Single Digit Inflation: How Sustainable?

Nigeria’s inflation rate dropped to the much coveted single digit level of 9% in January 2013. This was supported by similar significant moderation in all the major key inflation categories in manners that suggest a distributed moderation in the level of prices in the country. However, it is good to note that the moderations in the inflation figures are caused, largely, by the base effect. We recalled that the immediate past year’s consumer price indexes were significantly elevated because of the surge in trend due to the partial removal of subsidy on the pump price of petrol in January 2012; we however recognise that while the base effect is significant at the new low inflation rate recently reached, an actual slowdown in prices as a result of the January effect may also be at play.

Considering the base effect on its own merit alone, we argue in this report that the single digit inflation achievement is not likely to be a one-time phenomenon although we may see a gradual rise in the months to come as the January effects wear out. We highlight the implications of the single digit inflation level of the currently tempered monetary policy stance and argue that it could only at best be cautious in the months to come in the bid to avoid sparking off a spiral of inflationary trend.

Moderate Prices across Board
All item less farm produce (Core) inflation moderated to 11.3% on a year on year basis from 13.7% in December 2012. Core inflation peaked at 15.2% in June 2012 on the back of the underlying structural (transport costs due to high petrol price) and infrastructural constraints before the gradual moderation that saw it to 13.7% in December. Food inflation however appears sticky, moderating by only 0.1% to 10.1% in January compared to December 2012 figure. This is perhaps as a result of the lingering effect of the flooding which affected agricultural production in the later part of 2012. In additional historical trend, food inflation also shows that its volatility has been stable in recent times despite the structural shocks and sustained infrastructural constraints to the underlying sector. Imported food inflation however rose significantly to 14.1% year on year from 9.8% in December 2012, reflecting rising international food prices in the last one year.

The January Effect
Housing, water, electricity, gas and other fuels, clothing and footwear, furnishings & household equipment maintenance, and transport categories’ inflations, which collectively account for 35.89% of consumer price index weight, were still on the rise in January, on a year on year basis. And the rate of price changes of these categories appeared slower on a month on month basis. Each of these categories of inflation moderated by at least 10 basis points on the average in January compared to their levels in December 2012. This indicates possible presence of January effect. The January effect is characterised by milder or slower consumer demand as households recover from the festive spending in the previous December. The coincidence with schools resumptions and the payment of school fees may also have forced a readjustment in household scale of preference against these consumer categories during the month.

The presence of the January effect is further supported by the mild moderation of at least 20 basis points in each of the headline, all items less farm produce and energy as well as the food inflation categories in the month of January. Core inflation rate however increased in the month of January by 800 basis points to 1.4% in comparison to the previous month. The effect of sustained scarcity and attendant hike in pump prices of petrol in January on the energy prices and hence the non-food items components of inflation in January are arguably responsible for this increase.

Low Systemic Liquidity and Stable Exchange Rate
Money market liquidity environment in January was substantially tight and supported the milder aggregate demand during the month. The market closed with a net outflow of ₦652.76 billion due largely to high outflow through the OMO and Primary market activities of the Central Bank of Nigeria (CBN) which resulted in a net outflow of ₦938.55 billion during the month. Uptrend in short term rate in the earlier part of the month perhaps explains the shortage of liquidity until the federal allocation came into the system in the third week of the month to ease the rally in rates.

Trend analysis suggests that the CBN effectively utilised the OMO market to manage systemic liquidity successfully in 2012. It ensured that almost all excessive forms of liquidities were mopped each time they are released into the system. On the average, money market liquidity net –₦242.2 billion per month in the 13 months to January. In other words, the CBN could effectively sustain this tool at keeping system liquidity in control in 2013 with implication for the stability of any liquidity induced price volatility.

The stability of the Naira exchange rate in the last six months also supported milder inflation pass-through in January. Fortunately, movement in global commodities prices were flat on the average in January 2013. According to the World Bank commodities market review for January, energy and non-energy prices rose by 3.5% and 0.4%, respectively while food and beverages prices declined by 1.0% and 1.2% respectively. Food and Agriculture Organisation (FAO) reported a three consecutive month’s flat movement in its global food price index at the end of January. These suggest a milder inflationary trend and threat from global inflation.

