Friday, March 20, 2015 6:08 PM / FDC
Exchange rates are important economic tools because they affect the price of every country’s imports and exports, as well as the value of foreign investment. In import dependent economies, policy makers and business stakeholders are often concerned about severe consequences of currency volatility, especially depreciation on the cost and return of their foreign transactions.
The recent plunge in the global oil prices and the attendant de-valuation of the naira has been the subject of debate in recent months. The naira was initially devalued by 8% at the official market while the interbank and parallel market rates traded at new record lows. As the currency pressure persisted, the Central Bank of Nigeria (CBN) closed the RDAS/WDAS market for the Interbank Foreign Exchange Market (IFEM) in a bid to reduce the level of reserves depletion. The naira depreciated to a record low N210/$ and N227/$ YTD, from N186/$ and N191/$ in December 2014 at the interbank and parallel markets respectively.
Exchange rate fluctuations and its impact on trade is a complicated one because of the feedback loop between them.1 In theory, an increase in the value of any currency should raise the cost of foreign goods, thereby discouraging the demand for imports. This is a positive development for an economic with sufficient domestic alternatives. while it is worrisome for an import dependent economy. Depreciation of a currency makes export cheaper and attractive and this enhances domestic production in the long run.
Devaluation Impact on Import and Export
The exchange rate plays an important role for businesses that export and import goods and services. Essentially, the extent to which depreciation or devaluation affects a country depends on the rate of its exports relative to its imports.
Currency Devaluation and Import
The relationship between the naira volatility and the national import statistics reveals that historical devaluation and depreciation of the naira corresponds with a subsequent and immediate fall in import. Although the level of impact varies due to other underlying factors such as policy regulations, currency volatility has a significant immediate impact on imports, at the least in the short-term.
Currency Devaluation and Export
The currency-export trend indicates that a decline in export precedes devaluation of the naira in most cases. In other words, naira depreciation or devaluation appears as a response to decline recorded in exports.
Since Nigeria’s exports mainly consist of oil, it is important to separate the above relationship between oil and non-oil exports. According to the graph below, the currency fluctuation appears to lead to naira depreciation.
Conversely, non-oil exports rise following naira depreciation, an indication that non-oil exporters benefit from currency depreciation.
Exchange rates are important prices with substantial implications for trade and investment flows for every economy. In Nigeria the plunge in global oil prices (by over 60%) resulted in the devaluation of the currency. The new exchange rate policy will definitely create winners and losers. While exporters are winners, importers seek government subsidies to mitigate their losses.
In general, historical data show that previous naira devaluations have resulted in an improved level of non-oil export. However, it is observed that currency depreciation has immediate negative impact on imports, at the least in the short-term. Therefore, the current devaluation will most likely raise Nigeria’s non-oil export and reduce the level of import.
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