FINANCE - 03 NOV 2017

The Economic Logic of New Banknotes

The Economic Logic of New Banknotes
None

The existence of bank notes, specifically paper money or fiat money, is one of the most controversial topics in finance. Money can be defined as any commodity paid and received in exchange for other commodities and services without reference to the personal credit of the one who offers it; so while a personal note is not money, a bank-note – backed by a central bank – is. 

A fascinating concept!

Today, some nations are scaling back high banknote denominations under the guise of tackling criminal activities. In 2016, the European Central Bank announced an end to the issuance of €500 notes (infamously known as ‘Bin Ladens’) as part of counter-terrorism efforts. The notes were taken out of issue in 2010 after a report showed criminals accounted for 90% of demand.

In North America, Canada withdrew its Canadian $1,000 note (then worth US$670) from circulation for the same reason in 2000. Singapore is also phasing out the Singapore $10,000 note, the world’s most valuable note (worth $7,100).

These notes are extremely portable, making them attractive to both legitimate users and would-be criminals. But even though reining in high banknote denominations will not eliminate crime and corruption, doing so would increase criminals’ costs and make them easier to detect.

In 2005, Nigeria rolled out the ₦1000 note – an outright contradiction to the rest of the world – on the singular merit of portability. It didn’t stop there. The government discussed the possibility of higher denominations; as high as ₦5000 slammed on a piece of paper, maybe on a polymer at best.

And the contradiction extends further. At the time, the Nigerian economy was enjoying a boom, which most economists would consider an argument against the need for higher denomination bank notes. Yet, Nigeria persisted, perhaps for selfish reasons. But as the economy grew, policy-makers had leeway to forge ahead, damn the consequences. 

 

The Agenda for the Naira 

Fast forward two years and Nigeria was thinking differently. Economic growth began to slow on the back of a global recession. As many countries adopted radical measures to arrest the slide, Nigeria sought a response to contain the external shock. 

In August 2007, the Central Bank of Nigeria announced the second phase of the Strategic Agenda for the Naira. Phase One was launched in 2014; it was a 13-point reform agenda designed to restructure, refocus and strengthen the Nigerian financial system. One objective was to drop two zeros on the naira and issue more coins. In practice, this would have had a purely nominal effect and no direct real economic effect. It is akin to shrinking all naira-denominated assets, liabilities, and contracts – something close to US$1 exchanging for approximately ₦1.25.

The objective? To anchor inflation expectations, strengthen public confidence in the naira, reduce the cost of production, distribution and processing of currency and make for easier conversion to other major currencies. It is safe to say that if pricing becomes more efficient (due to redenomination) and the economy continues on a growth trajectory, the economic benefits of the agenda would be measured as positive.

If the agenda happened, pricing would become efficient which means one can pay ₦1.25 for a commodity. Here, coins will become relevant once again but carrying coins won’t be as interesting as using a card to complete such transactions. This would drive cash businesses to the banks. The banks will then have enough data to drive financial inclusion hence cashless economy can be easier.

The timing was right too. Under the stewardship of President Musa Yar’Adua, there was apparent will to push through certain structural reforms. Moreover, with GDP growth above 6%, single-digit inflation, and robust external reserves, the economic picture was favourable. Any behavioural changes at this time would have set the pace for driving cash businesses into the banking system.

However, the outcome wasn’t set in stone. 

 

Castle on the Hill

The naira agenda, once on a platter of gold, now rests in a castle on a hill. The vision it outlined is unlikely today, given the weak state of the domestic currency. But it is an agenda that can be revisited at a time in the future when we have gotten things right again. 

The naira is a reflection of an average Nigerian’s confidence except for the ‘dollar carrying’ men. The essence of money is in its value. Value is ascribed to money by the trust that people place in it vis a vis its origin. If this is true, Nigeria is at a disadvantage to explore the economic benefits of new banknotes with higher denominations.

The Soludo campaign for the re-denomination and re-introduction of a new currency structure (notes and coins) will probably be the finest this generation would witness, in terms of timing and achievability. However, it is not impossible for Nigeria to reap the benefits of adjusting banknote denominations. It will be an uphill task for the administrators. With reforms and enabling conditions to better anchor inflationary expectations and strengthen public confidence in the naira, the naira agenda can be revisited.

Korede Ologun

Korede Ologun

Read Latest

Cows For Collateral

ECONOMY - 23 NOV 2017

The dangers of high interest rates in Nigeria

FINANCE - 21 NOV 2017

Does Poverty Fuel Terrorism?

COLUMNS - 17 NOV 2017

Is Nigeria's Debt sustainable?

ECONOMY - 15 NOV 2017

Advertising