The value of a country’s currency is a function of how much of that nation’s currency that will be required to purchase a unit of that nation’s currency.
In Nigeria, we have adopted a fixed exchange rate system where the Central Bank of Nigeria fixes the rate at which the Naira will exchange against foreign currencies. In these instances, the Naira can be devalued or revalued by the Central Bank resulting from pressures from the market and the economic reality confronting Nigeria at a particular time.
Nigeria’s Naira value is fixed in relation to the United States Dollars.
The Central Bank of Nigeria has deployed several policy initiative to shore up the Naira in recent times to the chagrin of JP Morgan accusing Nigeria of manipulating exchange rates to support the Naira and hence have expelled Nigeria’s Sovereign Debts from its Bond Index with Barclay’s Bank calling for a review of its decision earlier to include Nigeria’s Debts Instrument.
Factors that drive Currency Devaluation
When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency’s fixed exchange rate untenable. In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.
When to Devalue
Countries are often compelled to devalued their currencies when Central Bank believes that the allowing exchange rates system as it were, will lead it to deplete its foreign currency reserves which may in their wisdom not be a wise decision to take to get the nation’s currency to exchange at a rate that will leave it with a reasonable foreign currency reserve.
Effect of Devaluation
Exports: Goods/Services exported from Nigeria will appear cheaper and more competitive, particularly if the inputs required for such exports are not imported.
Imports: Products or services that are imported into a country will become more expensive. This includes, raw material inputs that go into production of finished products locally.
Inflation: Cost-push inflation resulting from higher input-cost may likely occur
Current Account: There may be improvement in current account position for countries whose devaluation led to increased exports and reduced imports. This may not always occur.
Why Nigeria Must not Devalue its Currency?
- The demand elasticity for most Nigeria exports are not price elastic. Making Nigeria exports cheaper will only lead to negligible increases in exports volumes. The value of the exports in relative terms may fall thereby worsening current account position.
- The global economy as at today is not in the best position. Devaluing our currency may not boost exports as global demand is currently sluggish.
- In Nigeria, firms have the strength to pass on increased cost to their customers in order to maintain profits but at reduced volumes. This will thus constrain production, leading to cut-backs and hence loss of jobs and increases in un-utilized capacity of companies with attendant costs.
- Nigerian products are currently not competitive in the world market due to other factors as: interest rates, power, security, technology available and not currency exchange rates.
- Any attempt to devalue the Naira will mean that Central Bank of Nigeria will be compelled to raise interest rates in an effort to curb inflation, which in turn negatively affect production of goods and services, slowing down economic growth further.
- The value of wages of fixed-income workers and income of the poor who are many who cannot raise their income will be fall, with the consequence of lower standards of living.
- When a country devalues its currency, it means that the value of foreign investor’s assets in the Country will be lower, relative to the Dollar, thereby increasing their foreign exchange losses. This can injure foreign investor confidence and therefore negatively impact on the country’s push for foreign direct investment.