When the Central Bank of Nigeria, CBN, recently authorised financial institutions across the country to sell foreign exchange freely at market-determined rates, many people got confused, mistaking the floating of the naira for the devaluation of it.
In this article, you will be exposed to the difference between these two approaches and explore their implications for the Nigerian economy.
First, what does floating the naira mean?
Floating a currency, also known as a flexible exchange rate, occurs when the value of a currency is determined by market forces such as supply and demand. In a floating exchange rate regime, the Nigerian Naira’s value would fluctuate freely in response to economic conditions and market dynamics. Factors such as trade flows, capital flows, interest rate differentials, and investor sentiment would influence the exchange rate.
Advantages of Floating
Automatic adjustment: A floating currency allows for automatic adjustment to changes in the economy. If Nigeria’s economy becomes more competitive, the Naira’s value may appreciate, making exports relatively more expensive and imports cheaper. This adjustment can help correct trade imbalances and stimulate economic growth.
Monetary policy independence: With a floating currency, Nigeria can pursue an independent monetary policy. The central bank can adjust interest rates and regulate the money supply to control inflation and stabilize the economy, without being constrained by the need to maintain a fixed exchange rate.
Devaluation
Devaluation, on the other hand, refers to a deliberate downward adjustment in the value of a country’s currency within a fixed or semi-fixed exchange rate system. In this scenario, the government or central bank intervenes in the foreign exchange market to reduce the value of the currency.
Reasons for Devaluation
Boosting exports: Devaluation can make Nigerian exports cheaper in international markets, potentially increasing demand for goods and services produced in the country. This can help stimulate export-oriented industries and improve the balance of trade.
Correcting trade imbalances: If Nigeria consistently experiences a trade deficit (imports exceed exports), devaluation can make imports more expensive and exports more competitive, thus helping to rebalance trade flows.
Upshot
Floating a currency and devaluing it are distinct approaches to currency management.
Floating allows the currency’s value to be determined by market forces, while devaluation involves a deliberate downward adjustment in a fixed or semi-fixed exchange rate system. Each approach has its advantages and implications for an economy. In the case of Nigeria, as the Nigerian Naira continues to navigate its foreign exchange policy, policymakers must carefully assess the economic conditions and determine the most suitable strategy to achieve stability, competitiveness, and sustainable economic growth.
