Macro Analysis /

Nigeria: CBN's elevated funding to the government increases risk to the naira

  • Lending from the Central Bank of Nigeria to the federal government hit NGN20tn (US$45bn) in H1 22 – 11% of GDP

  • Persistent backdoor funding to the government negates the central bank's efforts to tame inflation and salvage the naira

  • Investors are likely to continue to book negative real returns on investments as yields remain suppressed

Nigeria: CBN's elevated funding to the government increases risk to the naira
Janet Ogabi
Janet Ogabi

Senior Research Analyst

Tellimer Research
12 August 2022
Published byTellimer Research

The government's borrowing from the Central Bank of Nigeria (CBN) amounted to NGN20tn at end-June. The federal government (FG) finances its deficit via funding from the central bank through what is known as the "ways and means" to make up for low revenues.

Provisions in the Central Bank Act allow for funding of up to 5% of the government's previous year's revenues. But over the years, the government (especially under Buhari's administration) has exceeded these limits.

Bulk of the CBN's NGN20tn lending to the FG has been in Buhari's administration

For context, the government's total revenues in 2021 were NGN4.4tn (5%: NGN220bn), but the government has borrowed NGN2.5tn in H1 2022 (1.2% of the projected full-year GDP) as ways and means from the CBN.

Printing more money reduces fiscal pressure to ramp up revenue...

The central bank loans come at almost no cost to the government, making it a cheap source of fiscal borrowing (charged at 0.5% pa). These printed monies eases the federal government's pressure to ramp up fiscal revenues.

Since Buhari's government came to power in 2015, average annual fiscal revenues has dropped by 18% (in US$ terms: -57%) due to lower oil prices (avg brent: US$102/bbl vs US$57 during the previous administration).

The total fiscal deficit during the current administration's tenure (2015-2019) stands at NGN30tn of which NGN18tn has been financed via the ways and means. We note that the current administration has made progress in improving non-oil revenues (annual average up 63% in NGN terms, which is 44% of gross revenues), but it has clearly not been sufficient to significantly narrow the fiscal gap.

Ways & Means vs Fiscal deficits

... and increases inflation and FX risks

These loosened taps of funds to the government negates the central bank’s measures to curb excess money in circulation through cash reserve ratio (CRR) debits on banks and rate hikes. This increases inflation and FX risks, and leaves local investors with low yields on government securities translating to negative real returns.

For context on the low yields (despite high inflation), recall that the bifurcation of the OMO and treasury bills market in October 2019 increased the demand pressure on government securities, as local investors' idle monies increased system liquidity.

On the supply end of the spectrum, the CBN's backdoor funding to the government at low rates reduced the government's sale of treasury bills and bonds to finance the budget deficit (as highlighted earlier). The increased demand and reduced supply has left local investors stuck with negative yielding real returns ever since the separation of the OMO and NTB markets.

Yields have remained suppressed and returns negative since the separation of the OMO and NTB markets in Oct 2019

Securitising the CBN loans

Discussions to securitise the CBN loans have been ongoing for over two years. Earlier this week, the state governors called on the federal government to scale back on the ways and means financing (WMF) and instead securitise the outstanding WMFs over 100 years, at a 1% interest.

This will raise the government’s official debt stock to 34% of GDP (excl. AMCON: 2.9% of GDP) from 23% in Q1 22. This brings the government closer to breaching the fiscal debt threshold of 40% of GDP (increased from 25% in 2021 and still lower than the World Bank's 55% limit), meaning the government is still in safe debt territory.

However, should the backdoor funding from the CBN persist, it complicates the central bank's efforts to tame inflation (although they are largely driven by cost-push factors) and to stablilise the naira. It also means that local investors are likely to continue booking negative real returns on investments as yields remain suppressed (compared with inflation).

It is worth stating, however, that we retain our expectations for yields to increase based on the following:

  1. Lower liquidity from declining maturities in the coming quarters compared to Q1 22.

  2. An increase in the government's domestic borrowing.

  3. A projected hike in Nigeria's benchmark interest rate amid global rate hikes and surging inflation.

And we have seen yields rise since, even above levels from a year ago. However, the chances that yields rise high enough to significantly narrow the negative real return gap in the short term are slim (as seen in Ghana where the 1-yr yield is close to inflation at 31% – see chart below), not to mention turning the real returns to positive territory.

Nigeria's yield curve (%)

Ghana's yield curve (%)