Nick Agule
Twitter: @NickAgule
Email: nick.agule@yahoo.co.uk
Facebook: Nick Agule, FCA
28.02.2024
Introduction
The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) yesterday, 27th February 2024 briefed the nation on the outcome of its meeting.
A major decision that was announced was to raise the Monetary Policy Rate (MPR) from 18.75% to 22.75% (400 basis points). The MPR is the rate at which the CBN loans money to the commercial banks. The commercial banks in turn add their margins to the interest rate and charge higher rates on loans they extend to their customers.
Here are the reasons why this is a wrong decision for Nigeria’s ailing economy and rather than being the “necessary steps to get the country’s fiscal and monetary health back to normal” as the CBN Governor announced, rather portends the killing of the economy:
- The CBN erroneously thinks Nigeria is suffering from inflation alone, but the country is suffering from stagflation which is a triple whammy of inflation, low output and massive unemployment. Tragically if a doctor gets a diagnosis wrong at the outset, the medication will be wrong and possible death of the patient becomes a reality! This is the situation Nigeria’s economy faces now!
- Inflation alone can be tackled with increases in interest rate because if there is too much money in the economy that’s fuelling demand for goods and services, if the MPR is increased, individuals and businesses will find it more expensive to borrow so the volume of money in the economy will be reduced. Also interest on savings will rise and individuals and businesses will find savings more attractive therefore demand for goods and services will fall. With the combined effect of less money in the economy and lower demand, prices of goods and services will fall (fall in inflation is achieved!).
- With stagflation however, if you increase interest rates, you are doing more harm to the economy than good because you solve stagflation by increasing output hence creating more jobs. If you increase interest rate, it becomes more difficult for businesses to access credit to boost output. As businesses fold up, the unemployment situation worsens! To resolve stagflation therefore requires interest rates to be cut so that businesses can afford cheaper credit and boost supply which consequently boosts employment thus leading to economic recovery. Cutting rates risks increase in inflation but if the CBN is faced with the twin evil of inflation and low output/high unemployment, the economy stands a better chance of survival if there is a boost in output and a cut unemployment. If interest rate is hiked, the economy may never recover. But if interest rate is cut, output will rise and unemployment will fall and even if there is a side effect of increased inflation, it is a better outcome overall!
- A rise in interest rates tackles demand-pull inflation. However, Nigeria’s inflation is not only demand-pull (rising prices due to demand). There is a massive cost-push inflation (rising prices due to increasing input/production costs) arising from the twin government policies of increase in fuel costs and foreign exchange unification. Due to the poor power supply in Nigeria, businesses are forced to run on generators and the increasing fuel costs are transferred to prices. Same for increasing transportation costs. Same for increasing costs of imported inputs. Even the increased cost of borrowing becomes inflationary as businesses transfer all these costs to the consumers! All these factors lead to rising prices without a change in demand. INTEREST RATE RISES WILL NOT RESOLVE COST-PUSH INFLATION!
- To make matters worse, the CBN increased cash reserve ratio (CRR) to 45% (which is the amount of deposits that commercial banks must transfer to the CBN) e.g. if a customer deposits N1m the commercial bank must transfer 450k to the CBN and only have 550k to loan to the economy. This curtails the bank’s ability to boost the economy which is in stagflation and badly needs a boost in output or slow death is imminent! Increasing interest rates in an economy that is struggling to breathe (low output and massive unemployment) is killing such an economy!
- Another major cause of inflation in Nigeria is supply shortages (from low output). Even if demand remains the same or even falls, if the supply of goods and services falls, there will be inflation! A good example is food. Because less food is being produced due to insecurity around the country’s farming communities and even where farming is taking place it is by manual labour that does not produce much, and imported food has become too expensive due to naira crash, and farm inputs have become more expensive due to forex crash, the supply of locally produced food to Nigerian markets has drastically fallen such that even if demand is held constant, the prices will rise. Demand for food and other necessities does not respond to MPR because people must eat therefore even if MPR increases to 100% consumers will not save because they must buy food to survive! The solution to the food crisis therefore is to reduce interest rates so that farmers can access cheap credit to produce more food! And urgent steps must be taken to mechanise agriculture and insecurity must be addressed! FOOD INFLATION WILL NOT RESPOND TO INTEREST RATE INCREASES!