Monetary Policy Loosing Strength
Expectedly, money market rates and fixed income yields have adjusted to the single inflation rate achievement almost too quickly and in manner that suggests that the expectation has been priced into assets prices early in the year. With these rates well below the monetary policy rates (MPR) of 12% and inflation rate in single digit, the strength of monetary policy in the evolving market scenario is weaker. Despite the leadership of the monetary authority indicating that it is not likely to commence a reduction in the MPR rate any time soon, yields continue to contract and money market rates stayed below the MPR for sustained longer periods afterward. The longer the monetary authority maintains a policy stance, the more likelihood that the market would begin to ignore it, making monetary policy less effective.

Monetary policy would however be very critical to keeping inflation in the single digit region in 2013 considering the key areas of price vulnerability during the year. The tool may however have to be refined. This is because, keeping the headline inflation rate consistent in the single digit region, especially for a developing economy going through expansive reforms of infrastructure and hence a expansionary fiscal policy stance, could be more challenging as shown by the experience of Turkey. In Nigeria, it would require changes to the structure of the economy, management of government determined prices and fiscal policy. Progress in these fronts is currently controversial thereby putting monetary policy is a vantage position to keep inflation rates on check.

Responsive Monetary Policy in 2013
In this regard, we expect monetary policy to remain alert, implying that the MPR may remain flat through the quarter of the year and perhaps into the second half. In addition, the rising exposure of the Nigerian economy to the threat of hot monies suggests that the monetary authority must thread with caution. This is to avoid unnecessary spark off in foreign capital reversal which could destabilise the price stability achieved thus far. The fixation on exchange rate stability as the indicator that would signal a reversal in current policy stance may therefore be appropriate at this time. Also, the challenges that the fiscal policy outlook poses to systemic liquidity dynamics, potential accretion to the foreign reserves and excess crude account (ECA), and ultimately exchange rate stability remain cause for concern.

Single Digit Inflation May Characterise 2013
The CBN and the National Bureau of Statistics (NBS) forecast inflation for the year is 8.5% and 9.77% respectively. In fact, the CBN expect the core inflation to moderate to as low as 6.6% year-on-year by June 2013. These forecasts are reasonable, provided the consumer price indexes (CPIs) stay on trend and government does not renege on its pledge to keep the current fuel subsidy regime. This is because, where the CPIs stays on trend, no monthly CPI in 2013 would be higher than any corresponding month in 2012 by as much as 10%. The 24 months average monthly change in the CPI as at January 2013 was 0.83% within the range of 3.35% and -0.54% and a standard deviation of 0.74. In other words, a monthly estimated growth of 0.83% in the CPI going forward would be an acceptable trend. At this rate, which we expect would be lower in some months; the maximum inflation rate possible at some months in 2013 is 10.1%.

There are however a number of threats to inflationary trend in 2013. Major threats to inflation in 2013 in broad terms include:

  • The high probability of food price volatility
  • Expansionary fiscal policy
  • Imported inflation via the exchange rate channel

The Nigerian Meteorological Agency warned, in their seasonal rainfall prediction (SRP) report for 2013, of a likelihood of higher incidence of flooding than experienced in 2012 in the current year in the main agricultural producing areas of the north and neighbouring states. And considering the weight of food in the consumer basket (51.7%), a major shock to food inflation portends upward pressure on the headline inflation. Secondly, the expansionary national spending that is implied by the crude oil price budget benchmark of $79 per barrel could distort systemic liquidity, limit potential accretion to the ECA and ultimately the sentiments against the Naira exchange rate. Where the Naira exchange rate loses the current stability, the pass through impact on inflation would be negative.

Every indicator suggests inflation rate in 2013 is poised to remain in the single digit region despite the existence of major threat. The ability of the CBN and the monetary authority to contain the liquidity effect of the expansionary fiscal policy and perhaps manage the potential challenges that the deluge of hot monies poses would be critical to sustaining this feat. We expect the monetary policy to remain supportive in this regard, albeit from a reactive stance rather than leading the market. We are confident that the level of the foreign reserves could support the Naira exchange rate stability in the short term.