Nigeria’s excessive Money Supply growth rate is fueling the largest naira depreciation in history

CBN's policy of low interest rates accompanied by intervention funds may have triggered massive naira depreciation

 by Research Team

An increase in money supply is likely one of the factors fueling the currency depreciation being experienced between the naira and dollar in recent weeks.

This is based on an analysis of the money supply data from the central bank, over the last decade, particularly since the apex bank started its policy of intervention in the public and private sectors.

The amount of money supply in the economy is at its highest level on record at about N48.8 trillion while currency in circulation is above N3 trillion for the 8 straight month. Demand deposits, which are money held by banks on behalf of the customers are also at an all-time high of N17 trillion.

The amount of money in supply has accumulated over the years largely due to the low-interest policy of the CBN (adopted to spur economic growth), trillions of naira in CBN intervention funds, and CBN bailouts of federal and state governments via its Ways and Means powers. The result is too much naira chasing dollars.

Follow the money

For most economists, the relationship between Money Supply and Economic productivity is critical, especially as failure to adequately deploy monetary policy will result in adverse consequences of price instability (that is, inflation). 

• The CBN’s policy to stimulate policy supply was in good faith, as it aimed to get Nigeria out of a recession quickly while creating jobs and encouraging local production.
• But it hasn’t worked out as planned.
• Specifically, proponents of the Quantity Theory of Money argue that excessive growth in money supply, without commensurate growth in productivity will simply result in price level increases or inflation as economists term it.  
• Nairametrics readers will also be familiar with higher inflation being a driver of currency depreciation. Thus, excessive money supply growth that is not matched with rapid GDP growth leads to inflation and currency depreciation. Readers can read more here and here. 

So, what about Nigeria? 

Since 2020, Nigeria’s money supply has exploded from N28.8 trillion in 2019 to now N48.8 trillion in June-2022. This is a 69% increase in Money supply (M2). 

Nigeria’s Money Supply Chart Source: CBN/Nairalytics

However, despite this astronomical Money Supply growth, Nigeria’s Nominal GDP growth was a paltry 5.6% in 2020 and 13.9% in 2021 (Real GDP growth rates are even worse). 

• In other words, this 69% increase in money supply, simply dwarfs the country’s productivity growth rates.  
• As the chart above depicts, the explosion of money supply in the last few years found its way into domestic assets.
• Therefore, putting upward pressure on price levels, as well as, adversely impacting Nigeria’s inflation differentials with major currencies and contributing to currency devaluation overall 

More trouble: Of greater concern is that despite the contributory upward pressure on inflation, the spikes in the money supply don’t seem likely to reduce anytime soon. 

Specifically, as previously mentioned, the latest data shows June-2022 money supply is now at N48.8 trillion. This is the highest level ever attained. In fact, as a proportion of GDP, the money supply is at the highest level ever. 

 Some key facts to ponder

• Notably, money supply is now averaging 25% of Nominal GDP (compared to 21% earlier)  
• As previously mentioned, this mismatch simply means a higher inflation differential which over the long term will show up in exchange rate depreciations. 
• Since the 2010-2014 period, Money supply stock has grown more than three folds from N15 trillion to N48.8 trillion.  
• Notably, Naira has declined from about USD$1 / N160 in the early part of the last decade, to now trading at over USD$1 / N415-N600 as of June 2022.
• This reflects Naira’s declines rate of circa 30.8%
• In other words, Naira is weakening by a 30.8% clip based on current trends. That is just simply remarkable  

So, what happens next? 

The Central Bank is likely to continue to prioritize its quasi-monetary policy (economic word for liquid investments) activities of doling out record levels of intervention programs.  

• Albeit the efficacy of those intervention programs remain questionable, especially if funds are not being deployed as expected  
• Additionally, the CBN is also likely to continue to fund the Federal Government’s deficit, this can be seen in the Ways and Means interest being paid by the FG (i.e. N405 billion in interest charge as of April 2022) 

Consequently, Nigerians should expect that if this mismatch of Money Supply growth excessively outpacing GDP growth continues, the results in price levels and currency depreciation should continue apace. 

• Interestingly, the CBN has announced interest rate spikes in an attempt to encourage domestic capital formation, but that is unlikely to stem the rate of inflation and resulting currency depreciation, especially if money supply growth continues to outpace GDP growth in this manner.