CBN Report: Fiscal Deficits Impacts Naira, Spikes Interest Rates
■Says fiscal expansion remains major source of exchange rate instability ■Study advocates legally binding fiscal rule establishing a ceiling for budget deficits relative to gross domestic product, others James Emejo
A Central Bank of Nigeria (CBN) report reveals that persistent budget deficits are undermining the Nigerian naira, sparking exchange rate volatility and complicating attempts to control interest rates. According to the research, government fiscal imbalances are a major catalyst for currency depreciation, warning that ongoing borrowing and spending could strain monetary stability and impede business credit and private investment.
The study, published in the CBN Journal of Applied Statistics, analyzed the impact of fiscal deficits on key economic indicators from 1981 to 2024 using a Vector Autoregressive (VAR) framework. It found that budget deficits are a primary driver of exchange rate depreciation, accounting for a large share of immediate fluctuations and contributing to long-term currency declines.
Additionally, fiscal imbalances exert prolonged upward pressure on interest rates and likely induce a contraction in the money supply, potentially necessitating restrictive monetary actions to offset government expansionary policies. The findings highlight the self-reinforcing nature of fiscal pressures, where budget deficits account for nearly all of their own variations initially and retain significant influence over time.
Moreover, the research discovered no strong correlation between fiscal expansion and inflation, attributing Nigeria's inflationary pressures more to supply-side shocks, structural bottlenecks, and exchange rate impacts on domestic prices. To address the risks, the study recommends legally binding fiscal rules setting limits on budget deficits relative to GDP, establishing a non-oil Fiscal Stabilization Fund, managing external reserves strategically, and adopting trade policies to decrease import reliance.
The report also stresses the need for better coordination between fiscal and monetary policies to enable the CBN to manage liquidity proactively and improve private-sector access to credit, which would help sustain economic growth.
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