It started with a lie of omission. When the House of Reps committee on banking were finally able to get former CBN Governor Godwin Emefiele to attend a hearing on his naira redesign policy in February last year, he began with an impassioned speech.
He wanted to save Nigeria’s economy from the sharp points on the pitchfork of criminal currency hoarders, dirty bank notes, inflation and financial exclusion.
The CBN was responding, according to him, to a situation which made the bank powerless to fulfil its duty to curtail and manage money supply. He moved swiftly to illustrate this, between 2015 and October of 2022, currency in circulation had more than doubled, from N1.4 trillion, to N3.3 trillion – of which, N2.7 trillion was cash outside banks.
The CBN’s mandate is to manage money supply within the economy. Correct. Money in circulation had more than doubled between 2015 and October 2022. Not quite according to CBN’s money statistics but the thrust was in the right direction. Except, many of us got so bogged down in the process and its politics, that there wasn’t sufficient interrogation of the economic sense of it in the first place.
Regulatory Overreach
Two of the four targets were self-evidently regulatory overreach – it’s not the job of the CBN to fight corruption outside of itself, and a Central Bank mandate to tackle kidnap ransoms is certainly not in economics textbook I’ve read, or in the bank’s list of functions in the CBN Act.
Over time, the CBN could simply have worked with banks to retain notes in disrepair as is the standard in the so-called “saner climes”. The Bank of England gave the far more adequately banked English a period of two years and seven months before the old £20 note ceased to be legal tender.
This is because, redesigning your currency is rarely a monetary policy tool for much more than upgrading security features to prevent counterfeiting. Unfortunately, the mad scramble to get the new notes designed which led Emefiele to defy Buhari’s directive to procure them domestically, left us with few significant changes on the security front.
So, we’re left with two mildly plausible rationales for such a destructive policy – demonetisation (as a bewildered international press ran with) and inflation busting (as the CBN constantly insinuated).
Demonetisation
The policy was tagged a cashless policy in many quarters. The perception of this was bolstered by the launch on the 26th of January 2023 of the AfriGo domestic card scheme to “drive financial inclusion”. The policy, it was argued, was designed to encourage (a deceptively soft way of putting it) the unbanked to adopt digital alternatives.
The trouble, however, was that the lack of financial inclusion, faced by 40% of Nigeria’s adult population at the time, was structural.
There are entire local government areas in Nigeria with no traditional bank branch, and the agent model of financial inclusion really gives meaning to the adage that “it’s expensive to be poor” with its regressive withdrawal charge structure. Internet access is limited in rural areas, so if POS machines fail in Lekki lounges, you can get a sense of their lack of reliability in the deepest recesses of the country.
People in rural areas were told to deposit all their cash in Tier 1 accounts, which require a BVN or NIN, to access the new notes; and were restricted to maximum withdrawals of the new currency of N10000.
This trapped everything above that amount in accounts that they would have to pay to access. It was easy for Emefiele to talk about sending CBN staff out to their local government areas with cash, because most Nigerians don’t realise that there are 25 local government areas in Nigeria which are bigger than the entirety of Lagos, and many of them have far less access to reliable transport.
In any case, the CBN had been pursuing demonetisation with far less dramatic consequences for years, and with far more efficacy. Consequently, if one was to believe Emefiele’s claim to the sudden urgency of the policy, the only rational excuse left was this nebulous claim about its capacity to arrest Nigeria’s economic decline.
Grappling with Inflation
In the CBN’s FAQs on the redesign, it was suggested that the CBN chose its policy timing because redesign was overdue, and bringing “a considerable amount of
money currently outside banks back into the financial system may help ease inflationary pressures”. Throughout the period, Emefiele’s CBN constantly signalled that the move would strengthen the Nigerian economy in this regard. In his House of Reps committee hearing, he argued that the scale of currency outside banks was inhibiting the CBN’s capacity to control money supply. What he omitted to inform Nigerians, was that currency in circulation was just 1.52% of GDP and falling.
Bizarrely, in October 2022, currency outside banks represented just 5.6% of M2 and 13.29% of M1, down from 7.27% and 16.99% in December 2015 respectively. Sounds like jargon but what does that mean? In short, around 19 of every 20 Naira in circulation was already in the banking system (in layman’s terms, almost all).
The pace at which cash outside banks grew between 2015 and 2022 was an indication, not that this measure of money supply was spiralling out of control, but instead of Nigeria’s widening inequality.
To confound one further, between June and October 2022, month on month inflation had fallen steadily from 1.82% to 1.24%, suggesting that the worst of the pains from the devastating floods of 2022, and the disruptions of supply chains from the Covid pandemic were loosening. The peak was behind us.
Worsening the Money Supply Problem
Furthermore, if money supply was driving inflation, a massive influx of demand deposits would only worsen the problem. Why?
While the CBN is the only institution which can issue currency notes, they aren’t the only institution which can create new money.
