Currency Restructuring And Seigniorage –The Impact On The Economy

The Central Bank of Nigeria (CBN) recently announced its plan to embark on ‘Project Cure’, aimed at restructuring the nation’s currency.  Under the proposed currency structure, the lower bank notes of ₦5, ₦10 and ₦20 will be coined, while the existing denomination of ₦50, ₦100, ₦200, ₦500 and ₦1,000 will be redesigned with new security features. A new high currency denomination, the ₦5,000 note, will also be introduced.

Although the Federal Government has suspended the proposed currency restructuring following the intervention of the National Assembly leaders, the policy has continued to generate record debate and commentaries from several quarters since August 23 when it was first announced.

According to the monetary authority and the proponents of the policy, the key benefits of the proposed currency restructuring include:

  • Reduction of the cost of currency management such as printing, movement, storage, counting and distribution. For instance, a ₦1 million transaction would normally require 2,000 pieces of ₦500 notes or 1,000 pieces of ₦1,000 notes, but with the introduction of ₦5,000 notes, only 200 pieces would be needed. This is a significant reduction in volume, and it offers great convenience for those who have cause to handle large amounts of cash.
  • Enhanced portability and the facilitation of business activities of some segments of the economy where cash is required for day to day transaction (i.e. the informal sector).
  • Reduction of risk and the vulnerability of cash carriers, as higher value of cash can now be easily moved around.
  • Increase the capacity of Automatic Teller Machines (ATMs) to store more money, reduce ATM stock out time and serve bank customers better.
  • Facilitate the return of coin in circulation as higher currency notes will be converted to coin. Of course, coins are relatively durable and our historical apathy to the use of coin is solely due to value consideration not its portability.

On the flip side, while the policy supporters and the monetary authority, have argued that there is no theoretical basis linking currency denomination or its physical properties to inflationary dynamics, cynics argued that Nigerians’ apathy to the use of coins might push prices to the lowest denomination of currency notes. The rounding up effect is likely to result in general rise in consumer prices.  Other major down sides of the proposed policy includes:

  • The likely hike of the incentive for currency counterfeiting in the country
  • The tendency of the policy to undermine the use of electronic channels for transactions thereby defeating the ongoing CBN cashless regime in the country
  • Corruption and illegal incentives will arguably thrive on the back of higher currency denomination.

Is There A Currency Crisis?
A key aspect of the ongoing debate borders on the integrity of the naira as a currency. Sceptics argued that printing higher denomination of the naira may suggest that the country is facing a currency crisis. The experiences of countries such as Ghana and Zimbabwe who have had to restructure their currencies as a result of such crisis comes to mind.  In fact, Zimbabwe had to partially dollarise its economy in a bid to stabilise domestic prices. The CBN argued that the restructuring would optimise the currency structure and ensure cost effectiveness and balance currency mix.

Seigniorage Versus Inflation
There is an aspect of this important decision which no one seems to be talking about. This is the issues of seigniorage. Seigniorage is the link connecting currency denomination, coin production, currency restructuring and inflation. In simple term, seigniorage is the tax revenue generated by the government from the difference between the face value of a currency note or coin and the cost incurred in producing it. Seigniorage is profit from money creation, a way governments generate revenue without levying conventional taxes. Since this tax is not the usual tax which takes money out of the system, when government spends it, it represents monetary expansion. However, monetary expansion is inflationary.

Seigniorage dates back to the days of commodity money, when the value of the currency is related to the precious metal used in producing it. The difference between the face value of minted coins and the actual market value of the precious metal they contained represent the seigniorage earned by the government.  Where this difference is considered insufficient for government, the authority often substitute less valuable base metal for some of the precious metals to be coined.

Under the current fiat money standard, where all papers and coins issued are backed by nothing than the faith and confidence in the issuer, the costs of issuance per unit of currency has declined substantially. The only factor limiting the quantity of money a country can issue is the level of inflation it can live with. According to a professor of economics, Richard Burdekin, under the fiat money system, seigniorage revenue is given by the product of inflation rate and inflation tax base. Inflation tax base reflects the purchasing power of the public and it’s the level of real money balances (nominal money holdings divided by the price level).

