Since the removal of the peg on the exchange rate by the Central Bank of Nigeria (CBN), the naira has been wobbling against the dollar at the Investors’ & Exporters’ (I&E) FX Window.
The CBN, on June 14, 2023, collapsed all segments of foreign exchange markets into the I&E window. After trading on Monday, the naira depreciated to 770.38 per dollar as against 663.04/$ on Friday at the I&E window, the official FX market.
What is devaluation and depreciation of a currency?
According to the International Monetary Fund (IMF), currency devaluation is the deliberate downward adjustment in the official exchange rate, which reduces the currency’s value.
While when market forces generate changes in the value of the currency, it is known as currency depreciation or appreciation. A decrease in the value of a currency is known as depreciation, according to the IMF.
“The US dollar depreciates, the Nigerian Naira devalues, both are the same event but the difference is when the FX market is free, it’s called depreciation, when it is controlled, it is referred to as devaluation,” Kalu Aja, a personal finance consultant, said.
According to him, since the peg has been removed in Nigeria, it is a depreciation, but both words are often used interchangeably in non-formal settings.
How does devaluation/depreciation of a currency occur?
Under a floating exchange rate system, market forces generate changes in the value of the currency, known as currency depreciation or appreciation, according to the IMF.
Since 1973, exchange rates for most industrialised countries have floated, or fluctuated, according to the supply of and demand for different currencies in international markets.
An increase in the value of a currency is known as appreciation, and a decrease as depreciation. Some countries and some groups of countries, however, continue to use fixed exchange rates to help to achieve economic goals, such as price stability.
Under a fixed exchange rate system, only a decision by a country’s government or monetary authority can alter the official value of the currency.
Governments do, occasionally, take such measures, often in response to unusual market pressures.
Nigeria has floated its currency.
Aja explains how the removal of the currency peg now allows supply and demand control prices.
“What most have missed is the peg, they see only the devaluation. Peg removal means the naira can go to N1000/$ or N300/$,” he said.
“If people remitting into the country send $25 billion in August alone, then $1 becomes N300, meaning that if it devalues, it means it can appreciate,” he said.
Effects of devaluation on a country
When a country’s currency is devalued, it means that its value decreases compared to other currencies.
The IMF said: “This has two main effects. First, it makes goods and services produced in that country cheaper for people from other countries to buy. This can make the country’s exports more attractive and increase sales to other nations.
“Second, devaluation makes products from other countries more expensive for people in the country. This can discourage people from buying imports, which may help reduce the amount of money leaving the country for foreign goods.”
However, devaluation also comes with risks. One risk is that it can lead to higher inflation. By making imports more expensive, devaluation can cause prices to rise within the country. This can make it more difficult for people to afford everyday goods and services. To control inflation, the government may need to increase interest rates, but this can slow down economic growth.
The organisation highlighted that another risk is the psychological impact of devaluation. If people see devaluation as a sign of economic weakness, it can harm the country’s reputation and make it harder to attract foreign investment. This can weaken the overall economy and make it more difficult for the country to grow and develop.
Effects of devaluation on Nigerians
Olumide Adesina, a financial market analyst at Quantum Economics, said that devaluation can affect the purchasing power and welfare of Nigerians, especially those who rely on imported goods and services or remittances from abroad.
He said it can also have a negative impact on those who have assets or income in the devalued currency, as they lose purchasing power and wealth relative to other currencies.
How to protect your assets from devaluation
Adesina highlighted the following as ways to protect your assets from devaluation.
“Diversify your portfolio into foreign assets or currencies that are likely to appreciate or stabilize against currency depreciation, it helps hedge currency risk and maintain purchasing power around the world.
“Hedge with commodities or commodity-related assets such as gold, oil, metals, and agricultural commodities that tend to appreciate in value when currencies depreciate because in the global market goods are valued in dollars and depreciation makes the goods more expensive for domestic consumers.
“Reduce your exposure to foreign currency-denominated debt as the cost of repaying the debt is higher due to the devaluation of the foreign currency.
“Increase your savings and income in a depreciating currency, as a depreciating currency reduces your real income.”