How Excessive Money Supply Drags the largest naira depreciation

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

 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  as well as  CBN bailouts of federal and state governments via its Ways and Means powers have  resulted  is too much naira chasing dollars.

Although 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 it hasn’t worked out as planned . This may, however , not be farfetched .  Conventional wisdom and economic theories have proved that  the relationship between money supply and economic productivity is critical  as failure to adequately deploy monetary policy will result in adverse consequences of price instability or  inflation .  . 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.   Sequel to the inability of both the monetary and fiscal authorities to manage this relationship well  higher inflation being a driver of currency depreciation in the recent times .  This is so as  excessive money supply growth  is not matched with rapid GDP growth leading   to inflation and currency depreciation.   This is , putting upward pressure on price levels, as well as, adversely impacting Nigeria’s inflation differentials with major currencies and contributing to currency devaluation overall 

 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). 

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.   The explosion of money supply in the last few years found its way into domestic assets.

 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  

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 71% from N15trillion 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 at June 2022. This reflects Naira declines rate of circa 40%  

In other words, Naira is weakening by a 40% clip based on current trends. That is just simply remarkable  

The Central Bank is likely to continue to prioritize its quasi-monetary policy (economic work 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 on 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.