DEVALUATION OF CURRENCY

Devaluation may be defined as the reduction in the value of the country’s currency in terms of other currencies of the world. It can also be defined as a fall in the exchange value of a country’s currency in relation to the currencies of other countries.

Effects of devaluation of currency

Exports become cheaper: Devaluation of currency makes exports cheaper as the prices of goods produced locally fall.
Imports become expensive: When a country devalued her currency, her citizens spend more in purchasing of commodities from other countries.
Reduction in imports: It become more expensive to import goods and services into a country that devalued its currency. Fewer goods and services are therefore imported.
Increase in exports: There will be an increased to export goods and services tendency when a country devalued its currency. Devaluation encourages people to export because of its cheapness.
Balance of payment improvements: Improvement on balance of payments is achieved because of reduction in imports and an increase in exports.
Employment opportunities: Devaluation causes an increase in the number of industries and consequently creates more jobs for people.
Increase in number of industries: As a result of devaluation, exports is encouraged and become cheaper and this leads to expansion in the number of industries.

Conditions in which Devaluation can Improve a Country’s Balance of Payments

Devaluation will improve the balance of payment position of a country under the following conditions:

The elasticity of demand for imports must be elastic. Increase in prices of imports, as a result of devaluation will reduce the demand for import.
The country’s exports must have elastic demand in other countries.
Other nations must not devalue their own currencies.
For devaluation to be effective, there must be no increase in wages and other incomes.

Mathematical Approach to Currency Devaluation and Exchange Rate

Exchange rate is the rate at which countries exchange their currencies or the rate at which a country decides to buy or sell her currency in relation to other currencies of the world.

Example 1

Assuming that Nigeria is willing to buy or sell cocoa at N400.00 per ton and the U.S.A. is willing to buy or sell at $50.00, then the value of the two currencies can be fixed as: N400.00 = $50.00

N8.00 = $1.00

The exchange rate is therefore $1.00 to N8.00.

Example 2

Let us assume that the initial exchange rate of the Nigerian naira and the US dollar is N1.00 = $5.00.

A Nigerian importer is to purchase 60 computer systems at a cost of $40.00 each from the USA.

Total amount required to purchase the computer systems = (60 × $40.00) = $2,400.00

Since the exchange rate is N1.00 = $5.00 total amount of naira required:

$2,400.00 = 2,400.00/5 = N480.00

This means that a Nigerian importer would spend N480.00 to import the 60 computer systems to Nigeria.

If Nigeria devalues her currency by 100%, the new exchange rate would be N2.00 = $5.00 or N1.00 = $2.50.

The amount of money the Nigeria importer will have to spend will now be

$2,400.00 = 2,400.00/2.5 = N960.00

N960.00 would be required to import the same 60 computer systems.

Example 3

In year A, 80 naira exchanged for a dollar and later in year B, 130 naira exchanged for a dollar through the forces of demand and supply.

(a) State the effect of the above on the value of the dollar.

(b) How much, in naira, would be needed to purchase $50,000 dollar worth of a generator from the USA in year A?

(d)(i) Calculate the percentage change in the value of the naira between years A and B. (ii) From your calculation, state the effect on the value of the naira.

Solution

a) The value of the dollar appreciated.

b) In year A,

N80 × $50,000 = N4,000,000.00

N4,000,000.00 would be needed.

c) In year B,

N130 × $50,000 = $6,500,000.00

N6,500,000.00 would be needed.

(d)(i) Percentage change in the value of Naira

= N130 – N80 / N80 × 100

= 50/80 × 100/1 =62.5%

(ii) The value of Naira has depreciated.

Nigeria’s Balance of Payments

Nigeria’s balance of payment and foreign reserves have not been stable since its independence in 1960. At a time, surplus takes place, while at another period deficits occur and this has brought a lot of problems into the country.

During the oil boom of 1973 and 1974, for example Nigeria had a favourable balance of payments position with a reasonable surplus of N1276.8 million and N3102.2 million respectively as a result of rises in oil price. This period of oil boom did not last long for in 1978, the price of crude oil slumped as a result of the oil glut that took place in the international oil market. The oil glut reversed Nigeria’s balance of payments to a deficit of N1,293.6 million. This period was followed by balance of payments surplus between 1979 and 1980. The civilian administration which came in between 1981 and 1983, brought Nigeria’s balance of payments to a deficit. In an effort to control the balance of payment deficit, the government introduced several policies such as Economic Stabilisation, Structural Adjustment Programme (SAP), with Second-tier Foreign Exchange Market (SFEM) as its subsidiary.