CBN study links rising budget deficits to naira weakness, higher interest rates
Nigeria’s mounting budget deficits are undermining exchange rate stability and creating delayed upward pressure on interest rates, raising fresh concerns about the impact of government borrowing on monetary policy effectiveness, private-sector investment and the country’s macroeconomic stability.
A study published in the Central Bank of Nigeria (CBN) Journal of Applied Statistics found that persistent fiscal imbalances are a major driver of naira depreciation, with their effects extending beyond currency markets to interest rates, money supply and investment.
The research, titled “Budget Deficit Dynamics and Macroeconomic Performance in Nigeria”, authored by Ndubuisi E. Uguru, analysed annual economic data covering 1981 to 2024 using a Vector Autoregressive (VAR) framework to establish the relationship between fiscal deficits and key macroeconomic indicators.
Its findings indicate that budget deficits account for a substantial proportion of exchange rate fluctuations, contributing to sustained currency depreciation, while exerting delayed upward pressure on interest rates and triggering contractions in money supply.
The study attributed the contraction in money supply partly to defensive monetary tightening, whereby the monetary authority responds to fiscal expansion and its associated macroeconomic pressures with restrictive policy measures.
“The results revealed that budget deficits are a primary driver of exchange rate depreciation, accounting for a substantial share of exchange rate fluctuations in the immediate period and triggering a sustained currency decline, while also exerting delayed upward pressure on interest rates and paradoxically inducing a significant contraction in the money supply, likely reflecting defensive monetary tightening,” the research stated.
The findings highlight the risks associated with persistent government borrowing, particularly when fiscal expansion increases pressure on the foreign exchange market and complicates the CBN’s efforts to maintain monetary and financial stability.
The research also found that budget deficits account for 100 per cent of their own variance initially, retaining about 53 per cent by the tenth period, suggesting that fiscal imbalances can become self-reinforcing and persist over time.
On investment, the study observed that capital formation is largely determined by its own dynamics in the short term but becomes increasingly influenced by inflation and money supply over the longer term.
However, the research found no statistically significant direct relationship between budget deficits and inflation, suggesting that rising prices in Nigeria cannot be attributed to fiscal expansion alone.
It noted that supply-side shocks, structural bottlenecks and exchange rate pass-through play more significant roles in shaping price movements.
The study described the broader findings as evidence of fiscal dominance, a situation in which government borrowing and spending pressures constrain monetary policy autonomy and undermine the effectiveness of efforts to maintain macroeconomic stability.
To address the challenges, the researcher recommended introducing a binding fiscal rule establishing a legally enforceable limit on budget deficits relative to gross domestic product (GDP).
Such a framework, according to the study, would help contain fiscal imbalances, reduce the crowding-out of private investment and ease upward pressure on interest rates.
It also recommended strategic foreign reserve management and proactive trade policies, including establishing a non-oil Fiscal Stabilisation Fund and providing incentives for domestic production to reduce Nigeria’s vulnerability to external shocks and deficit-related exchange rate pressures.
On monetary policy, the study called for a transparent framework for fiscal and monetary coordination that would enable the CBN to manage money supply more proactively rather than resorting to abrupt restrictive measures in response to fiscal expansion.
It further advocated improved private-sector access to credit, lower borrowing costs and stable inflation expectations to encourage investment and strengthen long-term economic growth.
The findings come amid rising government financing requirements and continued adjustments to Nigeria’s fiscal and monetary policy frameworks.
President Bola Tinubu presented the 2026 Appropriation Bill to the National Assembly in December 2025 with a proposed budget deficit of N23.85 trillion.
By April 2026, the Federal Government had increased its planned borrowing for the year to N29.20 trillion following an expansion of the proposed budget size and financing requirements, according to official documents reviewed by Nairametrics.
The growing borrowing requirement has intensified concerns about debt sustainability, domestic liquidity conditions and the potential competition between government and private-sector borrowers for available credit.
On the monetary policy front, the CBN reduced the Monetary Policy Rate (MPR) by 350 basis points to 23 per cent in September 2026, following its 307th Monetary Policy Committee meeting in Abuja.
The reduction followed the committee’s decision to retain the benchmark rate at 26.5 per cent in July and represented the largest single rate cut since December 2006.
The study’s findings nevertheless suggest that sustained fiscal discipline will remain critical to consolidating monetary policy gains, stabilising the naira and creating a more predictable investment environment.
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