Excess liquidity hurts push for lower inflation

SAMI TUNJI examines Nigeria’s rising inflation crisis, the impact of excess liquidity, among other factors, further spotlighting efforts by the Central Bank of Nigeria to curb it through monetary tightening, stressing the need for fiscal-monetary coordination, structural reforms, and enhanced financial discipline to stabilise Nigeria’s economy

Nigeria’s battle with inflation remains one of the most pressing challenges to its economic stability. The latest data from the National Bureau of Statistics shows that headline inflation stood at 34.80 per cent as of December 2024, with core inflation playing a dominant role in driving price increases.

According to the NBS’ Consumer Price Index report, there was a marginal rise of 0.20 per cent due to heightened demand for goods and services during the festive season. On a year-on-year basis, the December inflation rate marked a significant increase of 5.87 percentage points compared to 28.92 per cent in December 2023.

Several factors have contributed to this sustained inflationary pressure, including structural bottlenecks, exchange rate volatility, and energy price adjustments. However, excess liquidity is a critical yet often overlooked factor exacerbating the situation.

Data from the money and credit statistics of the Central Bank of Nigeria showed that the country’s broad money supply (M2) surged by 51 per cent year-on-year to N108.96tn in November 2024. This figure marks a significant rise from the N72.03tn recorded during the same period in 2023. M2 includes cash, demand deposits, savings deposits, money market deposits, and time deposits, providing a comprehensive measure of liquidity in the economy. While the rising liquidity supports economic activities, it also stresses the need for balanced fiscal and monetary policies to sustain economic growth without exacerbating inflation.

However, there is still the risk of excess liquidity. Excess liquidity is when too much money circulates within the economy relative to the supply of goods and services. When this happens, consumer demand increases significantly, outpacing the capacity of businesses to meet that demand, which in turn leads to higher prices. This phenomenon, known as demand-pull inflation, has been a major contributor to Nigeria’s inflationary trend.

Understanding excess liquidity and its role in inflation

Excess liquidity in Nigeria’s financial system can be traced to various factors. One of the primary causes is unorthodox monetary policies implemented in the past, particularly in response to economic shocks. During the COVID-19 pandemic and subsequent global disruptions, the CBN injected significant liquidity into the system through various stimulus packages and intervention funds. While well-intentioned, these interventions, particularly those targeting sectors such as agriculture and small businesses, resulted in too much money chasing too few goods. Without corresponding improvements in supply chain efficiency and production, the additional cash in circulation only served to push prices higher.

In July 2024, at the BusinessDay CEO Forum, the Governor of the Central Bank of Nigeria, Olayemi Cardoso, said that Nigerians are facing the consequences of excess money supply into the economy, citing the N27tn Ways and Means loan and N10.5tn interventions of the past administration.

He said, “The MPC has made it very clear that for them the major issue is taming inflation and has also made it very clear that they will do whatever is necessary to tame inflation. Sadly, we have a situation where a lot of money supply went into the system. We all saw Ways and Means soar to N27tn. We saw interventions of N10.5tn. It has its consequences. In large respect, that is what we are paying for now.”

Government borrowing and deficit spending have also played a significant role in increasing liquidity. Nigeria has frequently relied on domestic borrowing to finance its budget deficits, resulting in an influx of cash into the financial system. Banks’ credit to the government rose by 54 per cent, reaching N39.6tn in November 2024 compared to N25.7tn in November 2023. Also, the federal government’s fiscal deficit widened from N9.25tn in the first nine months of 2023 to N12.89tn during the same period in 2024, marking a 39.3 per cent increase. This growing deficit highlights the persistent gap between government revenue and expenditure, compounded by escalating debt servicing costs. With public sector spending outpacing revenue generation, the excess funds often find their way into the broader economy, fuelling inflation.

Also, instability in the foreign exchange market has compounded the problem. As the naira depreciates, the cost of imported goods rises, putting further upward pressure on prices. The increased demand for foreign exchange, driven partly by speculative activities, exacerbates inflation by making imports more expensive.

