At the height of the arguments around the pros and cons of a naira devaluation, President Buhari had argued that he needed to be convinced of the utility of the call for a more flexible exchange rate. Well, we do have some evidence to hand: inflation (year-on-year) in February was 11.4%.
The president anchors the better part of his argument in support of the Central Bank of Nigeria’s (CBN) managed float of the naira on the adverse consequence on domestic prices of the devaluation of the naira. Now we know that he is wrong. Despite the CBN’s best effort in this regard, domestic prices are hurting retail consumers and businesses alike. Given the pace at which prices rose between January and February this year (about 200 basis points), even domestic politics could soon succumb to the depredations of rising inflation.
How rapidly (and badly) this process is underway was brought home to me in a conversation, a couple of weeks back, with the chief financial officer of a confectioner in Lagos.
Prized at the low end of the market, this manufacturer long prided itself on having successfully integrated its production lines backward. However, over the period that the CBN has run its new exchange rate regime, it has seen costs rise for all inputs. For flour and sugar? Yes. But also for packaging. Cartons currently cost so much, it plans to start bulk delivering its sweets in polythene bags. Of course, the price of these same polythene bags have doubled over the last 9 months, as producers of water packed in sachets would attest. Nonetheless, polythene bags are still cheaper than cardboard packaging.
Still, you cannot pack biscuits in polythene bags, and haul the consignment over the awful roads that it takes to get goods to market in Nigeria. Nonetheless, the fear of turning its cash cow into crumbs before it reaches the markets is the least of this company’s worries. As input costs spike, it has over the last couple of months reduced the number of shifts it runs at its factory by one. It now runs two shifts. This is both a cost and price/quantity problem.
With so many companies downsizing, consumer spending across the country is down. And a bearish market is not one you readily pass on costs to. In response, this manufacturer has reduced the number of biscuits in its standard package from five to four. How about skimping on quality? Any one who eats at bukas as much as I do could not have failed to notice how much smaller the meat per serving is becoming. But then this CFO says that his N5 biscuit pack is not positioned in the market as a snack. For most of the business’ clients, its biscuits are a meal; downed with a bewildering array of beverages. Any reduction in quality would mean, therefore, that these biscuits are no longer filling. The market would then move in search of substitutes that fulfill the hunger need. As even novice entrepreneurs understand, lost markets are hard to plough back.
This sorry tale is a metaphor for operating conditions in just about every productive sector of the economy. Costs rise. Prices rise. Consumption falls — not only because rising prices erode disposable incomes. But more so because squeezed between cost increases at the supplier end, and market resistance of higher prices, businesses seek costs savings up to and including through layoffs. Incidentally, this process hurts the poor most; for they are less capable of the adjustments forced on them by rising prices. Thus, whether President Buhari likes it or not, falling output and rising prices are a fact of the new Nigeria that he appears to be building.
In conversation with a policy wonk, while preparing this, I was reminded that the adverse impact of rising prices on the “poor and vulnerable” remains the strongest argument for the central bank to have prioritised its erstwhile commitment to single digit inflation rates. Same person reminded me that whereas the years of plenty up to mid-2014 are looked back on with nostalgia today, much of the wealth create then ended up in far fewer hands. The cohort of the country’s poor has thus steadily increased as its adjusted quality of life has worsened.
On balance, this is not as frightening a failure as it would seem. On one hand, thanks to the limited past reforms to the economy, especially the much larger role for markets in the fixing of prices in more sectors of the economy, the pass through from a depreciating naira to local prices appears to have been muted this time around. Conversely, it is the central bank, and not the executive branch of government, that is responsible for fighting inflation. Which is why the CBN set itself a target of keeping inflation last year within an annual band 6% – 9%. However, by May of the same year the annualised increase in domestic prices had breached the upper limit of this target.
So why has the central bank appeared impotent in the face of rising prices? Three possibilities recommend themselves. But first, an understanding of the simple (simplified, some would argue) process by which central bank’s see off rising prices in an economy. Assuming the standard definition of inflation as “too much money chasing after fewer goods”, central banks then try to raise the return to banks of keeping deposits with it. This process mops up liquidity from the system. And the “too much money” bit of the inflation definition is addressed, at least.
True, this process hardly addresses the “fewer goods” problem. However, this is a fiscal policy challenge: boosting the long-term productivity of the domestic economy. It is, in addition, longer-term. Confronting the fiscal constraints posed by shrinking crude oil export earnings, current macroeconomic policymaking is obsessed by shorter-term anxieties. Therefore, the CBN tarnishes its inflation-fighting credentials as part of a process of driving down the federal government’s borrowing costs — one of the side effects of squeezing financial liquidity out of the economy is that interest rates on both savings and lending products rise.
A second possibility recommends itself, though. If the story with which this piece opened illustrates anything, it is that current domestic price rises have not been driving by money sloshing around. Costs have risen as the naira has ceded grounds to other tradable currencies, and both manufacturers and service providers have sought to pass these costs through higher prices to the markets. The cost-push nature of our rising price levels was pointed out to me this weekend. As was the fact that traditional central banking tools (interest rate movement, for example) might not suffice in the circumstances.
At the margins of this week’s meeting of the CBN’s rate-setting committee (the Monetary Policy Committee — MPC), therefore, are some commentators who still hope that the MPC may find the nous and the nerve to signal its continued commitment to fight inflation. In revising the country’s sovereign credit outlook to negative, from stable at the weekend, Standards & Poor’s (S&P), a global rating agency, indicated the country’s foreign exchange policies as distortive of both domestic product and financial markets.
However, the section of the commentariat still invested in the CBN’s competence may have missed a March 7 report in The Citizen, an online newspaper, which quoted a new publication by the monetary policy department of the Central Bank of Nigeria, as favouring nominal income targeting over inflation targeting.
Admittedly, the literature is replete with arguments about how too narrowly focused on keeping domestic prices stable, a central bank may overlook the effects on domestic output, of its monetary policy measures. And the countervailing argument that by concentrating on output growth (without adjusting for price movements), central banks may better use monetary policy to smooth out the volatility in business cycles.
So, truth to tell, there may be a case for the CBN continuing to ignore rising domestic prices. But it is a case that the apex bank has so sordidly failed to make. At least, so far! S&P put this succinctly: “Nigeria’s monetary policy has also weakened the country’s credit profile in our view.”