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Thursday, 16 June 2016

DEVALUATION/ FLOATING EXCHANGE RATES IN LAYMAN'S LANGUAGE. By Abubakar Usman Almajiri.

DEVALUATION/ FLOATING EXCHANGE RATES IN LAYMAN'S LANGUAGE.
  
By Abubakar Usman Almajiri

   OPINION  

Numerous friends have in-boxed, phoned and inquired  that I help them understand the issue of devaluation. There may be others who may need help on that. Please find below an itemized attempt by me at explaining it.


A trader changes dollars with naira at a currency exchange store in Lagos...A trader changes dollars with naira at a currency exchange store in Lagos February 12, 2015. Electronic trading in Nigeria's naira was halted for the second day running on Thursday as the currency of Africa's biggest economy continued to crumple due to weak oil prices and escalating tension over this week's delayed election. REUTERS/Joe Penney (NIGERIA - Tags: POLITICS ELECTIONS BUSINESS)
A currency trader in Nigeria, which has bowed to market pressure
 to devalue the naira, counts notes © Reuters
I have summarised it in plain language and think I have over-simplified this, but it can still be understood in the small piece below:

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                             CONSIDER THIS ILLUSTRATION FIRST 

  Let us say machines and all implements for a plant for manufacture of batteries or fertilizer is $100,000 from USA. Lets assume a dollar is N197. That means you will need N197,000,000 to erect the company. Lets say foreign operators are paid $10,000 monthly. that will be N1,970,000 a month.   If the dollar should be N500, the same plant and implements will cost N50,000,000 and the same foreign operators will earn  N5,000,000. The higher the dollar the higher the Naira cost.
 
  Now how about lower rates? Lets say our government is able to fix and support  a N1 to $1?! The same plant will cost just N100,000 and the foreign operators will be paid only N10,000. This means that thousands of Nigerians can afford to go abroad and purchase many industries and technologies and  machines and can afford to hire foreign experts to do the work of technology transfer without any bilatralism.  

Imagine what that can do to unemployment, economic growth, taxes to government, VAT, infrastructure development and so on. 

1. There is Fiscal Policy and Monetary Policy. Both are tools used to influence a nations economic activity. Fiscal policy has to do with the the Government executive and legistlature. Monetary policy has to do with Central banks and includes interest rates, supply of money amon others, and Devaluation issues falls under the monetary policy.


   2. As a matter of monetary policy, CBN in veiled liaison with government, sets and implements foreign exchange policy. This is a policy that governs how a country's currency exchange  rate with others. 
   3. There are basically two broad choices of Foreign Exchange policies (Forex Policies)
   a) Fixed exchange rate policy
  b) Floating exchange rate policy.


   4. Fixed Exchange rate policy is a system by which the CBN sets a rate by which the currency exchanged to the dollar or any other currency. Emphasis is on the dollar because must currencies usually convert to dollar first before relating to respective currency. 


  5. Floating Exchange rate on the other hand is a system by which you dont fix or set or peg that rate of exchange between your currency and others. You allow market forces other known as demand and supply to determine the rate to exchange your currency. ie if your currency is demanded more by another currency, it becomes scarce and more expensive in relation to that currency. If your currency demands less of the other currency, your currency becomes not scarce and cheap for the other currency.


   6. Each of the policies is allowed to be practiced without any hindrance. There is rarely any of the developed countries that has not  practiced Fixed exchange rate system before situation changed for them to use a floating system. So each of them is useful but depending on the circumstances of you country.


    7. Each of the policy has its problem sides which are remedied through other economic and rational approaches. 


  8. If you choose to Fix your currency exchange rate, you will have to support the currency with your foreign reserve which is in your countries current account.  A country's current accounts are with the IMF and shows the sum of your total earnings in dollar on one side and total expenses on the other side. The earnings come from trade (sales) between your country and other countries or other sources like loans, grants, payments by diaspora to dependents back home and so on.  Expenses comes from similar things but in outflows. At the end of a period, the balance between the income and the expenditure indicates balance of payment and balance of trade. i will not discuss the here. But you should know that the balance can be favorable or adverse. The adversity can be reduced through cutting of imports and boosting of exports. You can decide to ban some imports as a way of reducing them but at the peril of you citizens who need it. you can also start local production and then exporting them too. That requires other details.


   9. If you choose Floating Exchange policy, you are allowing your currency to compete with others and find a value for itself. For a country like Nigeria whose import is by far more than exports, Floating the Naira against the dollar means Naira will be from N500 to 1000 or more even up to N5000 or more to a dollar any time soon. If that happens, for every product you have to buy from abroad, each dollar multiplies by the floating rate.


    10. Implications. Nigeria is not industrialised. and we urgently want to industrialise.  lets say machines for a plant for manufacture of batteries is $100,000 and a dollar is N197 that means you will need N197,000,000 to erect the company. Lets say foreign operators are paid $10,000 monthly. that will be N1,970,000. If the dollar should N500, the plant will cost N50,000,000 and the foreign operators will earn  N5,000,000. The higher the dollar the higher the Naira cost. Now how about lower rates? Lets say our governmnet is able to fix and support  a $1 to N1?! The plant will cost us N100,000 and the foreign operators will be paid only N10,000. This means that Nigerians can afford to go abroad and purchase any industry, the machines and can afford to hire foreign experts to do the work of technology transfer without any bilatralism. How many industries do you think will emerge over night? And with government careful assistance we can get strong within a short time. Thats how good finance policies changes the economy like magic. 


  11. Epilogue: It is when local industrialization has reached an very strong level and ready to export that you change the policy to devaluation. Devaluation reduces the harshness of your fixed currency by making you products cheap to foreign parties so that they can afford your products  and you can sell well like china is selling today. You dont need the foreign experts now and they will not like you because you currency is not strong enough to keep them around. And they will go whilst your now fully trained people takeover. The same thing China did. The more you devalue, the more you sell your products and it will reach an extent when foreign powers will begin to beg or pressure you to revalue as they do China today. You cant afford to float your currency even at this stage unless you are sure you can withstand it or the real value of you currency can withstand it.


   12. Conclusively, as we devaluate or float our currencies, the beneficiary  is certainly not Nigeria or Nigerians but the developed countries who will find our oil extremely cheap and cost-less whilst we find their products extremely expensive. That is the main reason why IMF always goes north pole/south pole to see us devalute.   While they ask us to devalue or float, the ask china to overvalue. In our case, oil, which is what they require and which is non-competitive is bought almost free. But Chinas's industrial products which compete with their merchandise around the world and even in their countries will be too expensive and loose if China revalues its currency. 
     

Abubakar Usman Almajiri, who writes from Kaduna, is a social and public commentator.

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