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How to invest when inflation bites

Alice Abegunde, a mother of three teenagers, does not understand the reason behind the constant increase in the price of rice, her children’s favourite food.

“Every time I go to the market, they have added to the price of rice,” Abegunde, 44, a resident of Lagos State, says.

While Abegunde might not be able to connect the dot and blame the rice sellers for the rise in price, Emeka Johnson could, he knew times were going to be hard as inflation numbers kept rising and resolved to save more and spend less.

What Johnson does not know is that he is constantly losing money because the value of his money drops as inflation rises.

What is inflation?

Inflation is the general rise in the prices of goods and services over time. The “inflation rate” is the rate at which the change in prices happens; this is usually expressed in percentages over time. For instance, if inflation goes up 10 percent than last year, it means purchases will cost 10 percent more than they did last year.

Basically, inflation reduces the value or usefulness of money; the higher inflation rises, the less your money is worth, in real terms as time goes by. Therefore, inflation is about your purchasing power, that is, how much your money can buy.

What causes inflation?

There are reasons why prices rise. First, when everyone suddenly develops a taste for beef, the price of beef will rise. This follows a basic law in economics that, higher demand for a product will push up its price. This is also called demand-pull inflation.

What this means is that when the demand for goods and services in the economy exceeds the economy’s ability to produce them, their short supply places upward pressure on prices and gives rise to inflation.

Another reason prices rise is that the cost of producing goods and services increases. Companies would usually respond to higher cost of production by increasing the price they sell their products; they do this to cover the extra cost they incurred while producing. This is known as cost-push inflation.

How is inflation measured in Nigeria?

Every month we hear news about new inflation rate or data but have you ever wondered how it is calculated? Nigeria uses a well-known indicator called the Consumer Price Index (CPI), which measures the average change over time in prices of goods and services consumed by people every day.

In Nigeria, the CPI is calculated by the National Bureau of Statistics (NBS) and published every month. To calculate CPI, the NBS gets people to collect prices for thousands of items that an average Nigerian consumer buys such as food, prescription drugs, rent, petrol and many others. These items are grouped into categories called baskets. Every month, the NBS calculates the price changes of each item from the previous month and aggregates them to work out the inflation rate for the CPI basket.

Who controls inflation?

The Central Bank of Nigeria (CBN) is in charge of controlling inflation in Nigeria, not the government. The CBN has an objective of price stability, which means keeping inflation at a rate that keeps prices stable. An acceptable rate of inflation is single-digit inflation, anything above that will increase hardship in the country. At the moment, Nigeria’s February inflation rate is at the highest in four years, at 17.33 percent.

Read Also: Inflation tops discussion as MPC meets today

What inflation does to your money

There are reasons to worry about inflation and this concerns how rising prices affect money or our standard of living.

First, if expenses rise more rapidly than income as a result of inflation, it deteriorates the standard of living as that means it becomes difficult to afford as much as you used to, including the necessities.

When inflation rises, your savings might be worthless with each passing year, especially when the interest rate is lower. In Nigeria, the monetary policy rate (MPR) is currently at 11.5 percent. What this means is that the banks are to pay an average interest rate of 1.15 percent to their customers for saving with them.

If a depositor puts N100,000 in a savings account that pays 1.15 interest rate, after a year, you will have N101,150 in your account. But adjusted to inflation (17.3%), the N100,000 is only worth 82,700 in real terms.

If inflation really gets out of control, it becomes what is called hyperinflation, when money is worth so little that it is more or less worthless.

Why Nigeria’s inflation keeps rising?

Nigeria has had the problem of inflation before the pandemic arrived. In August 2019, the Federal Government made a decision to shut the land borders to trade with neighbouring countries as a way to boost local production.

However, this policy yielded little gains because the country could not produce enough to meet the demand of its huge population. Therefore, the gap the local production could not cover was passed on to the consumers in the form of high prices.

In July 2019, before this border closure policy was initiated, Nigeria’s inflation rate stood at 11.08 percent but since that time, inflation has been rising to reach the recent 17.33 percent.

The failed border closure pushed the cost of food upwards and this drove inflation during the period.

Even though Nigeria opened up its borders in December 2020, but prices are still rising as there are issues like insecurity in the North, where the majority of food items are grown.

There have also been a number of violent farm attacks, and clashes between herders and farmers in the North. This makes farmers apprehensive to go to their farmlands, and this would continue to weigh on food supply.

Why has the CBN not managed inflation yet?

