NIGERIA PREVIEW: Renewed Growth Risks Top Inflation Concerns

LAGOS (Capital Markets in Africa) — The Central Bank of Nigeria is likely to keep rates on hold on today as it bids to support the recovery amid the second wave of Covid-19 infections. Inflation is surging, but policymakers view the above-target rate as unavoidable, with supply bottlenecks being amplified by the pandemic. The rate decision is expected at 1 p.m. London time.

Activity in Nigeria has shown signs of improvement since the gradual opening up of the economy. The recovery, however, is likely to be set back by the second wave of infections and ongoing uncertainty around the vaccine rollout. This is likely to dampen the expected output recovery, even with the recent gains in oil prices.

This should keep the central bank on hold and push policymakers to step up their heterodox supply-side and credit interventions in order to boost the recovery.

The decision on rates is likely to be unanimous, given the central bank’s expectation for inflation to moderate in the near term — based on the commencement of the harvest season and the reopening of land borders closed since 2019.

We still forecast inflation to accelerate further, but don’t expect a rate hike until the recovery has gathered pace.

CBN to Hold Rates, Maintain Heterodox Policy Tools
The coronavirus pandemic has amplified the shortcomings of the Nigerian economy, pushing the central bank further away from its price stability mandate. Demonstrating this, the CBN cut rates by a total of 200 basis points last year in response to the crisis despite the rising trend in inflation.

The headline inflation rate increased from around 12% at the beginning of 2020 to 15.8% in December — it has remained above target since 2015. Policymakers, though, have continued to overlook the elevated level, arguing it is structural and unresponsive to conventional monetary policy. Instead, the central bank has adopted a number of unconventional tools in an attempt to balance the competing interests of lower inflation, naira stability, and economic growth. These have included:

Direct credit extension to sectors identified as necessary for growth and diversifying the economy.
Liquidity drainage through the cash reserve ratio, the loan to deposit ratio, and special market operations.
The use of multiple exchange rates and an import ban on more than 40 goods.

These measures amplify the distortions in the economy, causing more harm than good. Direct lending through the central bank’s credit facilities has weakened the effectiveness of the policy rate as the main tool for managing inflation — domestic lending rates and credit supply are not directly influenced by it. This has widened the disparity between lending and deposit rates.

At the same time, the use of other policy parameters to drain liquidity undermines stimulus measures and efforts to accelerate credit extension, making them counterproductive. Lastly, the exchange rate management practices create scarcity (of both dollars and essential goods), raising the overall level of domestic prices and thereby fueling inflation. They also undermine growth by deterring investment and making it difficult to source the intermediate goods required for big business to produce.

The second Wave Adds to Growth Risks
Nigeria’s economic activity has shown signs of improvement since the gradual opening up of the economy, but the PMI remains in contractionary territory. A robust expansion in output has proved difficult to sustain, because of OPEC production cuts and ongoing foreign exchange shortages that continue to hamper activity in the non-oil sector. Adding to the risks is a renewed virus outbreak and uncertainty around the vaccine rollout.

This outlook should continue to keep the CBN on hold until the recovery gathers pace, PMI indicators accelerate above the expansionary 50 marks, and annual GDP growth is positive. Until then, we expect policymakers to continue to overlook inflation and argue it is structural. This will allow the central bank to continue justifying the use of supply-side and other policy interventions. It may also encourage the CBN to introduce new measures to narrow the disparity between the lending and deposit rates.

What’s Behind Surging Inflation?
Nigeria’s inflation rate has been above target since 2015. This primarily reflects the impact of weaker oil prices (and therefore bigger foreign exchange shortages), as well as restrictions on the import of certain goods aimed at diversifying the economy through import substitution.

Further fueling inflation is border closures (which have now been reversed) and tightening import restrictions. Increasing pressure on the public finances has also led to a VAT hike, electricity price increases, and the removal of a fuel subsidy.

The harvest season typically eases the pressure on food prices. Rising insecurity and floods, though, have reduced a harvest that is already expected to disappoint. As such, we expect prices to remain elevated until the CBN takes a more concerted effort to tighten all policy levers.

Boingotlo Gasealahwe covers Africa for Bloomberg Economics in Johannesburg. She previously worked as a senior economist in the economic policy division of the South African Treasury. She has an MSc in development economics and an MBA from Oxford.