Bringing Back the Naira as a Safe Investment

The recent meeting of the Central Bank of Nigeria's policy committee raised a lot of questions about how well the bank is doing its job. The main focus was on the bank's decision to change the monetary policy rate (MPR) to better reflect the market. The big question is what the MPR actually does. In theory, the CBN's policy rate should help guide the financial system by affecting saving, borrowing, liquidity, inflation expectations, and the naira's exchange rate. It should show what the central bank wants to do. But for years, the MPR has stayed the same even while inflation kept rising and the naira's exchange rate fell sharply.

The CBN has tried to cover this issue with a mix of tools, some of which seem unusual. This raises more questions about how effective these tools really are. For example, the cash reserve requirement is set at 45% for deposit money banks. This means that almost half of the banks' deposits are kept with the central bank at all times. While this might prevent banks from creating bubbles in the foreign exchange and stock markets, it also limits the money available for lending. Even if we say long-term loans should come from equity, banks, not shareholders, should help businesses with working capital.

Another issue is how the CBN's cash reserve requirement might be just as disconnected as its policy rate. Banks that attract naira deposits face what some call a CRR tax. In a situation where many people prefer dollars, known as dollarisation, does it really matter that deposits in foreign currency accounts don't follow the CRR? And how does this affect the economy?

Could the dollarisation trend explain why some of the CBN's tools are not working well? Countries often start using dollars instead of their own currency when people lose trust in their local money. This shift can bring back stability that struggling economies can't find with their own currency, attracting more investment. Nigeria's dollarisation is only partial and not closely tied to policy. However, while the country may still benefit from printing its own currency, the CBN seems to have lost some control over monetary policy. This is shown by the money Nigerians are keeping in their dollar accounts.

Thankfully, there are different ways to regain this control without taking over dollar deposits. The CBN and the government can't just talk their way out of this situation. They can't ask Nigerians to save in naira while offering interest rates that are lower than inflation. In such cases, people will naturally move their savings into dollars, real estate, stocks, commodities, or other assets. The goal should be to give Nigerians a reason to save in naira again. So how can this be done? We need to keep inflation low. A while ago, inflation was at 30% year-on-year, which was shocking. Now, at just over 15%, it is still hurting the naira. One hundred naira today has the same buying power as about fifty naira did five years ago.

To fix this, the CBN needs to set a credible medium-term inflation target. It should also create incentives that make it costly to stray from this target. The commitment to not let the CBN finance government deficits must be strong and unwavering. This means that monetary policy should not be controlled by the federal government's need for money. It should aim for positive real interest rates for savers.

Yet, there is still a problem with monetary policy in Nigeria. The CBN cannot get rid of the issues caused by the federal government’s spending habits. How can we help our public officials understand that a government that spends more than it can afford leads to higher taxes, more borrowing, inflation, or a weaker naira? If the naira's strength depends on Nigeria's financial health, then we need both the fiscal and monetary authorities to work together under a common inflation goal. This starts with cutting down on unnecessary spending, expanding the tax base instead of raising rates, keeping off-budget borrowing in check, publishing clear financial accounts, improving public investments, and not using the CBN like a reserve fund.

This should help the economy create more goods and services that can be traded. The naira is a claim on Nigeria's economy for anyone holding it. We can't keep the naira's exchange rate stable only by raising interest rates and using reserves if the economy spends more foreign currency than it earns. In simple terms, the economy must do well for the naira to do well.