By Samuel Adeleke Adelaja
On May 21, 2024, the Central Bank of Nigeria raised the monetary policy rate to 26.25 percent (the third rate increase in four months) in an attempt to curb belligerent inflation woes and bring much-needed stability to the market. What impact have past rate hikes had on the state of inflation in an import-dependent economy such as ours and against the backdrop of a currently floundering naira?
According to the Central Bank and National Bureau of Statistics websites, across four MPR increases over the past 12 months—the first of which came in May 2023—there has yet to follow a corresponding decline in the rate of inflation (steadily increasing to close the year at 28.9 percent from 22.4 percent at the time). How effective, then, is MPR as a tool to combat inflation in an economy as nuanced as ours? Weighing the pros and cons of this well-trodden path will form the basis of this article as we look to consider other avenues towards taming the inflation ‘Nothing’ (see title).
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The Nigerian economy has faced material headwinds over the past decade, led, primarily, by a weakening currency and its commensurate impact on the buying power of a populace largely dependent on imported goods for basic survival. A weakening currency has, therefore, directly resulted in higher prices and Consumer Price Index levels scaling from 8.0 percent as of May 2014 to 33.7 percent as of April 2024.
Rate hikes: A few pros
Increasing MPR directly influences interest rates. Increasing the monetary policy rate raises the cost of borrowing and reduces the money supply—in essence, resulting in the cooling of an overheated economy. In other words, higher rates should lead to lower spending and, therefore, a lower increase in prices.
Attracts foreign investment. Higher interest rates make Nigeria a more attractive destination for foreign portfolio inflows, helping to stabilise the naira and balance of payments. While interest rates remain attractive, foreign investors are likely to create demand for the naira and inject much-needed USD into the economy.
Signalling effect. Increasing MPR communicates to the market CBN’s commitment to controlling inflation helps soothe market sentiment and create a sense of direction.
Don’t forget the cons
Slows economic growth. Increasing rates ad infinitum is not a viable option; finding the biting point is important. At increasing rates, businesses are less likely to borrow and therefore invest. Slowing an already decelerating economy could have a material adverse impact on employment levels and small businesses.
Impact on government borrowing. Higher interest rates, naturally, increase the cost of servicing public debt, which can strain government finances and redirect capital from much-needed funding programmes.
Less-than-effective means of tackling supply-side inflation. MPR increases are less effective in addressing supply-side inflation caused by factors such as rising production costs, supply chain disruptions, or, indeed, weakening local currency in an import-dependent economy.
So what alternatives exist?
The war on inflation cannot be fought unilaterally. It requires concerted, unified effort on all sides, given the magnitude of the problem. As such, the search for alternatives must expand to fiscal policy. Rationalising government spending for the current reality directly lowers aggregate demand in the economy; this must be executed with precision and in tandem with policies to encourage local and international private sector participation.
Support for innovation in critical industries (e.g., agriculture and manufacturing) to enhance productivity and reduce costs is another plausible lever available in a coordinated approach to tackling current inflation levels. Notwithstanding the considerable lag effect (this is not an overnight approach by any means), it does create positive momentum and clear direction for the future. While there have been clear initiatives introduced over time—the Anchor Borrowers Programme to provide loans to smallholder farmers and the Agricultural Transformation Agenda, which focuses on improving agricultural productivity through technology—these have been beset by challenges in consistent policy implementation.
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Joint policy coordination and consistency. Fiscal and monetary policy alignment strengthens policy credibility. Clear and consistent messaging reduces uncertainty, which is critical for managing inflation expectations. Through a coordinated approach, fiscal policy can offset the adverse effects of rate increases (an example of which would be stalling economic growth) by redirecting government spending towards social programmes or public infrastructure investment.
The Central Bank dilemma
The Central Bank has actively employed rate increases—generally a crucial aspect of maintaining economic stability—as its primary means to manage inflation. However, given the diminishing marginal effectiveness of this as an instrument, understanding its practical boundaries and the complex dynamics of the Nigerian economy—as discussed above—lean towards a comprehensive and coordinated policy approach.
Considering the unique challenges of an import-dependent emerging market with less than robust foreign reserves and a negative balance of payments, a combination of the above-mentioned strategies may be the remedy required to course-correct.
Samuel Adeleke Adelaja: Head, Partnerships at Airtel Business Africa; Investment Director at Airtel Africa
