Last year, as inflation reached record highs in many countries, central banks around the world adopted one of the most aggressive monetary tightening policies in decades. In response to the COVID-induced recession of 2020, most countries implemented both fiscal and monetary stimulus fireworks simultaneously. For example, the US threw in about $5.2 trillion of fiscal stimulus into the economy in an attempt to close an output gap of about $400 billion. In what is popularly known as quantitative easing phase four (QE4), the US Federal Reserve Bank grew its balance sheet from $3.9 trillion in mid-March 2020 to $8.8 trillion in early 2022. Other economies, such as Japan, the EU, etc., followed the same trajectory with massive monetary easing. Shortly, the US and other economies experienced a rebound in economic activity.

By 2021, the US would have crossed its pre[1]pandemic long-term growth level. But exiting the recession brought another shock: inflation! Inflation began brewing in 2021, rising to 7.0% in December 2021 in the US from a pre-pandemic level of 4.5%. In Nigeria, inflation hit a high of 18.17% in 2021 before decelerating to 15.60% in January 2022. The invasion of Ukraine by Russia in late February 2022 disrupted the global supply chain, led to spikes in energy and commodity prices, and monumentally quickened the inflationary pressure. Inflation reaccelerated in Nigeria to a high of 21.82% in January 2023. 

The Central Bank of Nigeria (CBN) ditched its earlier accommodative monetary policy in May 2022 and began raising the policy rates in what became the fastest and most aggressive interest rates hike since the 2001 tightening cycle. So far, the monetary policy committee (MPC) of the CBN has raised the benchmark interest rate by a cumulative 600 basis points to 17.5%p.a. from 11.5%p.a. in May 2022. However, after eight straight months of monetary tightening, inflation remains persistent and accelerating. In January 2023, inflation hit a record high of 21.82%, up from 17.71% in May 2022 when the CBN adopted its restrictive monetary policy. Although the CBN has reiterated its commitment to remain committed to tackling the spiralling inflation, it appears that the price pressure is falling out of its control. 

This time, inflation is more structural than monetary 

Interest rate hikes are usually employed by the central bank to rein in inflation. This is based on the understanding that inflation is at all times a monetary phenomenon – too much money is chasing too few goods. Thus, raising interest rates and reducing money supply will reduce the demand for goods and moderate the pressure on prices. In this regard, monetary tightening is a panacea for controlling rapidly rising prices.

Exchange rate pass-through 

However, what we have seen is that this current inflationary pressure is more of a structural problem than a monetary one, and if such structural problems are not addressed, the CBN may be flogging a dead horse. First, based on our estimates, the major drivers of inflation in Nigeria are the exchange rate pass-through, supply shocks, and fiscal deficit monetization. In the past year, the naira depreciated by 26% to N765/$ from N569/$ in February 2022. Nigeria is a net importer economy with a fairly inelastic import demand. In other words, exchange rate depreciation will translate to higher prices. 

Supply shocks 

Nigeria has seen one of its most supply shocks in the past year. Escalating insecurity in food[1]producing, including Benue, Plateau, Kastina, Zamfara and other northern states, has reduced the volume of the cultivated lands. As the number of displaced farmers increases (now estimated at 7.2 million farmers), the supply of farm produce for both food and industrial purposes becomes increasingly constrained. Insecurity, especially kidnapping for ramson has also disrupted the supply and distribution of agricultural products, creating an excess demand problem which is usually inflationary. Also, the price of diesel (a major source of industrial energy and logistics fuel) spiked to a high of ₦828.82 per litre in January 2023 from ₦288.09 per litre in the corresponding period in 202, which is 187.69% higher. PMS scarcity distorted the uniform pricing with the price more than doubling to about ₦300 - ₦450 in most cities. 

Fiscal deficit monetization 

Another structural constraint is fiscal deficit monetization. Nigeria began a borrowing spree in 2015 raising its debt stock by 389% to N77.3 trillion at the end of 2022. The most interesting aspect of the fiscal rascality is the unprecedented increase in Ways & Means by 3,574% to N23.7 trillion from N645 billion in 2014. Fiscal deficit monetary involves “printing money” to finance government spending through the CBN and the inevitable macroeconomic cost is inflation.

Inflation pattern in most net oil exporting countries 

Indeed, a look at the inflation pattern in most net oil exporting countries shows that most of the net oil exporters dodged the inflation bullet except Nigeria and a few other countries with legacy constraints. For example, in Angola, inflation decelerated to 14% in December 2022 from 25.8% in April same year. Inflation also moderated in Iraq and Algeria over the same period. In Saudi Arabia, inflation rose marginally by 1% to 3.3% in December from 2.3% in April. Indeed, net oil-exporting countries enjoyed a tailwind in 2022, while Nigeria suffered a headwind with net oil importers. 

