STONE TOWN, TANZANIA - January 2018: Overcrowded local fruit and vegetable market with lots of sellers and buyers in Stone town, Zanzibar, Tanzania / Photo by Sun_Shine, Shutterstock
While inflation pressures seemed mostly synchronized in 2022 and the first half of 2023, they are beginning to diverge across Sub-Saharan Africa. As documented in the latest edition of the World Bank’s Africa’s Pulse Report, we can now see two distinct groups: low-inflation countries on the one hand, and high-inflation countries on the other.
By June 2024, 30 out of 43 countries in Sub-Saharan Africa had inflation rates that were low and declining, while the inflation rate in 13 countries was still high—in the two digits or more. In our view, this differentiated picture deserves further analysis.
Why are inflation rates diverging so dramatically, and what should governments do in each group?
Among high-inflation countries, headline and food inflation have been rising in tandem with exchange rates, as shown in Figure 1 (in red). By contrast, the stabilization of currencies was followed by a deceleration in food and headline inflation among countries with low inflation (in blue). Why is that?
Figure 1. Inflation and exchange rates: divergent experiences across Sub-Saharan Africa
Sources: Haver Analytics, International Financial Statistics, International Monetary Fund, World Bank Food Security Report.
Notes: The exchange rate index is computed so that increases (declines) in the index represent depreciations (appreciations)—it appears on the right-hand side (rhs). H/I = the group of countries with high and/or increasing headline inflation; L/D = the group of countries with low and declining headline inflation.
In the high-inflation group, most countries have pegged their currency to another one (say, the dollar or the euro) or to a basket of currencies within a narrow band. In many of these countries, contractionary monetary policies were ineffective in bringing down inflation due to uncoordinated fiscal policies (i.e., monetary financing of the deficit) or existing foreign exchange distortions that led to the emergence of parallel markets. While rising parallel rates fueled inflation, foreign exchange market interventions by central banks delayed the adjustment of the official rate. This led to an overvaluation of the currency and a loss of reserves. The scarcity of reserves, along with high inflation, created further pressures which weakened the currency. Ensuing realignment in the exchange rate led to a vicious circle that now risks un-anchoring inflationary expectations.
By contrast, many countries with low inflation have a hard peg currency regime (e.g., countries in the West African Economic and Monetary Union, or WAEMU, and the Economic and Monetary Community of Central Africa, or CEMAC) which has helped them impose discipline on inflation. Others were able to lower inflation by tightening monetary policy (i.e., South Africa and the rand-pegged countries). In some of these, tightened monetary policies, along with greater coordination between monetary and fiscal policies, led gradually to a strengthening of their currency, thus reducing the cost of imported consumer goods (including food and energy) and, hence, curbing inflation.
In our view, these developments should now lead to nuanced and differentiated responses in monetary policy between low- and high-inflation countries.
Countries with low inflation may cut interest rates if their inflationary expectations are well anchored and near or within their target bands. Some countries have already started an easing cycle (e.g., South Africa, Kenya, Rwanda, and Mozambique).
On the contrary, countries with high inflation may either pause interest rate hikes or increase their policy rates if and only if inflation expectations are not well anchored. Some countries in this group have embarked on courageous reforms of their exchange rate regime and the functioning of their foreign exchange market (e.g., Nigeria and Ethiopia). The success of these reforms may hinge upon ensuring central bank independence, managing the transition to a more flexible exchange rate agreement, and deploying complementary structural reforms that boost productivity-driven growth, all the while shielding the most vulnerable from the negative impacts of currency adjustments through social protection programs.
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