- Ways and means. This is a process where the CBN prints money (credits the account of government without value) which throws a lot of liquidity in the economy which in turn fuels inflation. The same CBN then raises interest rates to try and control the same inflation they have caused! The CBN can best control this inflation by stopping ways and means! INFLATION WILL NOT RESPOND TO INTEREST RATE INCREASES IF WAYS AND MEANS CONTINUES!
- With a massive unemployment approaching 50% and even those who are working are poorly paid or not paid at all, the CBN can provide data to support their conclusion that Nigeria’s inflation is demand-pull because empirical evidence suggests otherwise. At a minimum wage of N30,000 ($20), most households cannot even afford the basic necessities. Where is the demand the CBN is seeing? Interest rates increases in other economies have succeeded in taming inflation because 95% of the people are in jobs with money to spend whereas in Nigeria majority are living from hand to mouth! INTEREST RATE INCREASES WILL WORSEN THE UNEMPLOYMENT CRISIS IN NIGERIA!
- The CBN says interest rates increases will help with the foreign exchange crisis. However, those who are converting their naira balances into dollars will not stop even if interest rates rise to 100% because they want their money saved in dollars! Those who are looking for dollars to pay school fees and medical costs abroad will not stop because interest rate has gone up! Even if interest rate is 100% they will still buy dollars to pay the fees and medical costs! Interest rate increases rather does more damage to the foreign exchange crisis because as local businesses are unable to access cheap credit they will fold up or produce far less, Nigerians will thus continue to import goods including food thus worsening the exchange rate and exacerbating inflation. Only a boost in local production can support naira to become stronger and interest rate increases does damage to output!
- To underscore that the CBN has been getting it wrong, since the interest rates have been increasing, inflation is jumping higher and higher and not slowing as expected. There is no other evidence that interest rates rises is the wrong solution because the patient (economy) is not responding to treatment (interest rate increase)! In other nations, interest rate increases have succeeded in slowing down inflation but not in Nigeria! Nigeria is suffering from typhoid (stagflation), but the doctor (CBN) thinks it’s malaria (inflation)!
- With power supply at 3,000MW, the Nigerian economy is on life-support and cannot produce enough goods and services to meet even the basic demand. The Nigerian inflation is caused by low supply and not high demand as the CBN thinks! There can never be high demand when the people are multi-dimensionally poor! The solution is to boost power supply to at least 10,000MW in the first instance. Qatar where President Tinubu will soon be heading to are less than 3 million in population but delivery 12,000MW of electricity which is an average of 4,000MW per day to 1 million people but Nigeria is giving 3,000MW to over 200 million people! There is no way the Nigeria’s economy will do well with such abysmally poor power supply regardless of the interest rate! INTEREST RATE HIKES WILL NOT RESOLVE INFLATION FUELLED BY LOW SUPPLY WHICH RESULTS IN LOW EMPLOYMENT – STAGFLATION!
Conclusion:
To resolve Nigeria’s stagflation:
- The CBN is to STOP further rate increases and begin rates cut in line with President Tinubu’s pledge in his inauguration speech.
- The CBN is to reduce the CRR so that banks can have more liquidity to lend to the economy to boost ouput!
- Reduced rates will boost supply and cut unemployment leading to an eventual fall in inflation even if it rises at the first instance.
- Fiscal policy to release the power sector 100% into the private sector. Transmission company (a bottleneck in the power value chain) to be leased or sold to global power operators to boost the capacity. No sufficient power supply, no economy!
- Fiscal policy to mechanise agriculture, tackle insecurity, lease/sell steel plants, lease/sell the rail infrastructure, stop gas flaring and harness for power, domestic and industrial uses etc.
#ABetterNigeriaIsPossible
- Nick Agule is an oil and gas expert and a public affairs analyst.
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