Extra liquidity hurts push for decrease inflation

SAMI TUNJI examines Nigeria’s rising inflation disaster, the influence of extra liquidity, amongst different components, additional spotlighting efforts by the Central Bank of Nigeria to curb it by financial tightening, stressing the necessity for fiscal-monetary coordination, structural reforms, and enhanced monetary self-discipline to stabilise Nigeria’s financial system

Nigeria’s battle with inflation stays one of the urgent challenges to its financial stability. The most recent information from the Nationwide Bureau of Statistics exhibits that headline inflation stood at 34.80 per cent as of December 2024, with core inflation enjoying a dominant function in driving worth will increase.

In keeping with the NBS’ Client Value Index report, there was a marginal rise of 0.20 per cent as a consequence of heightened demand for items and providers throughout the festive season. On a year-on-year foundation, the December inflation price marked a major improve of 5.87 share factors in comparison with 28.92 per cent in December 2023.

A number of components have contributed to this sustained inflationary strain, together with structural bottlenecks, change price volatility, and vitality worth changes. Nevertheless, extra liquidity is a vital but usually missed issue exacerbating the scenario.

Information from the cash and credit score statistics of the Central Bank of Nigeria confirmed that the nation’s broad cash provide (M2) surged by 51 per cent year-on-year to N108.96tn in November 2024. This determine marks a major rise from the N72.03tn recorded throughout the identical interval in 2023. M2 contains money, demand deposits, financial savings deposits, cash market deposits, and time deposits, offering a complete measure of liquidity within the financial system. Whereas the rising liquidity helps financial actions, it additionally stresses the necessity for balanced fiscal and financial insurance policies to maintain financial progress with out exacerbating inflation.

Nevertheless, there may be nonetheless the chance of extra liquidity. Extra liquidity is when an excessive amount of cash circulates inside the financial system relative to the provision of products and providers. When this occurs, shopper demand will increase considerably, outpacing the capability of companies to fulfill that demand, which in flip results in greater costs. This phenomenon, generally known as demand-pull inflation, has been a significant contributor to Nigeria’s inflationary pattern.

Understanding extra liquidity and its function in inflation

Extra liquidity in Nigeria’s monetary system will be traced to varied components. One of many main causes is unorthodox financial insurance policies carried out prior to now, notably in response to financial shocks. Throughout the COVID-19 pandemic and subsequent world disruptions, the CBN injected important liquidity into the system by varied stimulus packages and intervention funds. Whereas well-intentioned, these interventions, notably these concentrating on sectors corresponding to agriculture and small companies, resulted in an excessive amount of cash chasing too few items. With out corresponding enhancements in provide chain effectivity and manufacturing, the extra money in circulation solely served to push costs greater.

In July 2024, on the BusinessDay CEO Discussion board, the Governor of the Central Bank of Nigeria, Olayemi Cardoso, stated that Nigerians are dealing with the results of extra cash provide into the financial system, citing the N27tn Methods and Means mortgage and N10.5tn interventions of the previous administration.

He stated, “The MPC has made it very clear that for them the foremost subject is taming inflation and has additionally made it very clear that they are going to do no matter is critical to tame inflation. Sadly, we now have a scenario the place some huge cash provide went into the system. All of us noticed Methods and Means soar to N27tn. We noticed interventions of N10.5tn. It has its penalties. In giant respect, that’s what we’re paying for now.”

Authorities borrowing and deficit spending have additionally performed a major function in rising liquidity. Nigeria has continuously relied on home borrowing to finance its funds deficits, leading to an inflow of money into the monetary system. Banks’ credit score to the federal government rose by 54 per cent, reaching N39.6tn in November 2024 in comparison with N25.7tn in November 2023. Additionally, the federal authorities’s fiscal deficit widened from N9.25tn within the first 9 months of 2023 to N12.89tn throughout the identical interval in 2024, marking a 39.3 per cent improve. This rising deficit highlights the persistent hole between authorities income and expenditure, compounded by escalating debt servicing prices. With public sector spending outpacing income technology, the surplus funds usually discover their means into the broader financial system, fuelling inflation.

Additionally, instability within the international change market has compounded the issue. Because the naira depreciates, the price of imported items rises, placing additional upward strain on costs. The elevated demand for international change, pushed partly by speculative actions, exacerbates inflation by making imports costlier.