If the CBN is responsible for keeping prices stable, you may wonder why they have not done anything about it.

When high inflation occurs alongside high unemployment and low economic growth, the CBN finds itself in a dilemma.

The CBN strategy for addressing inflation is to reduce the amount of money in circulation, called tightening. They do this by raising bank’s interest rate, this makes people borrow less as it is more costly to borrow. This reduces the money in circulation and brings down the inflation rate.

On the other hand, when there is high unemployment and low economic growth, the CBN pursues an expansionary policy, which means they reduce the cost of borrowing for more people to borrow for investment, boosting employment and economy growth.

The current dilemma of inflation is occurring at a time unemployment is high and economic growth is low. The unemployment rate expanded to 33 percent in the fourth quarter of 2020, up from 27.1 percent in the third quarter.

The economy grew 0.11 percent in the fourth quarter of 2020 and -1.92 percent in the whole of 2020.

Godwin Emefiele, the governor, CBN, said in the last MPC meeting that since the country just crawled out of recession in Q4 2020 if the MPC tightens, it would make it difficult to access credit needed, as the investment needed to drive growth and the economy could slip back into recession.

“We would not lose sight of inflation. Inflation may move up in April but we expect inflation to begin to moderate from May. By that time we should have our Q1 GDP numbers and we hope it shows significant growth and then we begin to attack inflation,” Emefiele said.

How inflation affects investment

Since inflation makes it difficult to save as the value of money is eroded, investment is another option but this also is affected by inflation.

Most investors aim to increase their long-term purchasing power. Inflation puts this goal at risk because investment returns must first keep up with the rate of inflation in order to increase real purchasing power.

For instance, an investment that returns 10 percent before inflation might seem great but in an environment where inflation is 17 percent, the actual returns will produce a negative return of -7 percent when adjusted to inflation. This is not a profitable investment.

A profitable investment would always be one that can give a return on investment above inflation rate.

How your investment can beat inflation

Even when inflation hits savings and investment hard, it is still important to keep wealth growing. And there are ways to do this:

Ayodeji Ebo, head, retail investment at Chapel Hill Denham, explains that there are not many investments that can give returns above Nigeria’s inflation rate, and where there are, they come with risks so investors will need to increase their risk appetite.

Despite the economic uncertainties, it is not all bad news as there are ways to beat inflation.

Eurobond

“One way is investing in foreign currency denominated fixed income instrument like Eurobond, corporate Eurobonds, sovereign Eurobonds is one way to hedge your funds against inflation,” Johnson Chukwu, CEO, Cowry Asset Management, says.

Eurobonds currently offer a yield of 7-8 percent on long-term investment as at March 18, 2021, according to data from Debt Management Office.

“Once you can invest in an instrument that gives you a dollar value assurance, then you mitigate the loss as a result of inflation and devaluation of currency,” Chukwu states.

Stocks

This might also be a good time to invest in the stock market. The stock market has not been doing so well this year compared to how it ended last year. The market has dipped 3.37 percent, this is because the investors who initially trooped into the stock market as a result of the low yield environment experienced last year are moving out as the interest rate is gradually rising this year. This means they are seeking other investment that can give better returns.

However, this presents an opportunity for investors to take position.

“Share prices are falling and this provides an opportunity to enter the stock market at a cheaper price so you can ride it when it is going up. For smart investors, now can be a good time to start picking some of the strong names that are trading cheaply on the stock exchange,’’ notes Yinka Ademuwagun, a research analyst at United Capital.

Berkshire Hathaway, CEO, Warren Buffett, said, “When investing in the stock you simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful.” In other words, “buy when the price is low and sell when prices are high.”

Another advice he gave was when planning to invest in individual stocks, don’t base your choice on which company is performing well right now. Instead, consider what business has staying power.

Real estate

Real estate in Nigeria, like in many parts of the world, is an ever-increasing-in-value investment.

Investing in real estate helps to keep pace with inflation because as inflation rises, so do property value. This also means a landlord can charge for rent, therefore earning higher rental income over time.

Treasury bills

Treasury bills are short-term sovereign debt securities maturing in one year or less. They might not be able to deliver an investment return higher than inflation but they close the gap in real interest rate.

The 364-day Federal Government less risky treasury bills is at 7 percent as analysed from Nigerian treasury bills primary market auction results for March 17, 2021.

Although, with an inflation rate of 17.33 percent, the real return for the 7 percent interest rate is -10.33 percent, but investing in treasury bills helps to close the gap in negative real return.

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