— In 2023, it was predicted that the naira would weaken even further. This piece explores the implications of naira devaluation for Nigeria's economy.
Because of the naira devaluation and the naira’s exchange rate to the US dollar being significantly higher than fair value, the Bank of America predicted that the country’s currency will fall even more in 2023.
In a Bloomberg study, economist Tatonga Rusike said that three indicators—the commonly accepted black market rate, the real effective exchange rate of the Central Bank of Nigeria, and the currency’s fair value analysis—showed that the naira was overvalued by 20%.
“We see scope for it to weaken by an equivalent amount over the next six to nine months, taking it to as high as N520 per U.S. dollar.”
While the naira will face increasing pressure “due to limited government external borrowing,” devaluation is unlikely to occur until after the 2023 elections, according to the bank.
Nigeria has two distinct exchange rates: the official rate, which is subject to strict controls, and the freely traded parallel market.
The official rate has decreased by less than 10% since December 2021, but the parallel rate has decreased by about a third in the same time frame, increasing the difference to almost 70%, based the bank’s study. It further stated that there is a bigger chance of excess demand for foreign currency in the parallel market the more the discrepancy with the official market.
May 2021 saw the CBN switch formal transactions from the fixed rate of N379 to a dollar to the more flexible Nigerian Autonomous Foreign Exchange rate, commonly referred to as the Investors and Exporters exchange rate. “We found out that we were no longer dealing in this so-called CBN official rate for transactions.”
But as of today, November 29, 2023, the dollar is worth N785.46 in the naira.
The former governor of the CBN revealed, during the monetary policy briefing, “We are still running a managed float. We are monitoring the market and seeing what is happening, for us to ensure that the right things are happening for the good of the Nigerian economy.”
However, in response to more stringent funding requirements and an impending tightening of policy by the Federal Reserve Bank of the United States, the International Monetary Fund recommended poor countries—including Nigeria—should allow their currencies to collapse in January 2022. Additionally, it suggested that the CBN and the central banks of developing countries hike benchmark interest rates.
The lending institution states that emerging economies should respond to more stringent loan requirements based on their particular vulnerabilities and circumstances. The ability to tighten monetary policy more gradually is available to those with policy credibility in managing inflation, while those with greater inflation pressures or weaker institutions must respond swiftly and comprehensively.
“In either case, responses should include letting currencies depreciate and raising benchmark interest rates. If faced with disorderly conditions in foreign exchange markets, central banks with sufficient reserves can intervene, provided this intervention does not substitute for a warranted macroeconomic adjustment.”
The IMF further explained how such measures would push emerging nations to choose between maintaining price stability and upholding global standards and helping a vulnerable domestic economy. In a similar vein, giving businesses more support than they currently receive runs the danger of increasing credit risks and undermining financial institutions’ long-term sustainability by postponing the recognition of losses. Reversing those steps might lead to further tightening of financial conditions and a weakened recovery.
Furthermore, fiscal policy has the potential to increase shock resistance. A genuine commitment to a medium-term fiscal plan would instill confidence in investors and facilitate the restoration of fiscal support during a slump.
It also added, “Such a strategy could include announcing a comprehensive plan to gradually increase tax revenues, improving spending efficiency, or implementing structural fiscal reforms such as pension and subsidy overhauls.”
Devaluation
Currency devaluation, such as naira devaluation, results in a currency’s value declining. This occurs when a country’s currency intentionally depreciates in value relative to another currency, set of currencies, or standard of exchange. Countries with fixed or semi-fixed exchange rates employ this tool of monetary management. It is sometimes confused with depreciation, which indicates a shift in a currency’s exchange rate, and is the reverse of revaluation.
A study suggests that a nation may lower its currency to correct a trade imbalance. Devaluation increases the cost of imports by lowering the price of a country’s exports and increasing their competitiveness on the global market.
Increased prices on imports will discourage domestic consumers from purchasing them, therefore bolstering domestic companies even more. As the trade imbalance narrows, growing exports and declining imports lead to an improved balance of payments. Stated differently, a nation that devalues its currency might reduce its deficit because exports at a lower cost are in more demand.
Despite not actively supporting currency devaluation, several nations are nevertheless able to compete in global trade because of their monetary and fiscal policies. Depreciating currencies are caused by monetary and fiscal policies, which attract foreign investors to more cheap assets like the stock market.
Devaluing a currency has disadvantages even though it could seem like a smart idea. While higher import costs protect home industries, they could become less productive in the absence of competition.
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Another advantage of more exports relative to imports is increased aggregate demand, which can lead to higher GDP and inflation. An increase in import costs may cause inflation. Aggregate demand drives demand-pull inflation, and since exports are cheaper, producers might be less inclined to cut expenses. This drives up the cost of products and services over time.
Encouraging exports is one of the criteria that some countries consider when deciding to discount their currencies. Goods from different nations have to compete with each other. On the other hand, exports become relatively more expensive to purchase in foreign markets as their currency appreciates. Stated differently, exporters gain more global competitiveness. Exports are encouraged while imports are discouraged. Studies, however, point to the need for prudence for two reasons.
If a government has a lot of sovereign debt to service, it would be inclined to advocate for a weak currency policy in order to reduce the expense of servicing that debt. If debt payments are fixed, a falling currency gradually lowers the cost of those payments.
When a nation’s manufacturing costs are high, its capacity to compete is diminished because its goods and services are more expensive overseas than those of its competitors. Devaluing one currency in relation to another will result in a fall in the price of its goods and services on the international market, which will boost exports. External devaluation, another name for this type of devaluation, is a popular economic stimulation tactic.
However, when a nation is a member of a single currency region, internal devaluation usually takes place. In order to become more competitive, the region will directly lower its production costs by lowering taxes, salaries, or the cost of public services, while it is unable to weaken its currency.
Though perspectives on internal devaluation among economists differ, its ultimate goal is the same as that of external devaluation: lowering the cost of goods and services to boost exports.
Competitive devaluation is the practice of two or more nations trying to lower the value of their national currencies in order to gain an advantage over one another in terms of exports and foreign investment.
Fiscal devaluation, as opposed to a direct devaluation of the currency, attempts to lower taxes, especially those associated with productivity, increasing the competitiveness of domestic sectors with those of foreign countries. To work and make exports more appealing, changes must be made to both direct and indirect taxes at the same time. Reduced employee taxes for firms will result in lower manufacturing costs.
In a meeting with our reporter, Nigerian economist Kolawole Akinwale voiced his worries about the nation’s economy in response to the Bank of America’s forecast of a 20% rise in the devaluation of the naira.
He said, “This is a bad omen for Nigeria’s economy. This means that the value of our currency will decline, which means the current exchange rate of our naira to the dollar will increase by 20 per cent. Nigeria will spend more on the importation of goods and services.
“This will cause a lot of inflation. The CBN needs to step up on the monetary policy. What I think CBN needs do is to ensure that the currency of the country from where goods are imported is used to make payment via Form M – a mandatory statutory document to be completed by all importers for the importation of goods into Nigeria
Additionally, he cautioned the CBN against using dollars to pay for commodities unless they are imports from the United States.
“If someone imports goods from China and issues Form M in dollars, CBN makes payment in dollars. This contributes negatively to the exchange rate. If payment is made on the currency of the country where import is initiated, there would be less demand for dollars,” Akinwale added.