The effect of excess liquidity on inflation is straightforward. At the first Monetary Policy Committee meeting of 2024, The PUNCH reported that members of the MPC of the CBN blamed the excess cash in circulation for the accelerating inflation in the country. The total currency in circulation climbed to N4.88tn in November, up by N328.91bn or 7.2 per cent compared to the previous month. Compared to November 2023, when the currency in circulation was N3.35tn, the November 2024 figure represents a 45.7 per cent year-on-year increase. These figures highlight the continued dominance of cash in the Nigerian economy despite sustained efforts to promote cashless transactions.

Consumers and businesses tend to increase spending when more money is available in the system. However, higher demand does not necessarily lead to increased supply in a country like Nigeria, where supply constraints persist due to infrastructural deficiencies, security challenges, and logistical bottlenecks. Instead, businesses respond by raising prices, leading to a cycle of persistent inflation. In addition to higher consumer prices, excess liquidity drives inflation in asset markets, such as real estate and equities, creating artificial price surges that further distort economic stability.

At the 2025 Monetary Policy Forum, Cardoso said, “Domestic structural challenges, exchange rate pass-through effects, and energy price adjustments continue to exert pressure on prices and economic activity.

“At the same time, we recognise that while structural factors play a significant role in Nigeria’s inflationary challenge, monetary dynamics have also contributed to price pressures.”

He added, “Excess naira liquidity in the system has amplified demand-driven inflation, further exacerbated by supply-side constraints stemming from structural deficits. These dynamics underscore the importance of a disciplined and coordinated approach to monetary policy to restore stability.”

CBN’s tightening measures to curb liquidity and inflation

In response to these challenges, the CBN, under Governor Olayemi Cardoso, has adopted a hawkish stance on monetary policy by pursuing  a series of tightening measures to restrict the flow of money into the economy and stabilise inflationary pressures.

One of the most significant steps was the increase in the monetary policy rate by a cumulative 875 basis points to 27.50 per cent in 2024. This sharp rise in interest rates is intended to make borrowing more expensive, discouraging excessive lending and spending. The expectation is that inflationary pressures will gradually subside by reducing the amount of money available for consumption and investment.

In addition to the MPR hike, the CBN raised the Cash Reserve Ratio for banks to 50 per cent. This policy requires commercial banks to hold a larger portion of their deposits as reserves, limiting the amount of money available for lending. The measure aims to directly curtail excess liquidity within the banking system by restricting credit expansion.

These interventions are further complemented by a series of foreign exchange market reforms, including unifying multiple exchange rate windows to improve efficiency. Clearing a $7bn backlog in foreign exchange obligations has also helped restore confidence in the FX market, reducing the speculative demand contributing to naira depreciation and imported inflation.

Another crucial step taken by the CBN has been the elimination of the “Ways and Means” financing—a practice in which the Central Bank directly funds government budget deficits. Cardoso has emphasised that this approach had previously contributed to excess liquidity, creating new money without corresponding economic productivity. By ending this practice, the CBN aims to instill greater fiscal discipline and prevent further inflationary pressure on the economy.

 

Effectiveness of CBN’s tightening measures

Cardoso earlier said that without the bank’s policy interventions, inflation would have surged to 42.81 per cent by December 2024.

“Counterfactual estimates suggest that without these decisive policy interventions, inflation could have reached 42.81 per cent by December 2024.

“Throughout 2024, the bank implemented several bold policy measures across six MPC meetings, including raising the Monetary Policy Rate by a cumulative 875 basis points to 27.50 per cent, increasing the Cash Reserve Ratio of Other Depository Corporations by 1,750 basis points to 50.00 per cent, and adjusting the asymmetric corridor around the MPR.”

Cardoso highlighted that the CBN implemented critical foreign exchange reforms to enhance market efficiency. He said these reforms reflect the CBN’s commitment to creating an enabling environment for inclusive economic development, adding that achieving macroeconomic stability requires sustained vigilance and a proactive monetary policy stance. He stated that the focus must remain on price stability, the planned transition to an inflation-targeting framework, and strategies to restore purchasing power and ease economic hardship.

While the CBN’s actions aim to reduce inflation, they also introduce significant trade-offs that could impact broader economic growth. One of the immediate consequences of higher interest rates is increased borrowing costs for businesses and individuals.

