A surprise bout of inflation is a major risk for the global economy, but monetary authorities in advanced markets are expected to be relatively tolerant of the phenomenon, not wanting to choke off a post-pandemic recovery before output gaps narrow further. This provides African central banks with much-needed policy space, especially for open economies and those with limited monetary sovereignty, and although inflation on the continent will rise in 2021, central banks are unlikely to turn off the monetary taps just yet.

Lagging far behind the rich world, only a small number of African countries are just beginning to roll out a coronavirus (Covid-19) vaccination programme. A global commodity rebound is set to lift the continent out of deep synchronised recession in 2020, but not by a convincing margin. Our expectation is for aggregate real GDP growth of only 2% in Sub-Saharan Africa in 2021. Fiscal arsenals are approaching the point of exhaustion, and many sectors need ongoing fiscal support. Here enters the importance of monetary stimulus in driving a recovery. We do not expect the US Federal Reserve (Fed; the US central bank), to taper the volume of its asset purchases until late 2022, despite its expectations of a stronger US economic rebound, or to hike its Federal Funds rate until late 2023.

Hence the global backdrop is supportive of continuing easy monetary conditions, as long as inflation stays within acceptable limits for foreign investors and central banks. For the latter, what comprises a tolerable inflation level can be hard to gauge. With the exception of the continent’s leading economy, South Africa, few central banks in Africa have strict inflation targets, as most subordinate price expectations behind broader economic performance. A key reason for this is that inflation in Africa is often cost-push and less a reflection of overheating. This is the type of inflation that we are expecting in 2021 for a large number of countries, based on higher global prices for certain goods and thus imported inflation. As a result of this, we expect the monetary policy response to be broadly tolerant.

Inflation anchored by output gaps and currency pegs

The main story regarding inflation is the output gap in Africa, with GDP in US dollar terms not expected to return to pre-pandemic levels until 2022. This will contain demand-side inflationary pressures as consumer spending power remains squeezed in a context of high unemployment. A draw-down in savings expected to power price growth in advanced economies is largely absent, with limited fiscal stimulus and generally a low propensity to save. Meanwhile, the 14 west African countries in the two the CFA franc monetary unions are shielded from imported inflation by their exchange rate peg to the euro. On average, the projected 2021 average annual inflation rate for these countries is just 2.4%, with the euro performing well against the US dollar.

Another anchor for price trends further south is low inflation in South Africa. The South African Reserve Bank (SARB, the central bank) expects inflation to stay well within its 3-6% target-range, at 4.3% for the year. We expect even lower inflation, of 3.7% based on softer economic growth than the SARB is projecting for 2021 (at 2% versus 3.8%), which makes its record-low policy rate of 3.5% sustainable. As South Africa is a leading trade partner for Namibia, Botswana, Lesotho and Eswatini—which all have currencies pegged at parity to the rand—low price growth in South Africa is reflected in these countries and provides their respective central banks with space to remain accommodative over 2021 at least. 

There is one notable exception. Despite inflation being lower than a loose 5-6% target range set by the government, Mozambique’s central bank hiked its policy rate by 300 basis points (to 13.5%) in January on the basis of a stronger price outlook, making it the first African country to tighten policy since the start of the coronavirus pandemic. Inflation in January was 4.1% and rose to 5.2% in April. The intervention was intended to mitigate the inflationary impact of currency depreciation, although since the start of 2021 Mozambique’s currency, the metical, has skyrocketed in value against the US dollar. As we expect the currency performance to be reversed, we expect the policy rate to be held steady for the remainder of the year.

Economies undergoing more intense price pressure

Despite output gaps and excess capacity being a continent-wide phenomenon, there are pockets of high inflation. Topping the African list is Zimbabwe with a rate of 194% year on year, followed by South Sudan (46.8%), Angola (24.8%), Zambia (22.7%), the Democratic Republic of Congo (DRC, 20.4%) Ethiopia (19.2%), Nigeria (18.1%), Guinea (12.3%), Sierra Leone (10.9%) and Liberia (10.5%). Of these, only Zimbabwe and Zambia have responded by raising interest rates. Some, including the DRC and Sierra Leone, have actually cut their policy rates, underscoring an absence of formal inflation-targeting and an expectation within central banks in those countries that inflation will abate organically.

A common theme among those that have lowered or not modified their policy rates is an assessment by monetary policy committees (MPCs) that inflation is being driven by external developments—mainly rising global oil and food prices, rather than endogenous demand. It seems unlikely that a tighter stance will be adopted, with the initial shock of higher world oil prices having passed some months ago. Some central banks, such as Nigeria’s, have been open about making economic growth a priority, despite inaction over high inflation having become a credibility issue. The Nigerian federal government has essentially had to intervene instead, with an implicit return to petrol subsidies (which were briefly withdrawn in 2020) to contain price pressures. The only economy experiencing high levels of cost-push inflation where we are expecting a policy rate hike (of 50 basis points) is in Angola, as inflation has remained stubbornly high and shows little sign of abating without intervention that could support the exchange rate.

Of those central banks that have already acted on inflation, this has been because of demand-side factors playing a more prominent role, at least in the view of MPCs. Zambia’s central bank raised its policy rate by 50 basi -points to 8.5%, partly to offset the impact of lax fiscal policy on inflation, but held the rate steady in May. The Reserve Bank of Zimbabwe hiked its policy rate by 500 basis points, to 40%, in a bid to calm rapid growth in broad money, and the Bank of South Sudan restored its policy rate to 15% in November, after cutting it to 10% during the pandemic, although in both cases this has failed to stem growth in the money supply or contain a new surge of inflation. Hence even when central banks have been acting on high inflation, they have generally been too cautious to bring a definitive end to the problem.

Fiscal pressures bring underlying price implications

A double-edged sword for the fight against inflation in the medium to long term will be the role of tighter fiscal policy. On the one hand, consolidation could circumscribe aggregate demand, but on the other there are early signs of new cost-push pressures that will emerge. For example, so far in 2021 a shift towards tighter fiscal policy in Botswana has prompted a hike in the rate of value-added tax (VAT), higher electricity tariffs/reduced subsidies, a new fuel levy and increases in other consumer taxes. Annual inflation jumped from 2.4% in January to 5.7% by April. Although the cause is cost-push and likely to be withstood by the Bank of Botswana (the central bank), without a change in the policy rate, higher taxation and subsidy cuts are inflationary themes that will develop more substantially over the next few years. Botswana has long been vigorously committed (at least in principle) to a balanced budget, more so than most other African states, but other countries that have turned to the IMF are now focussing on how to mend damage done to the public finances in 2020.

In January Kenya undid a cut to VAT that had been implemented in 2020 ahead of an agreement struck for a US$2.3bn loan programme with the IMF. Several other countries made VAT cuts during the initial shock presented by the coronavirus pandemic, either to medical supplies or to various staple goods. These will inevitably be reversed at some point in the near future, leading to higher prices. In the longer term there will need to be additional hikes to consumer taxes and subsidy cuts in order to bring down borrowing while protecting private investment, which will play an increasingly important role in managing inflation in future. However, our expectation is that for the most part these reforms will not be made until 2022 and beyond, and, as pressures are cost-push in nature, it again seems unlikely that central banks will feel compelled to act on these alone.

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