July 24, 2021 / 10.00AM / Op-ed by Prof Uche Uwaleke/Header Image Credit: The Guardian Nigeria
Analysts have expressed doubts about the sustainability of the fall in Nigeria's year-on-year headline inflation rate over the next five months (despite the recent decline from 17.93% in May to 17.75% in June 2021). Indeed, with supply-side disruptions still prevalent in the manufacturing sector, and difficulties associated with accessing foreign exchange at the Import & Export (I&E) window of the Central Bank of Nigeria (CBN), the likelihood of a reversal of the downward slide in the Y-o-Y inflation rate remains probable. To be sure, the structural challenges faced by the economy are yet to be frontally addressed by public policy administrators. In this OpED article, Professor Uche Uwaleke, a Professor of Capital Market, gives his insights into Nigeria's inflation outlook for the rest of the year, and the banana peels to a sustainable decline.
The recent 2021 Eid el-Kabir public holiday provided an opportunity to reflect on the capital market and economy in general. One macroeconomic indicator that readily comes to mind is the Inflation rate which is one of the most closely watched economic metrics by investors.
A few days ago, the National Bureau of Statistics reported a slowdown in headline inflation for the 3rd consecutive month with the June inflation rate printing at 17.75%.
Although still elevated and way higher than the CBN's upper band of 9%, it was a continuation of the slowdown in headline inflation which began in April 2021.
Be that as it may, downside risks to the inflation outlook suggest an end to the current disinflation soon. A reversal may kick in as early as July. Barring base effects, which played a major role in the downward trend because of successive high inflation rates of 2020, factors likely to cause a spike in inflation rate for July include increased demand witnessed during the festive period, the devastating impact of flooding reported in parts of the country, increased FAAC distribution to tiers of government of circa N733 billion and high exchange rate.
All these, in addition to legacy issues such as insecurity, transportation bottlenecks, high fuel and electricity tariffs, will weigh on commodity prices especially food in July.
Indeed, it is easy to predict the direction of prices (inflation, interest rates, and Exchange rates) in the coming months given already known exogenous and endogenous factors.
Last week Sunday for example, OPEC+ Ministers agreed to increase oil supply with effect from August in addition to new output quota. Expectedly, basket crude oil prices fell on Monday by circa $2 on average.
Across the globe, there are concerns over demand outlook amidst the spread of COVID'19 delta-variant.
In the US, vaccination progress at nearly 65% of the population is emboldening the Federal Reserve along the path of interest rates normalization. All these have grave implications for capital flows, exchange rates, and by extension inflation in Nigeria.
Back home, the passage of the Petroleum Industry Bill and consent of the National Economic Council for full deregulation of the downstream petroleum sector; fiscal surprises expected from the increase in FAAC distribution on account of naira devaluation and strong revenues especially from Petroleum Income Tax will all combine to influence inflation trajectory in the months to come.
Other factors include the approval of a supplementary budget of nearly N1 trillion by the National Assembly chiefly for defense spending; the increase in government borrowing threshold by the DMO from 25% to 40% concerning Debt to GDP as well as the fast depletion in foreign reserves and its consequences for Exchange rates stability.
Growing fiscal imbalance following more borrowing headroom will knock on interest rates and slow down the equities market with portfolio rebalancing in favour of fixed income Securities.
Without prejudice to likely impressive corporate results for H1 2021, a rebound in the stock market may take some time. Against this backdrop, the MPC of the CBN will likely hold rates again this month, perhaps for the last time this year.
With rising inflation and increasing pressure in the forex market, the CBN may be arm-twisted into changing the current accommodative monetary policy stance to rein in inflation and stabilize Exchange rates.
This may be accompanied by another upward adjustment in the Exchange rate (naira devaluation) in pursuit of rates unification. This change in policy stance may happen as early as September or in November 2021 during the last scheduled meeting of the Monetary Policy Committee.
The way forward is to reduce the ability of the government to engage in fiscal surprises by building buffers using Federation account revenue over N640 billion as earlier agreed to by members of FAAC.
Currently, the Excess Crude Account record is a paltry $60.8 million which puts the country in a precarious situation in the event of another oil price shock. Moreover, liquidity mop-up operations undertaken by the CBN often come at great costs.
As things stand, it would appear that foreign loans should be preferred to domestic loans to finance the capital component of the budget. This is especially so if they are sourced from Multilateral and Bilateral windows considered largely concessional. Such must not include Eurobonds or commercial loans from the International capital market.
On balance, I think the uptake of more foreign than domestic loans is better for the economy at this time without undermining the impact of currency risk. In the first instance, it will provide temporary relief to external reserves attrition, BOP position, and forex market liquidity.
In contrast, continuous domestic borrowing by the government drives up interest rates and crowds out the private sector. Worse still, using such proceeds to finance dollar-denominated capital components of the budget such as defense spending only draws blood from external reserves and weakens the ability of the CBN to intervene in the market.
Little wonder, the country's foreign reserves are said to be depleting at a fast rate. That said, the inflation outlook in the near term is bleak. The 2021 budget projects the inflation rate to come in at 11.95% by December. This is most unlikely- possibly sometime in 2022.
It bears repeating that given the major drivers of inflation in Nigeria, the government has a major role to play in line with the Fiscal theory of the Price Level. This calls for a strong handshake between the fiscal and monetary authorities.