By Tim Cocks and Joe Brock
LAGOS/ABUJA (Reuters) - In Nigeria, as elsewhere, foreign exchange markets can be a barometer of internal strife, so when central bank governor Lamido Sanusi noticed a surge in dollar demand at forex bureaux in July, he feared something was amiss.
The bank found tens of billions of naira was traded for dollars in cash, much more than importers needed to buy goods or investors to repatriate funds, and there was no trace of where the money came from or where it was going.
"Obviously this was some form of money laundering to cover all the trails," Sanusi told Reuters. "And with interest rates as high as they are, the only people who can take that much naira and buy dollars are people who are not borrowing their money."
The prime suspects, he says, are politicians jockeying for position ahead of what look likely to be bitterly divisive 2015 polls in Africa's second-biggest economy.
He blames "dollarisation of the economy by political elites" for continued weakness of the naira, despite central bank moves to prop it up with dollar sales that have depleted its reserves to an eight-month low.
Some economists dispute that explanation of the currency's troubles, but it highlights the economic risks of Nigeria's costly and often violent pre-electoral politics.
Nigeria's growth rate of more than 6.5 percent and its huge consumer market are a draw for foreign investors, but they worry about stability and the country's tendency to squander its windfall as Africa's biggest oil producer.
"OPEN AND DESTRUCTIVE"
Nigerian elections always cost the country billions of dollars and, often, many hundreds of lives, especially when they ignite ethnic rivalries or regional tensions between the largely Muslim north and mostly Christian south. This cycle could be especially costly, in terms of blood and treasure.
A feud is bubbling between President Goodluck Jonathan and rivals in his ruling People's Democratic Party (PDP) over his assumed intention to run for another term, which is distracting from vital economic reforms. A bill to reform the oil industry, which feeds 80 percent of government revenue, is stuck in parliament and unlikely to pass before the elections.
Thanks largely to the feud, unofficial campaigning has begun almost two years early, so politicians will need to sustain spending on patronage for longer.
Such spending can come from politicians' private interests, but there are other ways, including state money for projects that benefit constituents, and government contracts for allies.
"The need of politicians to spend money now will be a big drag on the economy," said Bismarck Rewane, CEO of Lagos-based consultancy Financial Derivatives. "If it comes from the treasury, the fiscal deficit will widen, you'll get more inflation, the naira will weaken."
There is also widespread concern that some politicians profit from criminal gangs that make money from kidnapping, extortion or the theft of oil from the Niger Delta.
Seven ruling party governors and a former presidential candidate have formed a PDP splinter group determined to stop Jonathan from running again, though as recently as Sunday he declined to say whether he would.
All but one are northerners who feel another spell in office would break an unwritten rule that the presidency should rotate between north and south every two terms, or are disappointed with his record on tackling security challenges like an Islamist insurgency in the north.
The president last month sacked nine ministers he suspected of disloyalty.
"The crisis in the PDP is very deep, and I don't see them resolving these issues ... It's such an open and destructive fight," said Jibrin Ibrahim, director of the Centre for Democracy and Development, an Abuja-based think-tank.
"The northern political class feels it needs to get back into power, and the president will do all he can to stay in."
It may not be such a bad thing for democracy, he says, if the dominant PDP ends up breaking up into two or three parties.
But it would damage public finances if state money is used to shore up wavering loyalties, and all three tiers of government - local, state and federal - will need to fight expensive battles.
"The more contentious the election ... the more funds will be utilized to fight it, both at federal and state levels," said Kayode Akindele, partner at Lagos-based advisory 46-Parallels.
Nigeria's cash position always plummets ahead of election time, but this time oil theft is proving an unprecedented drain, dragging official output to a four-year low, nearly a fifth below its 2.5 million barrels per day (bpd) capacity.
"Oil theft tends to shoot up in periods of heightened political instability and competition," London's Chatham House wrote in a report this month. "Nigeria's upcoming ... elections scheduled for 2015, are a particular wild card."
Rampant theft has also left the government with less money, despite high oil prices, just when governors and legislators are clamoring for it.
Nigeria's oil savings account had around $9 billion in it in December. By March it had fallen to $5.8 billion, after several withdrawals, including two distributions of $1 billion to governors for constituency projects. It has not recovered.
Finance Minister Ngozi Okonjo-Iweala has crafted a tighter budget plan for 2014 - 4.5 trillion naira ($28 billion), against 5 trillion in 2013 - mindful that parliament often inflates spending.
But the savings were made largely by slashing capital spending needed to address chronic infrastructure bottlenecks.
Though the budget is conservative in its oil price assumption, it assumes production of 2.39 million barrels a day (bpd), which analysts say may be optimistic, given the thefts. Output is currently around 2.11 million bpd.
"Nigeria is facing a very serious situation with ... oil output," Standard Chartered's Razia Khan said. "The test is: are the politics going to allow for keeping spending under control?"
($1 = 161.5500 naira)
(Editing by Will Waterman and Janet McBride)