How Exchange Rates affect the Economy of Nigeria.

The exchange rates are very vital in the economic well being of any given country and Nigeria is not an exception. Everything (importation and exportation, inflation, investment, and purchase power of the household among others) depends on the value of the Nigerian Naira (N) to other major currencies, including the US Dollar (USD) or the Euro (EUR). It is necessary that knowledge of the role of exchange rates on the economy of Nigeria is known to the policymakers, business and the citizens.

What Are Exchange Rates?

Exchange rate is the cost of the currency of one nation against the other currency. Central bank of Nigeria (CBN), in Nigeria, controls the value of Naira and balances between the supply and demand of foreign currencies as well as affecting trade and monetary policy. The exchange rates may be fixed or floating or a hybrid system and this will be based on the government and central bank policies.

Changes in the value of the Naira have a direct impact on the price of imported products, competitiveness of Nigeria exports and foreign investments as well as stability of the economy.

The impact of the exchange rates on trade.

One of the areas which are the most susceptible to exchange rates changes is trade.

 Imports: As the Naira loses its value against foreign currencies, the imports will be costly. Nigeria has a high dependency on imports in the refined petroleum products, machinery, food products, and pharmaceuticals. With the upsurge in the cost of imports, the cost is usually transferred to the consumers, and the overall cost of living follows suit.

 Exports: On the other hand, the weaker Naira would render the Nigerian exports cheaper and competitive in the global market. Exchange rate depreciation might favour agricultural produce, crude oil and finished goods and hence increase export earnings. But, the profitability relies on the demand and efficiency in the world market.

Exchange Rates and Inflation.

Inflation in Nigeria is directly affected by the exchange rate fluctuations. Less powerful Naira would raise the prices of imported goods and services, which will raise consumer prices. This imported inflation may impact on the most important items, which include food, fuel, and medical supplies.

Inflation decreases the purchasing power of households and may cause social unrest in case the wages are not increasing in line with the increased prices. On the other hand, an appreciation of the Naira will assist in reducing the cost of imports and alleviating the inflationary pressures.

Investment and Foreign Capital.

Investment decisions are also affected by the exchange rates. When Naira is relatively stable, a foreign investor is most likely to invest in Nigeria and incur less risk of losing their currency. On the other hand, unstable or weakly depreciating exchange rates may discourage foreign direct investment (FDI) and portfolio investment which is critical in the growth of the economy and creation of employment.

The domestic investors are also impacted. Companies that depend on imported raw materials will incur increased costs of production when Naira is depreciating and this will hamper expansion plans and decrease profitability.

Government Revenue and Debt

Nigeria earns a good percentage of government revenue through oil exports which are traded in USD. As the Naira loses value, the government will get a higher Naira in return of every dollar earned, and this may increase revenue. Nevertheless, it is also expensive to the government to repay foreign-denominated debt in Naira depreciation which may be a burden on the government.

It is therefore necessary to maintain a balanced exchange rate policy in order to control revenue and debt commitments.

Effects on Households

To the households of Nigeria, fluctuations in exchange rates have a direct impact on their day to day life. Diluted Naira increases the prices of imported goods including electronic, clothes, and fuel. This decreases the disposable income and the cost of living gets higher.

The currency depreciation can also increase the household cost in terms of tuition fee, healthcare expenses and transportation expenses. This may increase economic inequality and strain on the low- and middle-income families.

Policy Measures and Exchange rate management.

The government agencies and the Central Bank of Nigeria have employed diverse policies to control the effects of the exchange rates. These include:

 Foreign Exchange Interventions: CBN can either sell or purchase USD in order to stabilize the Naira.

 Multiple Exchange rate Systems: There are situations when the government has applied official and parallel exchange rate to adjust the importing and exporting demand.

 Import Controls or Subsidies: To alleviate the stress on the Naira, the government can restrict those imports that are not vital or issue subsidies to essential goods.

 Monetary Policies: Changes in interest rates and liquidity differences have the potential to affect the demand of foreign currency and value of Naira.

Difficulty in the Management of the Exchange Rates.

Irrespective of these efforts, the exchange rate in Nigeria is an issue that is difficult to control because of the following reasons:

 Overdependence on the export of oil that can be impacted by changes in world prices.

 Strong demand of the export foreign currencies and repayment of external debts.

 Parallel market activities and speculation which have the potential of destabilizing the official exchange rate.

 International financial crisis and inflation.

The Way Forward

To have sustainable economic growth, Nigeria must have a stable system of exchange rate. Key strategies include:

 Russia should diversify the Economy: The inflows of foreign currencies can be fixed by diversifying the Economy by encouraging agricultural production, manufacturing and service.

 Enhancing Competitiveness in Exports: Local industries have to be supported and non-oil exports increased to improve foreign reserves.

 Increasing the Monetary Policy: The CBN should have transparent and consistent policies that will increase investor confidence.

 Enhancing Financial Markets: A properly managed foreign exchange market is able to decrease volatility and prevent speculation.

The effects of the exchange rates on the economy of Nigeria are far-reaching as they affect the trade, inflation, investment, government revenue, and the welfare of the household. Although the weaker Naira is likely to stimulate exports, it will raise the cost of imports and living costs. On the other hand, an appreciating Naira is able to lower the inflation, but can influence the export competitiveness.

To make sure that the economy of Nigeria is stable in relation to the currency fluctuations and other economical pressures of the world, it is necessary to have a balanced exchange rate policy, diversification and better management of the monetary system. To the citizens, the impacts of the exchange rates are critical in the planning of household budgets, making of business and other economic activities that define the future of the nation.

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