Rapid monetary expansion causes inflation rate to rise, but the revenue effects are partially offset as individuals attempt to quickly spend the extra money before it depreciates further. For instance, if people spend money faster than it is being printed, the rate of price increase will definitely exceed the rate of money issuance. That was the classical case of Argentina in 1982 to 1985 when seigniorage rose patently and was accompanied by an increase in inflation. Argentina later witnessed hyperinflation when inflation rate got to over 20,000% in the early 1990s before the country’s economy was dollarise.

Where it becomes difficult for a government to fund its expenditures through conventional taxes or bond sales, it may become dependent on seigniorage revenues to maintain its existence. A classic example is the case of Zimbabwe whose government depend on seignorage for an estimated 50% of its revenue. Inflation rate in Zimbabwe was as high as 231 million percent in July 2008 and it has had to slash several zeros off its currency’s face value to reduce the size of Zimbabwean money. Monetary policy in Zimbabwe finally hit the rock after printing a trillion Zimbabwean dollar note in January 2009. In other words, seigniorage revenues are not only inflationary but eventually self-defeating. Under circumstances where the decline in real money balance becomes proportionately larger than the rise in the inflation rate, the inflationary policy actually backfires and lowers seigniorage revenue.

Seigniorage And ‘Project Cure’
Before we review the issue of seigniorage in the context of the CBN’s ‘Project Cure’, it is important to note a number of issues from the foregoing. The size, purpose and management of seigniorage matter in the way it impacts on price level. In addition, the relationship between the monetary and fiscal authority, in relation to how seigniorage and other earnings of the monetary authority, are appropriated is also important in this regard.

Deliberate use of seigniorage to support government revenue or fund deficit affects inflation. Where seigniorage as a proportion of government revenue rises, the impact on inflation increases until hyperinflation sets in. An analysis on hyperinflations suggests that there is a seigniorage-linked revenue maximising level of inflation, at which point additional revenue possible begin to fall. However, where seigniorage implications of issuing additional currency notes and coins are not deliberate, the treatment of the consequential money created as well as the size would determine the impact on price level.

In the latter regard, the independence and the power of a country’s central bank in the management of currency issuance, as well as the revenue generated from it are also important. Where the independence or power of the central bank is weak, there is the tendency for the government to seek to maximise seigniorage and seize the proceeds with implications for inflation. If an independent central bank also treats seigniorage as income or expend it to create assets against the irredeemable liabilities in its book, it is likely that the impact would be a rise in inflation.

In relation to ‘Project Cure’, the questions that the CBN needs to answer are:

  • What revenue does the country obtain from seigniorage i.e. its monopoly of the issuance of currency?
  • Who ultimately appropriates and benefits from these resources, the Central Bank or the treasury/ministry of finance?
  • What inflation rate would result if the monetary authority were to try to maximise revenue from seigniorage?
  • Does the Central Bank have adequate financial resources to pursue its monetary policy and financial stability mandate?

There is no gainsaying that the CBN is independent and legally protected to pursue the monetary policy with little interference from some quarters. It is therefore hard to argue of the fiscal authority’s involvement in the decision to restructure the nation’s currency and issue a higher denomination currency to maximise seigniorage. However, a review of the CBN’s annual report suggests that the apex bank generated an average annual seigniorage of ₦106 billion between 2008 and 2011 on notes and coins issued. It is however difficult to deduce the derived values of seigniorage from the annual account of the CBN, considering that notes and coins issued are liabilities, albeit irredeemable in the book of the CBN.  Again, 80% of the income of the CBN is appropriated to the Federal Government of Nigeria based on the provision of the CBN Act (Section 5(3)).

Whether ‘Project Cure’ would be inflationary depends on the merit of the answers provided by the monetary authority to the questions outlined above. Although, the answer to the third question may require extensive analysis, the exercise will be worthwhile and would support the sustained CBN objective of price stability which it has pursued vigorously in the last two years.  We are guided by the fact that any economic policy has its cost and benefit. To optimise the benefits of ‘Project Cure’, it is important to weight the merits and demerit of the policy before embarking on it.