Inflation, Interest Rates, and the CBN’s Quest to Defend the Naira

The Chair of the US Federal Reserve Bank (Fed), Jerome Powell, may not have calmed global bond markets with his pledge to act only if the markets turned rowdy. But by dampening prospects of a near-term rise in the Fed’s benchmark interest rate, he may have helped emerging economies more. Higher interest rates would have increased the cost of servicing emerging economy debts – many of which rose on the back of interventions last year to keep economies supported against the ravage of the pandemic. Higher interest rates would have hurt these economies, as it did in 2013 with the taper tantrum – not to be confused with a temper tantrum, taper tantrum refers to an actual event of panic selling of U.S. bonds when the then Fed Chair, Ben Bernanke announced the Fed would taper down on quantitative easing aka printing money.

A higher debt burden has meant more pressure on an already tenuous government revenue-to-debt service ratio in the country. But by far the biggest threat to the domestic economic outlook, were interest rates to trend up globally, would be the one to the naira’s exchange rate. Unusually low domestic money market rates have supported the naira carry trade – and the local investor community’s search for inflation-proof assets, even as the Central Bank of Nigeria (CBN) has struggled to put the kybosh on this via a slew of administrative measures.

Two downward revisions to the official exchange rate late last year, and one early this year, only strengthen concerns about the central bank’s inability to hold course. As does the CBN’s latest “Naira 4 Dollar Scheme”. Over the two months to end-March, the balance on the nation’s gross external reserve was down by $1.48 billion, despite crude oil prices continuing their north-bound trend. Up to this point, supply constraints have driven oil price gains. Expectations of a price recovery supported by rising demand as the world puts the worst of the pandemic-induced crisis behind it all seem to have forgotten that the fundamentals of the global oil market were already askew before March last year.

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Even at that, the global price for oil will have to set new record highs to salve the fiscal aches of most oil-producing economies. Current estimates of the oil price at which budgets break-even in Saudi Arabia and Russia are $83 per barrel and $67 per barrel respectively. In Nigeria, talk is of a much higher $93 per barrel break-even point.

More than the global outlook, then, much of the domestic economic outcomes over the next nine months will ride on the federal government’s willingness and ability to drive deeper structural reforms. It is thus welcome that money market rates recently started trending up. It does not help that headline inflation has remained sticky upwards – shrinking consumer spending at the bottom of the earnings ladder, and heaping pressure on the exchange rate from the top. But it would help that those economists are wrong in the near term, who are calling higher inflation as a result of the Biden administration’s infusion of a $1.9 trillion fiscal support package.