Global professional services consultant, KPMG has warned the Central Bank of Nigeria that deployment of monetary tightening strategies may fall short of expected results unless Nigeria addresses the underlying supply-side constraints fuelling cost-push inflation.
KPMG in Nigeria in its issue 15 of the Flashnotes publication released recently emphasized the need for a balanced approach that tackles both demand-pull and cost-push inflationary pressures.
The firm then called for collaborative efforts between fiscal and monetary authorities to dismantle the supply-side barriers contributing to inflation.
The document read in part, “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 emphasize 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.”
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.
“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,” the report stated.
On the CBN’s decision to elevate the Monetary Policy Rate to a historic high of 24.75 percent in March 2024, the report said it is expected to attract more foreign exchange inflows, driven by the appeal of higher interest rates.
According to the report, these inflows will primarily come from portfolio investments, seeking to benefit from the increased rates. It therefore cautioned about the potential volatility associated with these “hot money” inflows, noting the risks of sudden reversals that they pose to macroeconomic stability.
“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 give birth macroeconomic instability.”
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 report 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 percent in 2021, 3.1 percent in 2022 and 2.74 percent 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 percent 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.”
