for transportation (logistics) when goods are imported, manufactured, harvested (whatever), they need to move from point A (origin) to point B (wholesaler, retailer, customer) part of the cost of moving these goods is the cost of fuel for these vehicles be that fuel and/or diesel. The image below paints a somewhat grim picture of the situation. To understand how serious this is for businesses, the cost of a liter of diesel has risen by 4x, and that of fuel is about 3.5x, so whatever operations these businesses are doing any cost that bears fuel and or diesel has basically been multiplied by 4. I’ll paint another story.

Imagine a factory that bottles your favorite soft drink that operates 12 hours per day with a diesel generator that uses 100 liters every hour, some simple math here shows that the factory uses 1200 liters across the entire day. The price of diesel was NGN 300 in 2021, which means the total cost of operating the diesel generator was (NGN 300 x 1200) NGN 360,000 per day. Now that the price of diesel is NGN 1100

The factory would be spending NGN 1,320,000 (Crazy!) How else will that business survive?

1. Pass the cost to the consumers by increasing the prices of its drinks.
2. Reduce operating hours.
3. Lay off staff to manage costs.

Ladies and gentlemen, this has been a long piece, with lots to talk about but I shall have to end here for this segment.

And so, the End

In our last piece on the exchange rate, I said that the exchange rate in itself is not the holy grail, it is just an indicator of any country’s fundamental operations. I shall repeat the same thing here.

Over this article, we have seen many issues with the economy; from low raw material independence to nearly non-existent refining capacity, and under-development of the power sector, which are all forcing businesses and individuals to incur costlier and less efficient means of production.

The solutions are simple but immensely complex, what do you think those are?

T for Thanks and God bless.