Naira: The devaluation is not an option

That phrase is an excerpt from the speech of the future president of the Central Bank of Nigeria. It opposes the devaluation of the Naira . According to the Governor the exchange rate of the Nigerian currency is correct. This leads us to our analysis of the week: Why a nation devalues ​​its currency ? As a good Ivorian, I experienced the devaluation of the CFA franc in January 1994 . I can testify how the country has suffered in the months that followed the devaluation. Prices suddenly experienced an outbreak. There were not enough cash in circulation. But let us return to the main question : Why a nation must devalue its currency ?

Theoretical foundation

a. A nation “officially” devalues ​​its currency relative to other currencies, when it ” voluntarily” decrease the value of its currency compared to other currencies.

b . Market exchange rates can also reduce the value of a currency against another, when the demand for this currency is experiencing a decline.

Raison to devalue ?

When the exchange rate of a currency drops in value,  exports ( x ) become cheaper while imports ( m ) become expensive. If we define the trade balance Nx = x – m Then devaluation will normally increase the value of exports relative to imports. From what has been said : 1 . So a nation devalues ​​its currency in order to stop a chronic deficit in its trade balance (achieve  balance surplus) . If we redefine x as inflow of currency and m  as outputs of currency, then

Nx = Influx of foreign currency – Output of foreign currency exchange. 2 . If we follow the same approach , a devaluation will increase the stock of forex  compared to an outflow of currency . 3 . In the short term , a devaluation , increases the trade balance and also increases economic growth. According  to cases 1 and 2, a nation benefits from the devaluation when its economy is heavily exporting raw materials. When, therefore , the country is strongly turned to imports,  a devaluation will have no effect on the trade balance. Instead, it will widen the trade deficit and thus increase the outflow of foreign exchange . In the case of Nigeria , the future governor of the Central Bank states  that the devaluation of the Naira will have a devastating effect on the economy because Nigeria is a nation that is heavily importing. He is half right : Nigeria with its oil industry is an export nation. He currently experiencing a surplus in the trade balance, however,  when the price of oil is experiencing a decline , according to our analysis , a devaluation will widen the trade deficit and increase outflow of forex exchange.

When the political decision influences the Naira

The Naira began to be distressed when President Goodluck Jonathan  sacked the former governor of the Central Bank. The later found a  Billion hole in oil revenues . This leads us to the point b . Devaluation of a currency can be caused by the foreign exchange market ( speculative attacks). When speculators (domestic / foreign ) begin to express doubts about the practice of economic policy of a nation  and try to get rid of the local currency. In the case of Nigeria ,  the Independence of the Central Bank is in doubt. As a result, huge amounts of national currency will be exchanged against other currencies. In the long term , the amount of domestic currency in circulation will increase. At this level the rising costs of imported products can cause inflation The table below shows the event of a devaluation in Africa. Before devaluation , 1 USD was trading at 155 Naira . After a “potential” devaluation 1 USD is trading at 170 Naira . In other words to gain 1USD , it costs more Naira . The Naira is devalued. This is the same principle for Kwasha  of Malawi , the former French Franc .  The Central Bank may limit speculation against the domestic currency by making it difficult to get it ( higher interest rates).