Economy - As the inflation rate for the month of January trended downward to nine percent from 12 percent in December last year, informed analysts cautioned that rather than celebrate the attainment of a single digit inflation rate, economic planners should concentrate on policies capable of sustaining the tempo in the face of emerging economic challenges, reports Festus Akanbi
For the first time since 2009, in January this year, Nigeria posted a nine percent inflation rate. As expected, the economic "feat" has continued to feature prominently in public discourse especially those attended by officials of the federal government.
According to the National Bureau of Statistics (NBS), the Consumer Price Index (CPI) dropped by 300 basis points to nine per cent year-on-year in January, from 12 per cent in December 2012.
CPI is a measure of changes in the purchasing power of a currency and the rate of inflation. The consumer price index expresses the current prices of a basket of goods and services in terms of the prices during the same period in a previous year, to show effect of inflation on purchasing power.
The NBS also explained that the core inflation index also decreased to 11.3 per cent from 13.7 per cent in the previous month. The bureau, however, attributed the 25 per cent drop in CPI to base effects including lower food prices.
"These are as a result of higher price levels in the previous year, which imply that the year-on-year changes exhibited this year will be muted. In particular, the Nigerian economy exhibited several shocks in January 2012. The partial repeal of the premium motor spirit (petrol) subsidy led to increases in transportation costs as well as secondary effects, as the transportation costs affected both food and non-food prices.
"There were also the civil protests that followed, and the man-made price gouging during the month, as merchants tried to take advantage of temporary shortages. The resulting base effects - the relative lower rise in year-on-year changes exhibited in January 2013- is particularly noticeable in the decline in the Core index, decreasing to 11.3 per cent in January (from 13.7 per cent in December)," it had said.
The NBS, said further that the relative moderation in the headline index in January was helped by declines in seven out of the 12 United Nations Classification of Individual Consumption by Purpose (COICOP) divisions, as well as declines in major the Food and Core sub-indices.
However, apart from the impact of the lower food prices during the period under review, it is also on record that the inflation targeting effort of the Central Bank of Nigeria (CBN) also played very important role in the attainment of a single digit inflation rate in January.
How Sustainable is a Single Inflation Rate?
As government officials continue to bask in the euphoria of the positive development, keen watchers of the economy say what is more important is the sustainability of the effort to effectively tame inflation in the country. The question is how sustainable is the current level of single digit inflation?
Head of Regional Research, Africa, Standard Chartered Bank Razia Khan in her response to THISDAY enquiries said, "First of all, it is important to note that much of the 'improvement' in Nigerian inflation seen in January was no more than a base effect off a high base from last year, following the fuel subsidy adjustment, and related strikes. Already, some of this effect will have waned come February (when the base effect will not be as pronounced), most likely driving a rise in headline CPI to 9.6% y/y.
"Admittedly, the m/m rise in inflation was the weakest seen in Nigeria since 2009 - in the aftermath of the collapse in oil prices - which is a little curious, but still leaves us wondering about sustainability".
Pressure on Food Prices
"Second, although food prices have decelerated, there is still evidence of some pressure on food prices - with food prices in Jan rising 10.1% y/y and 0.8% m/m. We know that we probably have not seen the full effect of food price increases on the Nigerian economy (there was much stocking up ahead of the imposition of tariffs, and there may still be some latent impact from earlier flooding).
"I would also look at whether there has been any meaningful change in inflation expectations in Nigeria. On a 12-month basis, food price inflation is running at 11.1%. Core inflation is still running at 13.7%. Given that inflation expectations tend to be adaptive (albeit gradually), I would not necessarily expect any big change in pricing behaviour just yet," she said.
Speaking on the factors that support an improved inflation outlook going forward, Khan said, "Monetary policy has been relatively 'tight' (at least by Nigerian standards, if not with respect to actual inflation), Nigeria has benefited from significant offshore investor inflows, and the naira has been stable. All of these factors can be expected to have a positive impact on inflation. But countering this, how much has changed in a structural way in Nigeria? What has changed so fundamentally in the economy, that a lower range of inflation (than we have seen in recent years) is now guaranteed?
"I would suspect, not much. If recent hot money flows leave Nigeria, if the currency should come under pressure again (and I don't belong to the camp that believes that monetary policy is very tight - inflation may have come down, but so have market interest rates) why should inflation stay well-contained?
A Return to Double Digit Inflation
"Our current forecasts see a return to double- digit inflation by the mid-year (albeit to a narrow range above 10%), but as the political cycle and greater election spending kick in, we should see further pressures in 2014 and 2015 (with inflation averaging 13.1% and 13.3% respectively). I am not sure there is a case for easing now, given this outlook. Surely, policy should be formulated with a longer-term view of inflation?
(I would add that the fiscal stance of the authorities is also relevant)." Another analyst who spoke on the sustainability of a single digit inflation rate regime was Head, Research and Intelligence, BGL Plc, Mr. Olufemi Ademola. According to him, "Single-digit inflation rates are likely to characterise the major part of 2013. The Central Bank of Nigeria (CBN) and the National Bureau of Statistics (NBS) agree on this despite the difference in the forecast inflation for the year.
"The CBN expects core inflation to moderate to as low as 6.6% year on year by June 2013 well below the expected headline inflation rate of 8.5% for the period. The NBS forecast headline inflation at 9.77% in June and an average of 9.76% for 2013. However, there are major sources of inflationary pressure in the short term, which include the high probability of food price volatility, expansionary fiscal policy, and imported inflation through the exchange rate channel. "While food price volatility is beyond the control of monetary policy; the monetary authority could guard against excessive systemic liquidity caused by expansionary fiscal policy by sustaining the use of its open market operations (OMO) tools. Therefore all things being equal, the inflationary trend is expected to remain within forecast in the short term."
