The Central Bank of Nigeria (CBN) surprised by hiking interest rates by 150bps today, the first rate hike since July 2016. Eight of the 10 economists surveyed by Bloomberg had expected unchanged rates (which was also our expectation), with one projecting a 25bps hike and another projecting a 50bps hike. The decision to hike was unanimous, although five of the 11 MPC members voted for a smaller 50-100bps hike.
CBN Governor Godwin Emefiele said in a post-MPC briefing that “While it may seem contradictory to raise rates in the face of fragile growth, it is a dilemma that most central banks around the world today are grappling with at this time…On balance, it is quite clear and compelling that attacking inflation is more urgent in the sequence of policy objectives in this regard". This is a notable break from the past, with Emefiele’s CBN typically prioritising FX stability and growth over price stability.
Tighter policy is welcome given the recent rise in inflation, which rose from 15.9% to 16.8% yoy in April on the back of rising food prices and has now been above the CBN’s 6-9% target since May 2015. A recent Bloomberg survey of 13 analysts saw a revision of the median inflation forecast from 13.9% to 15.8% yoy in 2022. This is slightly more optimistic than our forecast, which sees inflation rising to 18.2% by July before moderating to 16.5% by December, for an average rate of 17% in 2022.
That said, today’s move is nothing more than a token hike given Nigeria’s weak transmission mechanism. Prevailing market rates for T-bills have diverged widely from the policy rate, with the 12m yield at c5% and 3m yield at c3.5%, meaning real rates are sharply negative. Further, the CBN continues to implement monetary policy in an unorthodox way, focusing on ad hoc cash reserve ratio (CRR) debits to manage liquidity in the system and effectively acting as a development bank by directly providing credit at preferential rates to strategic sectors (the rate on development finance loans will remain at 5% until 2023).
Further, past assertions by the CBN that inflation is largely a structural and supply-side problem are not without merit. Rising food prices were the main driver of the recent increase, which is driven by external (rising global food prices and the war in Ukraine) and internal (insecurity in food-producing regions) factors that are outside the CBN’s control. Other structural factors, such as an endemic FX shortage and trend towards pricing goods off the parallel market (the IMF estimates that around two-thirds of parallel market depreciation has already passed through to inflation), are within the CBN’s control and could be dealt with by devaluing the naira and implementing a flexible exchange rate regime.
The parallel exchange rate has risen above 605/US$ in recent days versus the official rate of 415/US$, reportedly driven in part by increased dollar demand from politicians as we enter campaign season. Meanwhile, NDFs are currently pricing in depreciation to 490/US$ over the next 12 months. This compares with the IMF’s estimate of a 15% overvaluation in 2021, with real appreciation of c10% since implying an overvaluation of c25% (equating to a 'fair value' of c550/US$ for the naira, between the rates implied by the parallel and forward markets). Meanwhile, despite the rise in oil prices, flows through the official I&E currency window are still around one-third of pre-Covid levels.
Today’s hike, while an important symbolic gesture of the CBN’s intent to rein in prices, is unlikely to have much of an impact. Moving to a flexible exchange rate would be a much more impactful measure, improving the growth-inflation tradeoff by removing a key structural rigidity (albeit at the expense of a short-term boost to prices, with the IMF estimating that a 15% devaluation of the naira would have a peak inflation impact of 2.2pp in the year of the devaluation). That said, under the leadership of Governor Emefiele and President Buhari, the FX regime will likely remain intact.
In this regard, the most interesting monetary policy development this month is not the rate hike, but the political intrigue surrounding Emefiele’s decision to run for president. This was later abandoned when Buhari mandated that all political appointees must step down to campaign, with Emefiele preferring the job security of his CBN post to a long-shot presidential run. With Emefiele viewed by many as politically compromised due to his now obvious APC party affiliation and presidential ambitions, there is now a chance that Buhari’s successor will remove him before the expiration of his term in May 2024.
While it is too early to speculate on the outcome of the February 2023 elections (especially in the context of a monetary policy note), there is a glimmer of hope for Nigeria to shift towards a more orthodox monetary framework if next year’s election gives way to a more market-friendly president and orthodox central bank governor. Until then, markets may have to content themselves with today’s token rate hike.
If the rate hike is accompanied by additional measures to drain liquidity and raise market yields, demand-side side inflationary pressures might fall at the margin and recent gains in the equity market could be reversed. And, while inflation is largely a structural and supply-side problem given relatively weak demand in Nigeria (the CBN sees growth moderating to 3.25% this year from 3.65% in 2021), Emefiele flagged the risk that pre-election spending could exert some upward pressure and we note the recent upward trend in monetary aggregate growth, both of which justify a tighter policy stance, in our view.
However, moving forward, policy measures by the CBN should be focused on moving away from unorthodox policy measures to improve the transmission mechanism and implementing a more flexible FX regime to remove a key impediment to growth. Without a broader shift to Nigeria's monetary policy framework, Nigeria's long-running battle with stagflation is likely to continue.
See here for our comprehensive annual macro overview on Nigeria from February 2022.
Nigeria annual macro overview: The song remains the same, February 2022 (Curran and Malik)
Nigeria: Stealth devaluation possibly underway, November 2021 (Curran, Ogunkoya & Omole)
Nigeria: FX overhaul promised post-Dangote refinery, October 2021
Nigeria: Ban of abokiFX furthers FX folly, September 2021
Central Bank of Nigeria adds fuel to the fire by banning BDCs, July 2021 (Curran & Ogunkoya)
Our discussion with Nigeria’s IMF Mission Chief, April 2021
Nigeria policy rate and FX regime left intact, March 2021