However, The PUNCH observed that borrowing in the private sector has remained robust, indicating that businesses are willing to absorb higher costs to maintain growth or stability. Nigeria’s private sector borrowed an additional N1.89tn from banks in November 2024, bringing total credit to N75.96tn. This figure was a significant increase from N74.07tn recorded in the previous month despite persistent interest rate hikes by the CBN. When compared year-on-year, private sector credit in November 2024 grew significantly by N16.27tn, or 27.3 per cent, from N59.69tn in November 2023. This substantial increase highlights the resilience of Nigeria’s private sector, which continues to rely on loans to navigate the challenging economic environment.

However, the private sector has expressed concerns over the implications of these tightening measures. The Manufacturers Association of Nigeria earlier called on the CBN to stop increasing the monetary policy rate and instead explore a monetary-fiscal option to bring down inflation. In a statement, the Director-General of MAN, Segun Ajayi-Kadir, said the recent hike in interest rates to 27.25 per cent would worsen the already challenging operating environment for manufacturers in the country. He added that the manufacturing sector’s grappling with rising production costs and shrinking consumer demand due to declining purchasing power also compounds the problem. Also, the Chief Executive Officer of the Centre for the Promotion of Private Enterprise, Dr Muda Yusuf, criticised the disconnect between the financial sector and the real economy, warning that further monetary tightening could worsen the situation.

“Key sectors like agriculture, manufacturing, and real estate are struggling and need monetary and fiscal support, not more restrictive policies,” Yusuf stated.

Another potential downside of these policies is the risk of a liquidity crunch in the banking sector. Commercial banks are required to hold a significant portion of their deposits as reserves, so their ability to lend is severely constrained. This action could lead to reduced access to credit for small and medium-sized enterprises, vital to Nigeria’s economic landscape. If businesses struggle to obtain financing, the overall level of economic activity may decline, compounding the country’s growth challenges.

According to the latest Credit Conditions Survey released by the CBN, the PUNCH further learnt that commercial banks in Nigeria saw a notable rise in unsecured loans to households and corporations during the fourth quarter of 2024.

The survey findings indicate that unsecured household loans surged by 15.8 points while lending to corporate borrowers increased by 23.4 points. In contrast, secured lending recorded a slight decline of 1.2 points within the same period. However, lenders reported an increase in default rates across all categories of loans in the fourth quarter, reflecting the economic pressures affecting borrowers.

Despite these concerns, inflation in Nigeria is not driven solely by excess liquidity. Even with aggressive monetary tightening, inflationary pressures may persist unless these underlying issues are addressed.

The need for fiscal-monetary policy coordination

The success of CBN’s monetary tightening efforts depends largely on coordinated fiscal policies from the government. One of the biggest challenges facing Nigeria’s inflation fight is the contradiction between monetary tightening and expansionary fiscal policies. While the CBN is raising interest rates and restricting liquidity, the federal government continues to spend aggressively. This contradiction undermines the effectiveness of monetary policy, as government spending introduces new liquidity into the system.

The government’s reliance on borrowing rather than revenue generation also presents a major challenge. If fiscal authorities do not take steps to reduce excessive spending and improve revenue collection, the cycle of excess liquidity and inflation will likely continue.

Speaking at the 2024 Spring Meetings of the International Monetary Fund and World Bank in Washington, DC, the Minister of Finance and Coordinating Minister of the Economy, Mr Wale Edun, said that the administration is committed to tackling the issue of surplus money circulating within the economy, stating, “We are determined to pin down Ways and Means to alleviate the pressure of excess money in the system.”

He explained that this measure aims to facilitate a collaborative effort between fiscal and monetary authorities to reduce inflationary pressures and stabilise the exchange rate.

“We need to borrow less and focus more on domestic resource mobilisation,” Edun said.

Nigeria’s inflation challenge is deeply rooted in the issue of excess liquidity, making monetary policy a crucial tool in restoring stability. The CBN’s tightening measures, including higher interest rates and stringent banking regulations, represent a strong effort to control inflation. However, these policies alone are insufficient without complementary fiscal discipline and structural reforms.