Rate Cut Unlikely
On whether the positive development coupled with the rising external reserves position would make the CBN consider a rate cut at the next MPC meeting slated for March 18, Ademola explained that one key development in the inflation dynamics is that the market might have currently relegated the monetary policy into following rather than leading the market. This, according to him, is because despite the indication that the monetary authority is not likely to commence a reduction of the MPR in the short term, yields continue to contract and money market rates stay below the MPR for long periods afterwards, which means that the relevance of monetary policy in the evolving market scenario may be weakening.
"However considering the key areas of price vulnerability during the year, monetary policy would be very critical in keeping inflation low in 2013. Since inflation in Nigeria has been found to be a structural issue, keeping inflation rate low would require changes to the structure of the economy, the management of government-determined prices, and fiscal policy. Since progress in these fronts is currently low, monetary policy may in a vantage position to keep inflation on track.
"In addition, the moderation in inflation rate has increased the real return on Nigerian fixed income instruments and potential for increased demand and inflow of foreign portfolio investment. Hence monetary policy would remain cautionary; implying that the MPR may remain at 12% at the next MPC meeting in March," the BGL official stated.
In his contribution, chief executive, GTB Securities Limited, Mr. John Ogar explained that "The year-on-year decline in inflation which brought the January 2013 figure to 9% is attributable to the base effects arising from the January 2012 fuel price increases which shot inflation up by 3.3%.
"While inflation is expected to remain benign due to the same base effects for most of 2013, (at least up to June 2013), the near term risks to this benign outlook is the possible decline in the output of staple food items due to the flooding of last year. This is borne out by the fact that prices were up 0.6% month-on-month in January 2013. Core inflation fell by 2.4% in January 2013 to bring it to 11.3%. We will need to see the February 2013 inflation figures to begin to plot a trend."
Ogar pointed out that "Although our external reserves position is healthy and is trending up, and inflation has moderated, the CBN by its posture has remained averse to a rate cut. It will go against the grain of market expectations, therefore, if the MPC cuts rate at the next meeting, as its decision will be weighed by several other global and macroeconomic considerations. In my view, they will hold rate at current level."
Dwelling on what to expect going forward, a leading financial advisory firm, Financial Derivatives Company Limited said there is a disconnect between policy rates and money market rates, as the market rates declined by 200bps prior to the inflation report. "Due to the benign inflationary outlook, we expect the average Nigerian Inter-Bank Offered Rates (NIBOR) to decline further in March. This points to the fact that as inflation continues to decline, the market has come to realise that the CBN has limited options on its current conservative stance. Therefore, a rate cut in March will only formalise market anticipation."
It believed that the naira may depreciate marginally due to lower interest rates, leading to a reduction in foreign investors' appetite for government debt instruments and lead to capital flight." With the high external reserves level (currently at $47.3bn), the CBN's willingness and ability to support the naira could increase in the near term. The strength and direction of the naira against foreign currencies is critical to importers of raw materials, as a weak currency will increase the cost of imported goods and may erode manufacturers' profits.
To analysts at FSDH Merchant Bank Limited, the structural bottlenecks in the economy, if not addressed, would continue to cause inflationary pressure in the economy. The firm stated: "Investors in fixed income securities and other fund managers consider inflation rate in making investment decision. We note that the supply bottleneck and rigidities in the economy may make the achievement of a sustainable single digit inflation rate in Nigeria a difficult task. An economy of this nature should be self-sufficient in terms of food production if appropriate policies are in place to encourage the use of modern farming techniques.
"We hold the view that rejuvenating agriculture in Nigeria will not be possible until the development of a good transportation system (road, sea and rail); increasing electricity generation that can support appropriate storage facilities of farm produce; appropriate funding of the universities of agriculture where intensive research can be carried out to improve farming processes to increase production.
"Adopting these measures, to position agriculture, will enable it produce enough to feed the nation and meet the intermediate input requirements of the manufacturing sector to reduce costs and thus position the economy on a path of sustainable single digit inflation rate regime."
During the month of January, composite CPI was higher by 0.62% m/m while the food index captured by "farm produce and processed foods" was higher by 10.01% y/y and 0.80% m/m with higher prices in bread and cereals, imported food, vegetables, fish, potatoes, yams and other tubers being the key drivers. In addition, core index increased by 11.30% y/y and 1.40% m/m. The increase in the core index was as a result of increase in the housing, electricity, gas and other fuels, in particular liquid fuels (kerosene), actual rental and imputed rent prices, garment prices, and non-durable housing goods.
Core inflation drops by 240bps to a new 12-month low. Beyond the contribution of base effects to the decline in y/y inflation, lower price changes in non-food items contributed to the lower core and headline inflation levels. This is in view of the moderation in core inflation to 11.30% y/y from the 13.70% recorded in the previous month. As a result, core inflation index is at the lowest level recorded since December 2011.
Analysts however expect to see a reduction in Monetary Policy Rate (MPR) in the coming month even as macro indicators remain positive. "Ahead of the meeting of the MPC in the coming month and easing inflationary threats, we still maintain our position on gradual reduction of the benchmark rate. Our optimism is further informed by the positive macro indicators, in particular the relative stability in exchange rates and significant increase in the level of foreign reserves," a research study said.