Money supply growth stokes dollar demand as CBN tightens noose

The persistent rise in money supply in the country has been described as one of the contributors to increased demand for dollars and the deprecation of the naira.

Money supply, which is referred to as M2, increased by 75.79 percent to N92.87 trillion in January 2024 compared to N52.83 trillion in the corresponding period in 2023, data from the Central Bank of Nigeria (CBN) revealed.

Money supply refers to the total amount of money circulating in an economy. It includes physical currency (like coins and banknotes) and various types of deposits in banks that can be quickly converted to cash.

When the money supply in an economy is increasing, it generally means there is more currency circulating within the economy. This can happen due to various factors such as increased government spending, expansionary monetary policy by the central bank, or increased borrowing by individuals and businesses.

Currency in circulation jumped to N3.65 trillion in January 2024, representing a 164.49 percent increase over N1.38 trillion in January 2023.

Last month, the Senate kicked off an investigation into the ways and means of loans to the federal government to the tune of N30 trillion including interest rate.

“Loads of naira sloshing around in loose monetary conditions contributes to the huge demand pressure on the US dollar and other foreign currencies as capital flight intensifies,” Kingsley Moghalu, former deputy governor of the CBN, said.

“This vicious cycle must be broken. Doing so will help achieve both price stability and exchange rate stability in the medium term. It is also calculated to increase confidence among investors, who need attractive yields to bring in portfolio investments that will help stabilise the exchange rate and do not wish to invest in high-inflation environments that erode value,” he said at a conference and awards in Abuja.

BusinessDay’s analysis indicates that under the leadership of Governor Olayemi Cardoso, the CBN has issued a significant sum of N1.5 trillion in Open Market Operation (OMO) bills. This move aims to combat inflation and stabilise the naira, which has experienced a notable decline, causing concerns within the economy.

The naira has consistently remained under pressure following strong demand for dollars, depreciating to as low as 1,615.94 per dollar on February 27, 2024 at the official foreign exchange market, while the parallel market exchange rate peaked at 1,825/$ a week earlier.

“There is so much naira now in circulation and several people with the naira do not trust the stability of the naira and so they want to save or hold value in dollars. In doing so, we put so much pressure on the dollar,” said Andrews Elueni, managing director of Flawless Capital Limited.

He said the external reserves and excess crude oil account have plunged as a result of people wanting to hold dollars.

“So the demand for dollars as of today is informed by consumption needs for imports. The second one is that we are holding value in dollars instead of holding value in naira,” he said in a phone interview with BusinessDay.

“We observed a correlation between the Monetary Policy Committee (MPC) rate increases and substantial growth in money and credit, indicating a counteractive measure. Despite four occasions of policy rate hikes in 2023, money supply (M2) and credit to the government expanded by 76 percent and 36 percent, respectively, between January 2023 and January 2024. Therefore, we could argue that the impact of interest rate hikes on inflation is limited or, perhaps, offset by the rapid increase in money supply growth,” analysts at FSDH Research said.

Last month, the Monetary Policy Committee (MPC) raised the monetary policy rate (MPR) by 400 basis points to 22.75 from 18.75 percent, adjusted the asymmetric corridor around the MPR to +100/-700 from +100/-300 basis points, raised the cash reserve ratio from 32.5 percent to 45.0 per cent, and retain the liquidity ratio at 30 per cent.

Yemi Cardoso, governor of the CBN, who chairs the MPC, said: “The MPC also deliberated extensively on various distortions in the foreign exchange market including the activities of speculators, putting upward pressure on the exchange rate with high pass-through to inflation.”

He said members were, however, convinced that the ongoing reforms in the foreign exchange market would yield the desired outcome in the short to medium term. Some of these reforms include the unification of the foreign exchange market, promotion of a willing buyer willing seller market, removal of all limits on margins for the International Money Transfer Operator remittances, introduction of a two-way quote system and the broad reforms in the bureau de change segment of the market to restore stability, enhance transparency, boost supply, and promote price discovery in the Nigeria Autonomous Foreign Exchange Market.

Muda Yusuf, CEO of the Centre for the Promotion of Private Enterprise, said that with the naira still around N1,600 per dollar, nothing much has happened since the hike in interest rate.

He said, “There is always a lag when you have a policy and an effect. I am not so optimistic about the kind of expectation that people have that this kind of monetary policy tightening will tackle the currency problem. Generally, it will yield some result but the impact will not be felt immediately.

“I am not so optimistic because quite a number of the liquidity is coming from outside the banking system. There is a lot of money that is with the government and in government accounts, and it is not as if there is any embargo on spending of such money. If you mop up the cash reserve ratio, it can only affect the credit that the banks are giving. It cannot affect government spending. So we need to tackle all the sources of liquidity beyond just increasing the interest rate.”

Analysts at the FSDH Research advised the CBN to temporarily halt lending to the government. According to them, raising rates and increasing lending to the government is counterintuitive, and the cost will be borne by businesses in the form of higher borrowing costs and inflation. “Fiscal authorities need to be forced to raise finance from non-CBN sources. Some options are aggressively reducing oil theft, exploring solid mineral exports, and curbing illegal mining.”