CBN and the burden of inflation

Around the world, prices for goods and services have risen as economies slowly emerge from restrictions that governments and medical authorities have deemed necessary to put in place to contain the spread and death toll from SARS-CoV -2, the virus that causes COVID-19. Unsurprisingly, stores, offices and businesses emerged from these closures much slower than their customers opened their wallets. The resulting excess demand over supply has been the main driver of rising prices everywhere.

For some time, the monetary authorities, particularly in Europe and North America, were convinced that this shock to the supply-demand balance was temporary and were therefore slow to respond to it. That was until signs of tightening labor markets and rising prices in sectors of the economy where price behavior had traditionally been non-volatile began to appear.

As a result, last month the US Federal Reserve began to tighten monetary conditions by raising interest rates. The Bank of England had begun tightening much earlier, while the European Central Bank, by accelerating the end of its bond purchase program, paved the way for a hike in its key rate. Significantly, frontier/emerging market central banks had started raising policy rates earlier and faster.

PREMIUM TIMES understands that by redirecting money from circulation into bank vaults, higher interest rates help quell the demand pressures that fuel inflation. This is the logic of the less accommodating monetary policies that we are beginning to see in developed economies. Higher rates in these economies also mean that investment funds will move funds from dodgy jurisdictions to these safer financial havens. As a result, frontier and emerging economies have acted to increase the attractiveness of holding assets in their currencies by increasing their returns.

Over the past two years, inflation in Nigeria has averaged 15%, for example rising from 11.02% in August 2019 to 18.17% in March 2021. It closed in February at 15.70% . In response to this pressure, the Central Bank of Nigeria argued that the main drivers of price pressure were transitory and therefore did not require any action on its part.

Like most Nigerians, PREMIUM TIMES has been waiting for this transition to end and for the rate at which domestic prices are rising to begin to decline. The one process that seems to have come to an end, however, is the spending capacity of the average Nigerian. By failing to curb runaway inflation, the CBN has contributed to a rapid erosion of the purchasing power of the average Nigerian. And the longer it refrains from acting to limit inflationary pressures, the more harmful the side effects of the necessary drugs would be.

PREMIUM TIMES understands that a major trade-off is involved when interest rates rise. While inflation can be successfully stifled, as Paul Volcker did in the United States by raising interest rates in the 1970s and early 1980s, it often pushes an economy into recession. Indeed, the markets are already interpreting the recent inversion of the yield curve in the United States as a harbinger of a recession.

The Central Bank of Nigeria might therefore be right when it says that in this interest rate conversation it has opted for economic growth rather than containing inflation. Unfortunately, this journal struggles to accept this argument in the face of available evidence. Banks are the primary transmission mechanisms through which the CBN’s interest rate policy affects the economy. When the central bank raises its benchmark interest rate, yields on retail deposits rise, pulling money out of the economy into bank vaults. But the cost of loanable funds is also rising, limiting economic activity.

However, during the period that the Central Bank of Nigeria has continued its zero interest rate policy, the only rates that have come down are those that depositors get from their banks. The consequent push of deposits out of bank vaults into circulation may have fueled the pivot of cash-rich segments of the economy into other asset classes, putting pressure on the naira along the way. Banks, however, continue to charge more than 20% for retail loans and around 14% for their large corporate customers. In other words, the difference between the interest income our banks get from loans and mortgages versus the interest charges they pay to savings account holders may have gone from an average of about 5% to an average of 15% over the past two years.

Should the CBN increase its benchmark rate, PREMIUM TIMES therefore cannot see this impacting already high bank lending rates. This, however, would reward depositors who refrain from spending and thus help contain rising domestic prices and pressure on the naira.

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