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AfricaDecember 22 2022

Africa’s great inflation challenge

African authorities must make tough choices as they are confronted by surging prices, writes Charlie Mitchell.
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Africa’s great inflation challenge

Crippling, runaway inflation is emerging as sub-Saharan Africa’s (SSA’s) biggest financial challenge, with heavily indebted economies across the region already in the doldrums. 

Currently at decade-high levels, inflation is destroying incomes for some of the world’s most vulnerable people. And in many weak African economies, monetary authorities do not have the tools to effectively fight back.

Desperate to get a handle on the situation, central bankers across the region have been hiking interest rates, including in major economies such as Nigeria, South Africa, Kenya and Ghana, and the monetary unions of west and central Africa. Doing so comes with its own risks, however, including hindering growth and shrinking incomes.

Only by successfully walking the fine line between keeping inflation in check and boosting economic activity, experts say, will African economies weather the storm.

Jacques Nel, head of Africa Macro at Oxford Economics, says the inflation challenge was “in short, enormous” and even harder to overcome in Africa than elsewhere. “Underdeveloped monetary transmission mechanisms mean that monetary authorities in many countries don’t have the tools to effectively deal with inflation,” he says. “These countries run the risk of inflation expectations becoming unanchored, resulting in a vicious cycle where inflation begets inflation.”

All year inflation has posed a persistent challenge in SSA economies struggling to rebuild from the Covid-19 pandemic. Nigeria, the continent’s largest economy, saw inflation hit 21% in October, exacerbated by devastating floods in food-producing regions and the weakness of its currency, the naira. 

In Kenya, east Africa’s economic powerhouse, inflation hit 9.6% in October on the back of a depreciating Kenyan shilling and dwindling international reserves. 

Ghana leads the pack – inflation reached 40.4% in October, causing business sentiment to slump to levels seen at the height of the Covid-19 pandemic and prompting the threat of protests. Ghana’s central bank had already raised its interest rate to a staggering 24.5%.

In the region as a whole, median inflation is hovering at around 10%, roughly double pre-pandemic levels.

In SSA, inflation can be life or death, and often the poorest countries are the worst affected. With food and energy accounting for half of household consumption in the region, living costs have spiralled, leaving many with nothing to eat. The International Monetary Fund (IMF) estimates that 12% of the region will face acute food insecurity by the end of 2022, with the prices of key staples such as maize and wheat spiralling since 2019. 

“Given the prevalence of informal activity and subsistence farming, incomes are unlikely to keep up with these price increases, meaning those least capable of dealing with higher prices are the ones feeling the brunt of these pressures,” Mr Nel says.

Food, fuel, floods and fighting

The drivers of inflation are many and varied. Despite a rebound last year, the fallout from Covid-19 – particularly its impact on global supply chains – has kept economic activity in SSA relatively muted. African countries tend to import much of their food, while key export industries, such as fruit and flowers in Kenya’s case, saw their exports collapse. And while wealthy countries were able to inject billions into their economies to stimulate growth during and after the pandemic, weaker African economies lacked the resources to do so. 

“Compared to other regions, the recovery [from Covid-19] in SSA has been slower,” says Marijn Bolhuis, an economist in the International Monetary Fund’s Africa department. “The gap between where SSA as a whole is now, relative to the pre-Covid path, is much bigger for SSA than for other regions.”

While inflation in advanced economies is driven in part by domestic demand pressures, external factors have prompted it in SSA, chief among them supply chain shocks and increased international food and fuel prices.

The war in Ukraine has caused commodity prices to jump, hurting import-dependent African economies, which have seen domestic prices spike, too. “Their inflation is driven by the fact that they have a dollar-based import base and this is usually higher than their exports, so their trade balance is negative,” says Trevor Hambayi, an independent economist based in Lusaka, Zambia.

In advanced economies food typically accounts for 15% of the household consumer price index (CPI) basket, but in SSA it exceeds 25% in most countries and 50% in Ethiopia, Zambia, Sudan and Nigeria, meaning food inflation hits livelihoods particularly hard. East Africa previously imported 90% of its wheat from Russia and Ukraine, but the war ceased shipments for months, driving prices up further.

Meanwhile, “effectively all African countries are highly dependent on refined fuel imports,” says Mr Nel. “This means that fluctuations in international oil prices have a direct bearing on the cost of transport, particularly in urban areas.”

Natural disasters, which scientists have tied to climate change, have also weighed on growth and spurred runaway inflation. Droughts across the Sahel have stifled food production and destroyed livelihoods, as have floods and landslides in Nigeria and South Africa.

In east Africa, 37 million people face acute hunger owing to the worst drought in 40 years, which has reduced northern Kenyan savannah to dusty scrubland. And conflict and civil strife, witnessed recently in Mali and Burkina Faso, can drive up prices too by hitting trade and transportation inside their borders. Farmers who cannot get hold of fertiliser, for instance, see their output fall, breeding scarcity.

Finally, a strong US dollar, owing to interest rate hikes by the Federal Reserve, has added to Africa’s inflationary pressures by depreciating currencies, which again raises import costs, and growing sovereign debt, which is usually dollar-denominated. After serious slumps, Ghana’s cedi and the Zimbabwean dollar are among the top 10 worst-performing currencies of 2022. And one quarter of African countries, the IMF reckons, are sitting on foreign exchange reserves below three months of imports.