The impact of extra liquidity on inflation is simple. On the first Financial Coverage Committee assembly of 2024, The PidomNigeria reported that members of the MPC of the CBN blamed the surplus money in circulation for the accelerating inflation within the nation. The overall forex in circulation climbed to N4.88tn in November, up by N328.91bn or 7.2 per cent in comparison with the earlier month. In comparison with November 2023, when the forex in circulation was N3.35tn, the November 2024 determine represents a forty five.7 per cent year-on-year improve. These figures spotlight the continued dominance of money within the Nigerian financial system regardless of sustained efforts to advertise cashless transactions.

Customers and companies have a tendency to extend spending when extra money is out there within the system. Nevertheless, greater demand doesn’t essentially result in elevated provide in a rustic like Nigeria, the place provide constraints persist as a consequence of infrastructural deficiencies, safety challenges, and logistical bottlenecks. As a substitute, companies reply by elevating costs, resulting in a cycle of persistent inflation. Along with greater shopper costs, extra liquidity drives inflation in asset markets, corresponding to actual property and equities, creating synthetic worth surges that additional distort financial stability.

On the 2025 Financial Coverage Discussion board, Cardoso stated, “Home structural challenges, change price pass-through results, and vitality worth changes proceed to exert strain on costs and financial exercise.

“On the identical time, we recognise that whereas structural components play a major function in Nigeria’s inflationary problem, financial dynamics have additionally contributed to cost pressures.”

He added, “Extra naira liquidity within the system has amplified demand-driven inflation, additional exacerbated by supply-side constraints stemming from structural deficits. These dynamics underscore the significance of a disciplined and coordinated method to financial coverage to revive stability.”

CBN’s tightening measures to curb liquidity and inflation

In response to those challenges, the CBN, below Governor Olayemi Cardoso, has adopted a hawkish stance on financial coverage by pursuing  a sequence of tightening measures to limit the stream of cash into the financial system and stabilise inflationary pressures.

Probably the most important steps was the rise within the financial coverage price by a cumulative 875 foundation factors to 27.50 per cent in 2024. This sharp rise in rates of interest is meant to make borrowing costlier, discouraging extreme lending and spending. The expectation is that inflationary pressures will step by step subside by lowering the amount of cash obtainable for consumption and funding.

Along with the MPR hike, the CBN raised the Money Reserve Ratio for banks to 50 per cent. This coverage requires business banks to carry a bigger portion of their deposits as reserves, limiting the amount of cash obtainable for lending. The measure goals to straight curtail extra liquidity inside the banking system by limiting credit score growth.

These interventions are additional complemented by a sequence of international change market reforms, together with unifying a number of change price home windows to enhance effectivity. Clearing a $7bn backlog in international change obligations has additionally helped restore confidence within the FX market, lowering the speculative demand contributing to naira depreciation and imported inflation.

One other essential step taken by the CBN has been the elimination of the “Methods and Means” financing—a follow wherein the Central Financial institution straight funds authorities funds deficits. Cardoso has emphasised that this method had beforehand contributed to extra liquidity, creating new cash with out corresponding financial productiveness. By ending this follow, the CBN goals to instill larger fiscal self-discipline and stop additional inflationary strain on the financial system.

Effectiveness of CBN’s tightening measures

Cardoso earlier stated that with out the financial institution’s coverage interventions, inflation would have surged to 42.81 per cent by December 2024.

“Counterfactual estimates counsel that with out these decisive coverage interventions, inflation might have reached 42.81 per cent by December 2024.

“All through 2024, the financial institution carried out a number of daring coverage measures throughout six MPC conferences, together with elevating the Financial Coverage Charge by a cumulative 875 foundation factors to 27.50 per cent, rising the Money Reserve Ratio of Different Depository Companies by 1,750 foundation factors to 50.00 per cent, and adjusting the uneven hall across the MPR.”

Cardoso highlighted that the CBN carried out vital international change reforms to boost market effectivity. He stated these reforms mirror the CBN’s dedication to creating an enabling surroundings for inclusive financial growth, including that attaining macroeconomic stability requires sustained vigilance and a proactive financial coverage stance. He said that the main focus should stay on worth stability, the deliberate transition to an inflation-targeting framework, and techniques to revive buying energy and ease financial hardship.

Whereas the CBN’s actions intention to scale back inflation, additionally they introduce important trade-offs that might influence broader financial progress. One of many fast penalties of upper rates of interest is elevated borrowing prices for companies and people.

