Rising federal budget deficits are a principal cause of naira depreciation and place delayed upward pressure on domestic interest rates, according to a study published in the Central Bank of Nigeria Journal of Applied Statistics.
The paper, “Budget Deficit Dynamics and Macroeconomic Performance in Nigeria,” was authored by Ndubuisi E. Uguru and drew on annual data spanning 1981 to 2024. Using a Vector Autoregressive framework, the research examined how fiscal deficits interact with key macroeconomic variables, including the exchange rate, inflation, interest rates, money supply and investment.
The findings show that budget deficits were a major source of exchange rate fluctuations, accounting for a substantial share of naira movements in the immediate period and contributing to sustained currency depreciation. Fiscal imbalances were also found to exert delayed upward pressure on interest rates and to induce a contraction in money supply, a pattern the study linked to defensive monetary tightening.
Budget deficits accounted for 100 per cent of their own variance at the outset and still retained about 53 per cent by the tenth period, indicating that fiscal imbalances can reinforce themselves over time. Investment was largely self-determined in the short term but became increasingly influenced by inflation and money supply over the longer term.
The study found no statistically significant direct relationship between budget deficits and inflation. It attributed price level movements primarily to supply-side shocks, structural bottlenecks and exchange rate pass-through rather than fiscal policy alone.
The authors described the results as evidence of fiscal dominance, under which government borrowing and spending pressures can weaken exchange rate stability and limit the autonomy of monetary policy.
To manage these risks, the study recommended a binding fiscal rule that sets a legal ceiling on the budget deficit relative to gross domestic product. It argued that such a rule could contain fiscal imbalances, reduce the crowding-out of private investment and ease interest rate pressure.
The research also proposed strategic reserve management and proactive trade policies, including a non-oil Fiscal Stabilisation Fund and incentives for domestic production, to reduce vulnerability to deficit-related exchange rate shocks. It further called for a transparent monetary and fiscal coordination framework that would allow the CBN to manage money supply more proactively instead of resorting to abrupt restrictive measures.