The MPR, an anchorless anchor 

Second, the MPR as an anchor and signaling rate is increasingly becoming disconnected from the short-term interest rates. This distortion in the term structure of interest rate deflates the effectiveness of interest rate hikes in Nigeria. Available data shows that after raising the MPR by 100 bps to 17.5% last month, the auction price of the 1-year Treasury bill rate declined to 2.24% from 14.84% at the end of November 2022. This apparent contradiction sends a mixed signal to the market, and undermines the potency of the rate hike. In the US and most other countries, one-year TB moves in the same direction as the MPR with inflation moving in the opposite direction. However, in Nigeria the case is different. Inflation moves with the MPR in the same direction while TB diverges.

How has inflation impacted Nigerians?

Inflation is a cankerworm and an unauthorized catchpole. It imposes inestimable costs and losses on consumers, savers, fixed-income earners, and businesses. Consumers: Households are worse off when prices rise faster than their nominal income, especially in countries where wages or salaries are not indexed to inflation. Inflation erodes purchasing power, and to the extent that consumption is a function of income, it affects the poor disproportionately. Given that low[1]income households spend a greater proportion of their income on essentials, inflation is indeed hitting the poorest households twice as hard as the richest ones.

A new Oxfam report shows that "the richest 1% bagged nearly two-thirds of all new wealth over the past two years, nearly twice as much money as the bottom 99% of the world's population." It went further to say that the three richest men in Nigeria have more wealth than 83 million citizens. Indeed, Nigerian consumers are living on edge. With stagnant wages and rising costs of living, deprivation and desperation are currently at an all-time high. 

Savers: When inflation rises quickly, money loses its value rapidly. This is because interest rates rarely keep up with increases in the general price level. With the saving rate of 5.25% (30% of MPR) and inflation at 21.34%, savers lose 16.09%p.a on their savings. In other words, N1million kept in savings account will only buy goods worth N839,100 after one year. The save lost N160,900! Anecdotally, the loss could be as much as N440,000 in one year. In other words, inflation discourages savings in the domestic currency and could force savers to fly to safety in dollar, a recipe for dollarization. 

Fixed income earners: Workers who are locked into fixed-wage contracts are another group who could suffer substantially from inflation. One of the most difficult things in Nigeria is wage/salary adjustment. A typical Nigerian worker can be on the same salary for over five years and salary is hardly adjusted during inflationary episodes. For example, the CPI has grown by around 82% since the last minimum wage of N30, 000 was announced. This implies that in naira terms, a civil servant that is paid N100,000 today has real income of N18,000 relative to the value of the same amount received in 2019. 

Fixed income investment: Inflation shrinks the real returns with double digit inflation most likely to yield negative real returns. Since the return on fixed income investment is static, every unit increase in inflation constitutes a unit increase in real returns. 

Businesses: When inflation rises rapidly and persistently, the prices of production inputs (such as raw materials), and capital goods (like machines) also rise. In other words, businesses lose purchasing power. The production budget constraints shrinks and total output dwindles. Companies often increase the prices of their goods or services in reaction to inflation, with the result that volume purchases decline. Also, the risk of bad and doubtful debt increases, and provide margin fells.

Impact of interest rate on businesses 

Interest hike is a two-edged sword. When the economy is running hot and inflation is exceeding permissible thresholds, an interest rate hike could be a veritable tool for cooling the economy and bringing inflation under control. This is most potent when inflation is a "monetary phenomenon": too much money chasing too few goods. It increases the propensity to save due to an increase in the saving rate, reduces access to cheap money, and induces holders of idle cash to invest their cash in interest bearing securities rather than holding idle cash for transactional purposes. By raising the borrowing costs, excess spending is moderated and inflationary pressure subsides. A higher interest rate can also strengthen the naira and lead to an increase in capital inflows. But this is not the end of the story! 

Interest rate hikes raise borrowing costs and can trigger a fall in asset prices. This can further depress a firm’s balance sheet and induce a cash flow crisis. It also heightens the risk of loan default and reduces businesses' access to loanable funds. Overall, investment falls, aggregate demand declines, and output growth slows or even contracts. 

Has Nigeria hit a brick wall? 

Although Nigeria seems to be on the precipice with the sword of Damocles hanging over its macroeconomy, there are still viable policy options that could pull the economy out of the woods. Nigeria must rethink its inflation containment measures. It must prioritize structural reforms. Structural reforms are the best policies to alter the supply-side economy. They are targeted at removing market impediments, thereby increasing the efficiency of the market process. Structural reforms can lead to an increase in the supply of inputs and the efficiency of resource use. 

To tackle inflation, Nigeria must reform its exchange rate system. Empirical evidence shows that exchange rate volatility as well as large depreciations are consistent with spiralling inflation. The current multiple exchange rate system must be jettisoned for a more efficient regime that removes the impediments in the willing-buyer-willing-seller market. 

The policymakers must show commitment to stop the current fiscal rascality. Mindless borrowing and the culture of financing recurrent expenditure by printing money must be discontinued. The policymakers must rethink their several price control and subsidy programs—fuel subsidy, interest rate subsidy, electricity tariff subsidy, fertilizer subsidy, and many more. The time for action is now or never.