The Economics of Printing the Naira

A lot of reactions have trailed the FG’s most recent announcement of taking fresh $5.5bn loan. While the backlash is normal, there is a particular stream of thoughts that FG should just print more naira instead of borrowing more.

Let me explain why I think that idea of printing more money is unfounded given the state of Nigeria’s economy. Naira is printed by the CBN. It’s a fact. We print money every year. On every naira note, you’ll see the year of printing. So why can’t we just print money?

Printing money isn’t as easy as it sounds. CBN fulfils some conditions before embarking on printing money. Two of these conditions are major. The conditions are technical. But I’ll try to simplify them. Let’s start with government bond. It’s issued by the federal government.

Whenever FG needs money, the sources are majorly two: tax revenues and bonds. Government bonds are similar to shares of private companies. When those companies are in need of money, they raise shares. People that buy the shares pay money.

The money paid is used to finance production by the issuing companies. What is produced is sold and profits are made. Part of the profits is paid back to the shareholders as dividends. Government bond operates same way. FG raises bonds and asks people to buy them in order to generate revenue for the government. The bondholders are paid interests. In most cases, the bond money is huge (we’re talking about federal government) and CBN statutorily buys the bonds. After deciding to buy the bonds, CBN looks at how much it has in its vaults.

If it has enough, it pays the FG. Remember the deal looks like CBN is buying the government bonds from the federal government. If it doesn’t have enough, it prints naira to buy the bonds. So CBN can’t just print naira. It needs the FG to generate bonds before doing so.

The printing of money looks like the FG is borrowing money from the CBN. It’s a form of government debt. We call this internal debt. That’s condition 1: the CBN must replace the amount printed with government bonds.

Condition 2 is about foreign reserves. As we spend naira, many different countries spend different currencies. All currencies in Nigeria except naira makes foreign reserves of Nigeria. Because $ is an international currency, CBN converts all currencies in our reserves into $.

Currently, we have about 35 billion dollars in the Nigeria’s foreign reserves. 35 billion dollars looks a big money until we see how other countries are doing. It’s not that big, because other countries that have oil are doing far better.

Saudi Arabia has about 500 billion dollars in its foreign reserves. Libya has close to 80 billion dollars. Iran has about 70 billion dollars. That’s to tell you that our 35 billion dollars is relatively small. Let me quickly go to why the noise about foreign reserves.

Remember its meaning… it contains currencies except naira. That means when naira is losing value on the forex market, we can buy naira with foreign reserves to defend naira. Let me make that clearer. What makes something lose value is its relative abundance. Anything in abundance will command little price. That is why when naira is losing value, it means naira is too much in the forex market. CBN will then intervene to ensure that it mops naira up. It will mop it up with foreign currencies/reserves. Remember you use currency to buy currency.

That means the greater the foreign reserves, the more the CBN’s ability to defend naira whenever it’s losing value. Now back to our story. There is general rule of thumb that countries should get panic as their foreign reserves are getting close to 25 billion dollars.

25 billion dollars is like the benchmark below which countries can no longer successfully defend their currencies. So with 35 billion dollars, you should know CBN has weak power to defend naira. That’s why 1 dollar is selling for around 500 naira at present. The depreciation will continue until God knows. Let’s now go to condition 2 proper. All I’ve been saying is preamble. To print naira, CBN must replace how much to be printed with its equivalent foreign reserves. The reason for that? To prevent naira from being relatively too much on the forex market. To prevent naira from losing value. If CBN just prints naira without replacing it with foreign reserves, there will be what we call hyperinflation. Hyperinflation is a terrible situation. Naira will lose too much value that we will be buying a sachet water for 10,000 naira. Or even more. Zimbabwe and Ghana had hyperinflation in the 2000s because of that. Venezuela is still battling with one. It’s a bad story. So let’s marry the two conditions. Condition 1 says CBN must replace the printed money with government bonds.

Condition 2 says CBN must replace the printed money with foreign reserves. Looking at Nigeria right now, there’s no way CBN can successfully fulfill the two conditions. CBN already has too much government bonds. The internal debt is very huge. Investors are now speculating that Nigerian debts are looking unsustainable. That was why FG was looking for alternative through increase in VAT. On condition 2, foreign reserves are already too low. CBN can’t afford to deplete them further. Otherwise, it will soon get to the threshold of 25 billion and everything will crumble.

Remember what happened in 2016 when our reserves were less than 25 billion dollars? If government bonds cannot be issued and foreign reserves cannot be depleted, CBN cannot print more money. Yet FG claims proceeds from tax are not enough. So the only option left is to seek loans externally.

That is the economics of money printing and government borrowing. No impressive alternative at the moment. Please note that I’ve analyzed only the economics. I don’t know the politics going on. Economics does not believe loans are bad themselves. What they are used for is the issue.

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