Devaluation refers to the reduction in the official value of a currency in relation to other currencies.
Nigerian Naira relative to US Dollar is currently $1=N416.21 (Official rate)
Nigerian Naira relative to US Dollar is currently $1= N570 (Parallel market)
What a huge gap between both markets! This is a major rationale for arbitrage (purchase of a commodity/currency at a lower price in one market to sell at a higher price in another market).
The Central Bank of Nigeria (CBN) supports the official rate at the current level with the external reserves (a country’s assets held in foreign currencies), as a result we have experienced a significant decline in the reserve in recent time (from $41.82bn about three months ago to current level of $40.01bn). A fall in reserves puts pressure on foreign exchange rate and raises concerns about the country’s ability to fulfill its foreign currency financial obligations.
So, what’s fueling the current depreciation of the currency in the parallel market? Demand or Speculation?
The pent-up demand for the dollar relative to the reserve is a major reason for speculation by investors. Investors continue to speculate on the fair value of the naira and take position on that basis. Also, the ban on sale of foreign exchange by the CBN to BDC (Bureau de Change) operators which reduced supply also had an effect on the depreciation of the naira.
There are three major sources of inflows into the Nigerian external reserves:
- Sale of Crude Oil: Due to the pandemic we saw a decline in global oil demand, and this sure impacted the price of crude. However, in recent time we have seen an upward movement in crude oil prices due to increased global demand. With the country’s over reliance on crude oil as the main source of income, whatever threatens global crude oil price affects us badly. Nigeria sure benefits from rising oil prices, but benefits more from higher oil production, production has been influenced in recent time by vandalism, smuggling, asset break down et al.
- Remittances: Inflow from Nigerians abroad to families and friends suffered a decline as well due to the pandemic, as some might have suffered job losses. In spite of the CBN Naira -for- Dollar Scheme, the figures remain low.
- FDI & FPI Investment: Foreign Direct Investment and Foreign Portfolio Investments have trimmed as well basically due to macro-economic concerns including foreign exchange illiquidity, insecurity, et al. The economic environment has not been conducive for such inflows.
How does this impact you?
Firstly, if you have obligations in foreign currency e.g have a child schooling abroad, import goods from abroad for sale, purchase imported goods (who does not?) this will affect you. You will need more naira to pay for the same fees/ goods.
Secondly, companies that import raw materials to produce will have to spend more naira to get dollars to purchase their raw materials and other input for production, they go on to produce and factor this into the price of goods, they will pass on these costs to you as consumers.
How well are you preparing for this future?
If you have future obligations in dollar (other international currencies), you should start planning by purchasing and investing your dollar. There are several investing options available including Dollar Mutual Funds, Dollar Fixed Income, Purchase of Eurobonds et al.
For investment options on Dollar investing be sure to reach out to us at Investment One Financial Services.
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