Why Nigeria doesn’t need N5000 note

When inflation begins to accelerate, you would likely see investible funds flowing from other investment markets into the real estate and commodities markets, such as the market for precious metals. In situation like this, guaranteed or fixed income investments suffer.

The transmission mechanism among the investment markets will remain optimal if there is price stability, which is the hallmark of any efficiently functioning economy. Therefore, given price stability, the flow of funds among the various investment markets would be predominantly determined by return expectations. Once there is distortion in price stability, the smooth functioning of the various investment markets is adversely effected, as the planned introduction of the N5,000 would cause.

Meanwhile, there is another important benchmark called the Monetary Policy Rate, which is the rate at which banks borrow from the Central Bank of Nigeria. The MPR affects other money market rates, such as the Nigeria Interbank Offer Rate, deposit and lending rates. When the MPR is increased, money market rates increase as well, and vice versa.

The impact of this relationship in the fixed incomes market is that yields will change in the same direction with the MPR and money market interest rates, implying that yields on Federal Government bonds, which are pricing benchmarks can, themselves, be extraneously influenced.

Therefore, given the choice of the CBN using the MPR as the anchor rate for the Nigerian economy, the CBN should always protect the MPR from unintended influences, because such influences will be transmitted into the investment markets. Personally, I consider the use of the MPR as the anchor rate by the CBN as inefficient, because the MPR is fundamentally a monetary variable, which may not be risk-free.     

I expect to see increase in the currency outside the banking sector, given higher propensity, lower cost and improved ease of carrying cash. In order to attract these flows back to the banking sector, interest rates would have to go up invariably. Yields on bonds would follow consequently, leading to higher pricing of investment instruments without any fundamental change underlying the investment markets.

In an import dependent economy as Nigeria's, the naira exchange rate may be adversely affected. Holding the quantum of money supply constant, increase in currency denomination will increase the velocity of money, as earlier noted, which will increase the currency outside banks. This phenomenon will expand the relative size of the informal sector, with the implication of increased activities in the parallel economy. I expect to see a depreciation of the naira in the parallel markets, thereby increasing the disparity with the official exchange rates. I am also of the opinion that there will be an increase in the supply of naira at the forex market for the same quantum of foreign exchange, especially at the black and parallel market segments.

The likely increase in the disparity in the official and the parallel exchange rates will be inimical to the proper functioning of the economy. In order to correct this anomaly, the CBN would have to devalue the naira to close or eliminate any wide disparity, or reduce liquidity in the system. However, the later would be more expensive to deploy because it would make available domestic credit more expensive as a result of higher interest rates brought about by increased illiquidity. More so, monetary policy would have been made more ineffective because of the relative reduction in the size of the formal sector, characterised by a weakened banking sector, where the use of monetary policy is usually very potent.

IMOH, Patrick E.
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