A decisive policymaking response to the current wave of global economic turmoil will be needed as the situation is likely to get worse before it gets better. An economic downturn in China, the lingering Russian-Ukraine war and persistent inflation, which has precipitated a cost-of-living crisis, are the confluence of factors that have re-opened economic wounds that were only partially healed post-pandemic.
In the October 2022 edition of its biannual World Economic Outlook report, the International Monetary Fund (IMF) essentially warned the global economy to brace itself, for the ‘worst is yet to come as inflation is yet to peak’. While the IMF left its 2022 GDP growth forecast unchanged from its July forecast – at 3.2%, the projection for 2023 has been revised downwards to 2.7% on the back of the increased likelihood of output contractions in countries accounting for circa one-third of the global economy amid rising prices and shrinking real incomes. The IMF also believes that inflation is broadening well beyond food and energy and expects it to rise further and peak at 9.5% in 2022 before easing to 4.1% by 2024.
A Global Wave of Tightening
Central banks across most of the world are aggressively tightening monetary conditions, in response to rising inflation, which is proving far more persistent and broad-based than initially anticipated, ostensibly prioritising price stability over recession fears, the risk of rising unemployment and declining wages. The four interest rate hikes – of a combined 300bps to 3.25% – by the United States Federal Reserve Bank have triggered a significant appreciation of the US dollar against most other currencies to highs not witnessed since the early 2000s. As at October 11, the dollar had experienced a year-to-date appreciation of about 15% against the euro, over 10% against the yuan, 25% against the yen, and 20% against the pound sterling.
Emerging markets and developing economies with pre-existing vulnerabilities are bearing the brunt of this. Higher US interest rates have sparked large capital outflows amid weak fundamentals and are pushing up borrowing costs, heightening the risk of additional credit defaults. A stronger US dollar makes dollar-denominated imports more expensive, raising imported inflation.
The announcement of debt-funded tax cuts worth £45bn ($50.3bn) by the government of the United Kingdom (UK) in late September sparked a broad sell-off, pushing the UK financial markets on the brink of collapse. The resulting plunge in the value of the pound sterling (which was later reversed) and surge in interest rates compelled the Bank of England (BoE) to intervene and stem the tide, through temporary and targeted purchases of long-dated UK government bonds to restore market stability. The strength of the British pound and the overall health of the UK economy is of particular interest to Nigeria as it ranks high on the list of sources of Diaspora remittances ($19.2bn in 2021), which represent the second-largest source of foreign exchange inflow into the country, second only to crude oil earnings. A weaker pound is a double-edged sword as it will lower the value of remittances from the UK, but also reduce the prices of British imports whilst also making UK education and medical services cheaper.
GDP growth: Illusion or Resilience?
The IMF has also lowered Nigeria’s GDP growth forecast to 3% in 2022 from its earlier projections of 3.2% in July. While it did not specifically state the reasons for the downward adjustment, it is likely to be connected with concerns over lingering fragilities raised in the past (supply shocks, foreign exchange scarcity and weak purchasing power) which have been exacerbated by recent events and government policy response.
While recent GDP growth numbers (3.11% and 3.54% in Q1’22 and Q2’22 respectively) have been better than expected, many analysts are wary that they could be painting an inaccurate picture. This is because other indicators, like the Purchasing Managers Index (PMI), which is a more efficient predictor of cyclical trends, stayed oscillating in the first half of the year. The ‘New Orders’ component of the PMI has increased consistently in 2022. This raises the question: are manufacturers bullish about consumer demand in the near term or are they front-loading against a rapidly declining naira? A ‘Yes’ to the latter is the more likely response considering the subdued outlook for consumer demand and the uncertainty limiting business investment. Front-loading would create an illusion of expansion against the reality of panic buying. The outcome could be a slowdown of purchases in Q4’22.
Exchange Rate Pass-Through fueling Domestic Inflation
Nigeria was already grappling with its own cost of living crisis before the advanced world began to feel the sting. Stagnant wages and surging prices have left the average Nigerian consumer reeling. Rampant food inflation, which reached 23.34% in September 2022 – its highest level since October 2005 – largely induced by insecurity in Nigeria’s farming belt, continues to be a major driver of the headline inflation index (now at a 17-year high of 20.77%). However, in recent months, perhaps the most potent driving force behind inflation has been the exchange rate pass-through effect as naira volatility at the parallel market intensified – ₦730/$. This is in addition to the knock-on effect on energy prices (particularly diesel at ₦800 per litre) and, to a limited extent, the impact of money supply growth (₦49.35 trillion in August 2022) and saturation, on the back of the Central Bank of Nigeria (CBN) intervention schemes. The CBN’s response to surging inflation has been a tightening of monetary conditions via three Monetary Policy Rate (MPR) hikes of a combined 400bps to 15.5%, and a 500bps increase in the Cash reserve Ratio (CRR) to 32.5%– one of the highest in the world.
The CBN intends to curb inflation through higher interest rates (yields on one-year Treasury Bills have risen to 13% p.a in October 2022 from 7.25% p.a in October 2021) while also mopping up liquidity from banks’ vaults to limit currency speculation, which is a key causative factor of naira weakness, and by implication, imported inflation. The hike in CRR resulted in ₦838.8 billion in additional liquidity sterilisation from the banking system, putting pressure on the industry’s profitability. This also implies that the CBN now has more funds available for the Federal Government via Ways and Means Advances (currently estimated at ₦22 trillion).
Higher interest rates mean rising borrowing costs which could erode corporate profits, stifle lending, limit GDP growth and stoke recession fears and uncertainty with general elections only a few months away. But the question remains – will the CBN continue to hike interest rates if inflation continues to surge? Amid persistent inflationary pressures, recent flooding incidents in several states are disrupting agricultural output. In Nasarawa State, floods have submerged the country’s largest farmland (10,000 hectares) which is held by Olam, valued an estimated $140 million and has a processing capacity of 90,000 tonnes of rice annually. The price of rice, one of Nigeria’s major staple foods, has spiked 53.5% to ₦43,000 per bag in the last month and is likely to hit ₦50,000 by December. This is likely to fuel food inflation further, making the aforementioned question even more pertinent. With the likelihood of even more policy tightening across advanced nations, the CBN’s delicate balancing act between inflation and GDP growth will be put to the test.
In the face of persistent inflationary pressures and recent flooding incidents in several areas, such as Nasarawa, where the country’s largest farmland (10,000 hectares) held by Olam and worth approximately $140 million is currently submerged by floods, the question becomes even more pertinent.