2020 bushwhacked just about everyone. And across the world, responses to the challenges presented by the year have been as uncommon as they have been unique. At the level of the domestic economy, though, one trend has remained constant. Prices have risen every month in the last one year. At 13.71 per cent in September, headline inflation, year-on-year, currently poses serious implications for the health of the economy. At the most basic, the mix of components in the basket with which the National Bureau of Statistics measures domestic price changes reflects the all-in spend of the man on the street. In other words, what we see when the national bean counters indicate a rise in prices is how it hits the average Nigerian’s wallet. This does not mean that for affluent sections of the population (an increasingly rare species) rising prices do not matter. The dynamics simply differ because consumption is not such a large share of the spend as one ascends the social pyramid. So, for this cohort, the movement in prices doesn’t hurt as much.
Remarkable, then, that the monetary authority continues to ignore rising prices. Despite the fact that rising prices are cratering the pockets of the poorest and most vulnerable segments of a very indigent population, the Central Bank of Nigeria (CBN) argues that the main causes of the one-year long rising price trend are legacy structural factors. Amongst which it recently listed the inadequate state of critical infrastructure and broad-based security challenges across the country; disruptions to supply chains following restriction to movements to curb the spread of the pandemic; adverse weather conditions; the inflation pass-through to domestic prices, following the depreciation in the exchange rate; and recent increases in energy cost. By extension, the apex bank’s argument is that when the effects of this price adjustments wear off (the so-called “base effect”), we should see a moderation in inflation.
Two conceptual errors plague this logic, though. First is the assumption that the price rises from adjustment to the structure of the economy will necessarily be one-offs. There are still sectors of the economy where the light of the price mechanism still does not shine through, and if we are committed to an economy that is both efficient in the allocation of resources and transparent in how it allocates, we will eventually have to open these sectors up. Further, as government comes up against both a revenue-raising and borrowing ceiling, these reforms will be inevitable.
But beyond that we have seen from the pump-gate price of petrol, that the price rises from reforms are not necessarily a one-off. If input costs go up, prices rise; and vice versa. And with the economy only marginally reformed, the rudimentary levels of efficiency that it is currently capable of can only occur on the back of rising costs. And as inflation rises, workers will demand that their pay be indexed to rising prices, putting pressure on their employers to increase the prices of the goods or services that they sell. These higher prices in turn drive new levels of price increases. In the, more likely, instance that, unable to pass rising costs on to their markets and/or absorb it on their balance sheets, businesses go under, then the addition to the growing army of the unemployed – while throwing up different conceptual challenges from those thrown up by rising prices – may imperil the economy even more.
This cycle could be vicious, and so central banks tend to take the battle against inflation seriously. At the fringes of the resulting conversations, however, it is also recognised that rising domestic prices hurt the competitiveness of an economy. One way that an economy may adjust to rising prices is by allowing its currency reflect the toll on domestic activity of rising prices. Accordingly, such currencies depreciate. Depreciating currencies, on the other hand, feed through to rising prices.
There is thus a compelling need for the CBN to rein in rising prices before the negative feedback loop becomes harder to break, and the cost of rolling inflation back becomes exorbitant. To do this, the CBN must rethink its commitment to a low interest rate policy. Not just because this fuels the federal government’s bulimia for borrowing, but also because the tools by which it has driven down prices, including sequestering huge sums of bank liabilities as part of the cash reserve ratio balances with it, will cost the economy and arm and a leg to unwind.
Moreover, the current policy mix may be loading problems at the back end for the financial services industry. Low money market yields have already depressed their profits. Most have compensated for this by rapidly growing their loan books. However, it is counter-intuitive that the industry has found means to increase its lending in one of the most difficult years for business, not just in the country, but in the world at large. In this conversation, we ought not to mistake the recent stellar performance of the stock market for evidence of the health of corporate Nigeria. Since the central bank pushed money market rates near the zero bound, liquidity has sloshed round the economy.
As deposits, the central bank continues to wield its mop to prevent this from putting pressure on prices, including at the foreign exchange market. Still, some of this liquidity is driving the price performance on the Nigerian Stock Exchange. The fundamentals of the businesses quoted on the exchange are a different kettle of fish altogether. But, they are arguably no better this year than they were this time last year. Instead, consensus is that one unintended consequence of the pandemic will be a softening of corporate balance sheets next year. At the very least, households will not spend enough to support businesses investing in larger capacities or newer more efficient ones.
At which point banks’ profitability will come under pressure. I am not sure that we can afford to add a financial crisis (next year) to the chain of crises that we currently have.
Source: Premium Times