Nevertheless, The PidomNigeria noticed that borrowing within the non-public sector has remained strong, indicating that companies are keen to soak up greater prices to take care of progress or stability. Nigeria’s non-public sector borrowed a further N1.89tn from banks in November 2024, bringing whole credit score to N75.96tn. This determine was a major improve from N74.07tn recorded within the earlier month regardless of persistent rate of interest hikes by the CBN. Compared year-on-year, non-public sector credit score in November 2024 grew considerably by N16.27tn, or 27.3 per cent, from N59.69tn in November 2023. This substantial improve highlights the resilience of Nigeria’s non-public sector, which continues to depend on loans to navigate the difficult financial surroundings.

Nevertheless, the non-public sector has expressed considerations over the implications of those tightening measures. The Producers Affiliation of Nigeria earlier referred to as on the CBN to cease rising the financial coverage price and as a substitute discover a monetary-fiscal choice to carry down inflation. In an announcement, the Director-Basic of MAN, Segun Ajayi-Kadir, stated the latest hike in rates of interest to 27.25 per cent would worsen the already difficult working surroundings for producers within the nation. He added that the manufacturing sector’s grappling with rising manufacturing prices and shrinking shopper demand as a consequence of declining buying energy additionally compounds the issue. Additionally, the Chief Govt Officer of the Centre for the Promotion of Non-public Enterprise, Dr Muda Yusuf, criticised the disconnect between the monetary sector and the true financial system, warning that additional financial tightening might worsen the scenario.

“Key sectors like agriculture, manufacturing, and actual property are struggling and wish financial and monetary help, no more restrictive insurance policies,” Yusuf said.

One other potential draw back of those insurance policies is the chance of a liquidity crunch within the banking sector. Industrial banks are required to carry a good portion of their deposits as reserves, so their skill to lend is severely constrained. This motion might result in diminished entry to credit score for small and medium-sized enterprises, very important to Nigeria’s financial panorama. If companies wrestle to acquire financing, the general degree of financial exercise might decline, compounding the nation’s progress challenges.

In keeping with the newest Credit score Circumstances Survey launched by the CBN, the PidomNigeria additional learnt that business banks in Nigeria noticed a notable rise in unsecured loans to households and firms throughout the fourth quarter of 2024.

The survey findings point out that unsecured family loans surged by 15.8 factors whereas lending to company debtors elevated by 23.4 factors. In distinction, secured lending recorded a slight decline of 1.2 factors inside the identical interval. Nevertheless, lenders reported a rise in default charges throughout all classes of loans within the fourth quarter, reflecting the financial pressures affecting debtors.

Regardless of these considerations, inflation in Nigeria is just not pushed solely by extra liquidity. Even with aggressive financial tightening, inflationary pressures might persist until these underlying points are addressed.

The necessity for fiscal-monetary coverage coordination

The success of CBN’s financial tightening efforts relies upon largely on coordinated fiscal insurance policies from the federal government. One of many greatest challenges dealing with Nigeria’s inflation combat is the contradiction between financial tightening and expansionary fiscal insurance policies. Whereas the CBN is elevating rates of interest and limiting liquidity, the federal authorities continues to spend aggressively. This contradiction undermines the effectiveness of financial coverage, as authorities spending introduces new liquidity into the system.

The federal government’s reliance on borrowing slightly than income technology additionally presents a significant problem. If fiscal authorities don’t take steps to scale back extreme spending and enhance income assortment, the cycle of extra liquidity and inflation will doubtless proceed.

Talking on the 2024 Spring Conferences of the Worldwide Financial Fund and World Financial institution in Washington, DC, the Minister of Finance and Coordinating Minister of the Economic system, Mr Wale Edun, stated that the administration is dedicated to tackling the difficulty of surplus cash circulating inside the financial system, stating, “We’re decided to pin down Methods and Means to alleviate the strain of extra cash within the system.”

He defined that this measure goals to facilitate a collaborative effort between fiscal and financial authorities to scale back inflationary pressures and stabilise the change price.

“We have to borrow much less and focus extra on home useful resource mobilisation,” Edun stated.

Nigeria’s inflation problem is deeply rooted within the subject of extra liquidity, making financial coverage a vital device in restoring stability. The CBN’s tightening measures, together with greater rates of interest and stringent banking rules, symbolize a powerful effort to manage inflation. Nevertheless, these insurance policies alone are inadequate with out complementary fiscal self-discipline and structural reforms.