Fighting with blunted weapons

With few good options, and partly as a response to monetary tightening in rich economies, African central banks have resorted to consistent interest rate rises in a bid to quell inflation. In late November, the Central Bank of Nigeria raised its benchmark rate for a fourth straight meeting to 16.5% after governor Godwin Emefiele warned: “As long as inflation is trending upwards, we cannot assure anybody that we will not raise rates.” It marks the longest unbroken cycle of monetary tightening since 2011.

Ghana’s central bank raised its main lending rate to 27% amid the worst crisis in a generation. Mr Nel expects Ghana’s interest rate to be pushed even higher, by another 200 bps early next year, and for monetary policy committees in Nigeria and Kenya to hike rates too.

Meanwhile, in a bid to bring relief to cash-strapped consumers, many African countries have introduced food and fuel subsidies, a risky step that could exacerbate the fiscal challenge that many face and jeopardise debt sustainability.

Angola has managed to buck the trend and actually lower interest rates. The oil producer has seen its headline inflation rate fall from 27.7% in January to 16.7% in October owing to the strong appreciation of its currency, the kwanza. Angola owes its relative success to higher oil prices, which resulted in massive foreign exchange inflows, and a successful IMF package concluded in 2021. Most African countries, far from exporting crude oil, are forced to purchase it at elevated prices.

A lot of countries are working to be able to maintain inflation and they are utilising financial instruments rather than productivity

Trevor Hambayi

While interest rate rises can tame inflation, they also dent economic growth and push countries towards recession. “A lot of countries are working to be able to maintain inflation and they are utilising financial instruments rather than productivity to be able to manage this,” says Mr Hambayi. “This is a very thin line because you need the economy to recover before your inflation becomes stable.”

Zambia too has successfully reduced inflation from 23% to 9.9% in a year, aided by a new government elected in 2020 whose comments on debt restructuring and economic stabilisation have been well-received internationally. Yet with no economic stimulus and no liquidity in the market, global domestic product (GDP) growth has been constrained. “So positively, yes the inflation is good, but negatively we have had no GDP growth and this has been affecting the cost of living for most households,” says Mr Hambayi. 

“What we do need on the continent is GDP growth, that is going to offer revenue growth to increase household income, which they can use to mitigate the inflationary issues that have come.”

Routes out of the crisis

Optimists might see opportunities in the crisis. With the eurozone and the US expected to record GDP contractions this year, African countries have a chance to attract growth-seeking foreign capital. In addition, with monetary tightening driven by external rather than demand-side pressures, Mr Bolhuis says, “If these supply shocks somehow go away,” such as global shipping costs falling, as they have begun to do, “then we should expect inflation in the goods that are directly affected by those disruptions to subside.”

The same applies for food and energy: grain prices and global energy prices have started to fall in the past six months.

Other countries could benefit from debt forgiveness, since many bonds are due to reach maturity in 2024 and 2025. China recently forgave 23 interest-free loans to 17 African countries, although in practice those loans were seen by recipients as grants. Some may look at restructuring their debt, as Zambia is currently doing.

In the longer term, however, SSA countries will need to channel dwindling financial resources into more productive uses to build resilience and strengthen their economies. Experts say self-sufficiency is the best bulwark against price fluctuations in the long term.

“Governments must reprioritise the amount of spending they have control over to support high value investments in, for example, agriculture to establish food security over the long term,” wrote Andrew Dabalen, the World Bank’s Africa region chief economist, in a recent report. “They must also invest in supporting long term growth, human capital and infrastructure; and the diversification of trade partners is also important.”

To that end, Mr Hambayi says African nations are well-placed to be able to bounce back and quell inflation in the coming years. “All the factors that are contributing to inflation are external, other than the fact that their trade balance is negative,” he says, so policymakers should be eyeing revenue generation through export diversification and import substitution for key commodities, namely crude oil and basic food grains. 

He acknowledges, however, that fiscal challenges will prevent many from scaling up domestic agriculture or setting a defined price for crude oil imports, because they cannot afford to pay those futures immediately.

Challenges remain

In the near term, there remains a substantial risk that supply shocks become entrenched, Mr Bolhuis says, leading to sustained inflation within the region. He says that “secondary effects”, such as elevated prices being locked into the system, have already begun to emerge in SSA countries, prompting concern.

Prices are expected to remain elevated in Kenya in the near term with the country likely to face a sixth failed rainy season. In addition, “the removal of some fuel subsidies combined with an increase in excise taxes and a weaker exchange rate will weigh on other components in the CPI basket,” says Mr Nel. 

In Nigeria, domestic fuel prices will likely remain elevated, with government subsidies proving futile. Short of a significant decline in oil prices, experts say, inflation will persist throughout most of 2023 in Nigeria, an oil-rich nation that lacks refining capacity.

As a result, Mr Bolhuis says most countries would be very wise to tighten monetary policy in the coming months. “Most countries that are hit by these supply shocks where most of the inflation is externally driven should raise policy rates cautiously” in order not to jeopardise their recoveries, he says. He adds that they should closely monitor for secondary effects – signs that inflation is becoming locked in – for instance in locally produced services including education and health.

However, “where you see that inflation expectations are unanchored and inflation is already very high, they need to tighten faster and more decisively,” says Mr Bolhuis. So too will countries with weak monetary policy frameworks and those that do not have a track record of keeping inflation in check.

As inflationary pressures worsen in the coming months, heavily indebted African governments will be asked to do more with much less. Food security will remain a perennial challenge for Africa’s poorest people.

“It is not that we do not have the resources on the continent, it is that we have very poor management in terms of fiscal discipline as well as fiscal consolidation,” says Mr Hambayi. “And that is the major challenge which gives us a cyclical problem.”

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