How does this work in practice? If I deposit money in the bank, the bank will have to keep a proportion of that money in its reserves (Cash Reserve Ratio) and keep a proportion of that money liquid (Liquidity Ratio). That is basically money that the CBN is putting on hold. Banks can’t really do anything with it except hold it until I come back for my money or transfer it to someone else.
The bank has freedom, within limits to make money off the rest of my money. So, for example, if another person goes to the bank for a loan, the bank can grant that loan mitigating the risk with my deposit. Any time they give a loan, they are creating more money.
That’s because, while that other person can take that loan and spend it, if I come back for my money, or if I pay for bill at a restaurant on my card, the bank must give me my cash or honour the payment.
The borrower can close that book by earning money to pay back the loan, but if he doesn’t, the bank is left short while still having liabilities to me. This is a feature of fiat currencies. In the digital age it’s even easier because they just need to change the numbers on my account.
It’s a delicate balance, banks are banking on the assumption that we won’t all come for cash at the same time. This is why the regulatory functions of the CBN are so important, moreso than even controlling FX.
If something throws off the balance, the whole system of money we have comes tumbling down. The CBN keeps a handle on credit creation through the Loan to Deposit Ratio (LDR).
That is the amount the bank can borrow out as a proportion of the deposits it’s holding there. It also must stress test banks to prepare for challenging eventualities.
Moreover, in an economy where the informal sector is estimated at 58.2% of GDP, and where the informal sector largely borrows informally, interest rate hikes are largely ineffective at taming borrowing. For informal businesses, outside of traditional money pooling systems like aajo, rates are generally dislocated from the formal banking system, making the marginal increments in MPR far less significant.
Banks lend disproportionately less to sectors like agriculture and trade which make up sizeable chunks of the economy. The sectoral breakdown of credit to the private sector shows that agriculture, which represents around a quarter of GDP, gets less than 5% of credit.
The Fallout
The result was predictable carnage. Banks and agents couldn’t keep up with demand. Power determined access – videos of the wealthy spraying fresh bundles of the new notes emerged as a naira-to-naira exchange rate opened up, and people starved.
Businesses saw extraordinary losses as the economy contracted and, per estimates from the Centre for the Promotion of Private Enterprise, the Nigerian economy lost N20 trillion.
Given the mounting costs from the myriad of supply side challenges businesses faced, which created desperation for credit, to be effective at taming money supply, the CBN then needed to clamp down on credit creation. Unfortunately, it did not, retaining the 32.5% CRR it set in September 2022 and retaining the 65% LDR of 2019. As demand deposits grew and cash outside banks dropped dramatically, banks had increased capacity to lend and, and money supply went up.
Add to this, a sharp uptick in Ways and Means advances. Inflation followed. Food inflation, which had dipped, started picking up pace again. By April 2023, month on month inflation across the whole basket was higher than the previous peak of June 2022 at 1.91%.
This happened for a few reasons. First, because people panicked. They bought in bulk, fearful and uncertain about the supply of goods and the value of the naira they held. Businesses price gouged, hiking up prices and exploiting the fears of ordinary Nigerians.
The naira depreciated in the parallel market where many businesses had been forced to access their dollars due to FX liquidity challenges in the official market and the sizeable list of restricted items.
Secondly, money supply was growing. M3 moved from N51.6 trillion in November 2022, to N53.2 trillion by February 2023.
That increased volume of Naira was chasing fewer goods as food in farms went unharvested because farmers couldn’t access cash to pay their seasonal hands as the value of currency in circulation fell below N1trillion.
This was on top of existing challenges as unpaid debt in the agricultural sector mounted and insecurity and fears of lost yields in the previous year’s floods haunted farmers. A mess all round.
How could we predict this? There were approximately 5.2 billion pieces of N200, N500 and N1000 notes in circulation at the time of announcing the policy.
Despite their “best efforts” by December 2022, CBN had ordered the printing of just 500 million pieces, less than 10% of the total. With such a large proportion of the population transacting primarily in cash, cash is a class issue.
The poor and powerless paid the lionshare of the price. Indeed, even if the policy were successful, the weight of transaction fees would have fallen heaviest on their shoulders.
A Morbid Legacy
There has been much speculation about the motivations behind such a rushed ill-advised policy. Whether it was the final tantrum of a failed presidential aspirant or a consequence of sheer incompetence, the move certainly made an impression.
Efemele (as one viral video renamed him) became one of Nigeria’s most hated men. So much so that people celebrated his arrest, even though it had nothing to do with the redesign policy.
A more stubborn, and often overlooked, element of this legacy has been the complete distortion of public discussions of monetary policy through the elision between money supply and currency in circulation that he advanced in his committee hearing.
For many Nigerians, after years of seeing the CBN as little more than a Dollar warden and a sugar daddy to credit starved sectors, the Naira redesign was their first introduction to actual monetary policy.
Those first impressions have been durable, they continue to shape conversations about monetary policy today, even as the dynamics of inflation and money supply have shifted profoundly.
If we’re to have any hope of getting past that rot, we must work hard to cut through and foster greater literacy in the terms of monetary policy.
