Inflation will resist monetary tightening if Nigeria fails to resolve supply-side limitations – KPMG

KPMG has asserted that Nigeria must tackle the foundational supply-side constraints fueling cost-push inflation; otherwise, the efficacy of the Central Bank of Nigeria’s (CBN) monetary tightening measures might be constrained. 

The News Chronicles referenced Issue 15 of KPMG’s Nigerian Flashnotes publication, wherein the firm underscored the importance of a balanced approach that addresses both cost-push and demand-pull inflationary forces. It called for collaborative efforts between monetary and fiscal authorities to eliminate the supply-side barriers contributing to inflation.

The document stated: “We acknowledge that price stability is a prerequisite for economic expansion. In monetary policy playbooks, we also acknowledge that increasing interest rates is a normal reaction to inflationary pressures.”

“However, we emphasize that monetary tightening is better suited for tackling demand-pull inflation. Because of this, monetary tightening measures may not have much of an impact on inflation unless supply-side bottlenecks that fuel cost-push inflation are also removed.”

“Eliminating these obstacles would necessitate coordinated actions by fiscal and monetary authorities. We are sure that these initiatives will more successfully achieve the desired price stability without compromising economic expansion.”

KPMG forecasts a potential decrease in inflation rates starting from mid-2024, primarily driven by statistical base effects.

This projected deceleration, however, hinges on the absence of any economic measures that could fuel price hikes.

The firm emphasized the influence of broader economic factors and policies, warning against solely attributing any decline in inflation rates to monetary policy tightening.

KPMG emphasized: “In the meantime, it will be crucial to evaluate the impact of the CBN’s monetary tightening on inflation in the coming months, as the base effect is anticipated to begin after mid-year.”

“Statistically, unless economic policies that significantly pressure prices are implemented, inflation is set to lose steam after mid-year, primarily due to the onset of base effect. Attributing a fall in inflation exclusively to a tightening of liquidity once the base effect kicks in after midyear may be incorrect.” 

The Central Bank of Nigeria’s (CBN) decision to raise the Monetary Policy Rate (MPR) to a record high of 24.75% in March 2024 is expected to attract increased foreign exchange inflows, driven by the appeal of higher interest rates. KPMG projects that portfolio investments will serve as the primary source of these inflows as investors seek to capitalize on the elevated rates.

However, the company issued a cautionary note regarding the potential volatility associated with these “hot money” inflows, highlighting the risks of sudden reversals and their impact on macroeconomic stability.

KPMG cautioned: “We anticipate that the higher MPR will draw larger foreign exchange inflows, which will fuel the Naira’s increase on the foreign exchange market. But as investors rush to take advantage of the higher interest rate environment, the majority of these profits are anticipated to come from portfolio investments.”

“The drawback of this influx of “hot money,” meanwhile, is the potential for abrupt reversals in reaction to shifting market signals. Macroeconomic instability has historically been linked to large-scale capital reversals.”

In the first quarter of 2024, Nigeria had an inflow of approximately $3.8 billion from international investors, who were drawn to government securities due to their strong yields.