The International Monetary Fund (IMF) has said that inflation caused by currency depreciation in Sub-Saharan African (SSA) countries is eight times stronger during a depreciation than an appreciation.
This suggests that inflationary pressures may not come down as quickly when local currencies strengthen against hard currencies in SSA countries.
In a recently published report, the IMF stated that the magnitude of the exchange rate pass-through depended on factors like natural resource endowment, domestic market competitiveness, and monetary policy effectiveness.
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In essence, a low level of competition in markets in SSA countries increased inflation rate because only a few market players dominated pricing, the report said.
“The low level of competition in emerging and developing economies meant that firms in these economies generally have greater pricing power; as a result, they can swiftly pass exchange rate depreciations through to domestic prices,” it stated.
“Lack of competition among firms in these economies has had significant costs, hurting the poor through higher prices of essential items and undermining growth and the ability of the economy to absorb shocks,” it further stated.
Similarly, the report stated that SSA countries with higher dependence on natural resources experienced higher exchange rate pass-through to inflation.
Oil-exporting countries also experienced more persistent pass-throughs due to such countries’ dependence on oil.
“Natural resource dependence is associated with weaker institutions, which undermines a country’s ability to manage macroeconomic shocks. Resource boom is also often associated with exchange rate overvaluation which can crowd out production from other tradable sectors,” the report said.
In terms of the appreciation-depreciation dynamic, the report noted that “in practice firms and importers generally have a stronger incentive to pass on a depreciation to prices than an appreciation” owing to a low degree of market competitiveness.
“Due to their higher market power, dominant firms operating in a less competitive environment have less incentive to reduce margins and hence appreciations. Therefore, they tend to adjust their prices more during a depreciation than during an appreciation,” it said.
This ensured higher profitability and markups for firms in SSA countries compared to other emerging market economies, it further stated.
However, the report noted that monetary policy effectiveness remains a crucial and effective tool in limiting exchange rate passthrough to inflation in SSA.
“Exchange rate passthrough to inflation is more muted in countries where inflation has been kept under check historically. This suggests improving monetary policy frameworks, and the proactive role of central banks in combating inflation can help reduce the exchange rate passthrough,” the report said.
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“Inflationary impulses from large depreciations can be persistent, and hence may require central banks maintaining a tight monetary policy stance for a sustained period,” it stated.
A researcher, Annie Olaloku stated that the Nigerian situation tallied in a way with the situation presented by the IMF.
“I think this tallies with the Nigerian experience: FX inputs are driving inflation but this is more acute for heavily concentrated sectors like cement (3 key players control 100%) and flour/wheat (5 players do 94% of milling),” she stated in a post on X.
Owing to the naira depreciating by almost 70 percent since June 2023, inflation has significantly increased.
The NBS reported an inflation rate of 31.70 percent last month, a record high in over 20 years as earlier reported by BusinessDay.
Thus, the Cardoso-led CBN has maintained a tight monetary policy stance to slow down the growth of the money supply and rein in inflation since he assumed office in September 2023.
Owing to the series of monetary policies designed to rein-in inflation, the Naira gained 42.58 percent of its value against the dollar from the lowest of N1,825/$ to on the parallel market since February 20, 2024.
However, this has not translated into lower domestic prices as commentaries on social media show.
“When the dollar was 1800, a bag of sugar was 74k, now that dollar is 1200, a bag of sugar is now 84k. Is the dollar really our problem?” Paul, an X user posted.
Another user, Al Ameen, echoed the same sentiments in a similar post.
“When the dollar was at 1900, you said the hike was the main reason for the increase in the price of Dangote sugar, and cement. Now that the dollar is 1340, the prices continue to increase rather than decrease. What is going on?”
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The report also noted that policies that promote competition should be prioritised to limit high exchange rate pass-through.
“We also find that higher levels of competition in domestic and more diversified economies, particularly countries that do not export oil, tend to have lower exchange rate passthrough. This suggests structural policies that promote competition in the domestic market and greater diversification may help lower the exchange rate pass-through in the region,” it said.
