Raising interest rate will not curb Nigeria’s inflation – World Bank

The World Bank has cast doubt on the Central Bank of Nigeria’s (CBN) recent monetary policy measures, suggesting that they may not effectively curb inflation as anticipated by analysts.

In its latest report, “Global Economic Prospects,” which outlines the economic outlook for 2024 and 2025, the World Bank projects Nigeria’s economic growth rate to be 3.3% in 2024, maintaining its earlier forecast. Additionally, the bank foresees a slight improvement in Nigeria’s GDP growth to 3.5% in 2025.

The World Bank attributes the projected economic growth to the current administration’s reforms in the petroleum and foreign exchange sectors. Following a recorded growth of 2.9% in 2023, these reforms are expected to stimulate a gradual improvement in economic conditions, leading to sustained, albeit modest, growth in the non-oil economy.

The oil sector, which has faced significant challenges, is also anticipated to stabilize as production levels recover.

However, the report highlights significant risks to this optimistic outlook, particularly the potential ineffectiveness of the CBN’s monetary tightening measures in controlling inflation. Despite an aggressive increase in interest rates by a combined 750 basis points since the beginning of the year, inflation remains a persistent issue.

The CBN’s recent monetary policy has seen interest rates jump dramatically. Governor Yemi Cardoso, in his first Monetary Policy Committee (MPC) meeting, raised the interest rate by 600 basis points from 18.75% to 22.75%. Subsequent hikes have pushed the rate further to 26.25%. The bank also increased the Cash Reserve Ratio (CRR) of banks to 45%, one of the highest rates globally.

These measures were aimed at taming inflation, but the results have been underwhelming. Inflation rose from 29.90% in January 2023 to 33.69% in April 2024, defying expectations that higher interest rates would slow it down.

Various stakeholders, including members of the Nigerian business community such as the Centre for the Promotion of Private Enterprise (CPPE), the Nigerian Association of Chambers of Commerce, Industry, Mines, and Agriculture (NACCIMA), and the Manufacturers Association of Nigeria (MAN), have criticized the CBN’s approach. They argue that the high interest rates are ineffective in combating inflation and instead harm the real economy by raising the cost of accessing capital.

Economists have also pointed out the contradictions in the CBN’s strategy. While the bank is increasing the MPR to combat inflation, other policies appear to counteract these efforts. For instance, the currency in circulation, a crucial factor in controlling inflation, has risen to N3.87 trillion at the end of March, up from N3.69 trillion in February and N3.65 trillion in January.

This increase indicates that a significant portion of currency is being held outside the banking system, which can compound inflationary pressures.

The CBN’s own data shows that over 90% of the currency in circulation is outside the banking system. This trend of hoarding cash poses a challenge to the bank’s efforts to control inflation.

Muhammad Abdullahi, a member of the MPC, acknowledged in the March meeting that high currency outside banks is one of the key monetary drivers of inflation. He said that while domestic food prices driven by supply shortages and high logistics costs are major inflationary pressures, monetary policy tools need to target money supply growth, exchange rate depreciation, and the high levels of currency outside banks to mitigate these pressures.

In January 2024, at the height of the currency redesign policy, the currency in circulation was N1.386 trillion, with 57% of this amount (N792.184 billion) held outside the banks. By March, this percentage had risen to 85.8%, with N1.445 trillion of the N1.683 trillion in circulation outside the banking system.

The World Bank report also touches on the broader economic context, noting that President Tinubu’s reforms, including the removal of the fuel subsidy and the unification of the foreign exchange market, have significantly impacted the economy.

The naira depreciated sharply, closing 2023 at N907/$, almost a 100% decline. This depreciation continued into 2024, with the naira weakening to around N1,400/$ and peaking at about N1,600/$ in February. These changes have driven inflation to its highest level in 28 years, with food inflation soaring to 40.53%.

While the World Bank’s projections offer a cautiously optimistic view of Nigeria’s economic growth, substantial risks remain, particularly concerning the CBN’s monetary policy effectiveness. The CBN has been advised to augment its monetary policy tightening by mopping up excess cash in circulation.