KPMG: Nigeria’s inflation battle hinges on fixing supply-side issues

KPMG has said that the effectiveness of the Central Bank of Nigeria’s (CBN) monetary tightening strategies may fall short unless Nigeria addresses the underlying supply-side constraints fuelling cost-push inflation. 

In issue 15 of the Flashnotes publication of KPMG in Nigeria, which was seen by Nairametrics, the firm emphasised the need for a balanced approach that tackles both demand-pull and cost-push inflationary pressures.

It called for collaborative efforts between fiscal and monetary authorities to dismantle the supply-side barriers contributing to inflation. 

The document read: 

• “We recognise that price stability is a necessary condition for economic growth. We equally recognise that raising interest rates is a natural response to inflationary pressures in monetary policy playbooks. 
• “However, we emphasise that monetary tightening is more apt for addressing demand-pull inflation. Thus, inflation may yield little in response to the monetary tightening efforts, unless the supply-side bottlenecks fanning cost-push inflation are also addressed. 
• “Eliminating these bottlenecks will require concerted efforts from both fiscal and monetary authorities. We are confident that such efforts will better deliver the intended price stability without trading-off economic growth.” 

Inflation may lose steam after mid-2024 

According to KPMG, a potential slowdown in inflation rates is on the horizon post-mid-2024, largely attributed to statistical base effects. 

However, this expected deceleration depends on the absence of new economic policies that might exert upward pressures on prices. 

The firm advised against attributing any reduction in inflation rates solely to monetary policy tightening, highlighting the influence of broader economic factors and policies. 

KPMG said: 

• “Meanwhile, with the onset of base effect expected after mid-year, the next few months will be important for assessing the impact of the CBN’s monetary tightening on inflation. 
• “Statistically, inflation is set to lose steam after mid-year largely because of the onset of base effect, except economic policies that significantly pressure prices are implemented. Attributing a decrease in inflation solely to the tightening of liquidity once the base effect kicks in after midyear might be inaccurate.” 

Higher MPR to drive portfolio investments 

The CBN’s decision to elevate the Monetary Policy Rate (MPR) to a historic high of 24.75% in March 2024 is expected to attract more foreign exchange inflows, driven by the appeal of higher interest rates. KPMG projected that these inflows will primarily come from portfolio investments, seeking to benefit from the increased rates. 

However, the firm also cautioned about the potential volatility associated with these “hot money” inflows, noting the risks of sudden reversals that they pose to macroeconomic stability. 

KPMG said: 

• “We expect the higher MPR to attract greater FX inflows that would drive the appreciation of the Naira in the foreign exchange market. However, most of these gains are expected to come from portfolio investments as investors move to take advantage of the higher interest rate environment. 
• “The downside of this “hot money” inflow, however, is the risk of sharp reversals in response to changes in market signals. Large scale capital reversals are historically known to birth macroeconomic instability.” 

Already, Nigeria has recorded about $3.8 billion foreign capital inflow in the first quarter of 2024 with investors (especially foreign investors) interested in government securities for high yields.  

Tightening policy threatens Tinubu’s $1 trillion economy goal 

KPMG further noted that the quest for price stability may inadvertently sacrifice economic growth. With Nigeria’s growth trajectory already on a decelerating path, the current policy stance could further deter investments in the real sector, negatively affecting employment and growth. 

The firm warned that high borrowing costs and a restrictive monetary environment might lead to an increase in non-performing loans and challenge the government’s ambitious goal of expanding Nigeria’s economy to a $1 trillion economy within the next eight years. 

The firm said: 

• “Furthermore, we note that targeting inflation from the demand-side (via a sustained monetary tightening of such scale) may inadvertently cause Nigeria to trade-off some growth for lower inflation. This is especially worrying as the nation’s growth has been slow, fragile, and decelerating (3.4% in 2021, 3.1% in 2022 and 2.74% in 2023) in recent times. 
• “With the real sector already burdened by high borrowing costs and inflation, the CBN’s decision could further shrink the sector by disincentivising investments. The higher borrowing costs may induce a scale back on investments in the real sector, adversely affecting employment and growth levels. 
• “Also, monetary tightening of such scale may give rise to higher non-performing loans. The higher interest rate environment may strain borrowers’ finances and raise their risk of defaulting on loans. 
• “Moreover, the government has expressed a desire to grow Nigeria’s economy to a $1 trillion economy over the next 8 years. This ambitious growth drive requires the economy to attain about 12% CAGR over the targeted period. 
• “However, the elevated Cash Reserve Ratio (CRR) could further restrict the ability of banks to channel credit to support the economy’s ambitious growth drive. Thus, the restrictive monetary policy environment further casts shadows on the attainability of the government’s economic objective.” 

Analysts at Augusto & Co earlier said that President Bola Tinubu’s plan to reduce interest rates in the country may clash with the existing tightening monetary policy of the CBN. They noted that the president’s preference for lower interest rates to support economic growth raises the risk of inaction and will be a true test of the CBN’s independence.

However, so far, the CBN has shown its independence with a hawkish monetary stance.