MUST READ: Factors that affects Exchange rates in Nigeria

 

2023 has proven to be a very challenging year for lots of Nigerians. From challenges such as

the scarcity of the naira to the issue of subsidy removal in fuel, one of the most prevalent challenges we have faced has to do with the exchange rate.

Being a country that imports most of what we use, the exchange rate has affected everyone in one way or another. Businessmen have hiked the price of their goods, and food prices have gone up, amongst other things.

The exchange rate has shown us shege. We have seen the naira crash to as much as 1,100 against the dollar in October. This blog post covers some of the reasons that cause the naira to fall

What is the exchange rate?

The exchange rate of the naira is simply the price of foreign currency. Given that the dominant foreign currency in Nigeria, as it is in many other countries, is the US dollar, the exchange rate in Nigeria usually refers to the price of the US dollar. Every other currency’s exchange rate, such as the exchange rate of the British Pound Sterling, derives from the price of the US Dollar.

WHAT DETERMINES THE EXCHANGE RATE IN NIGERIA?

The price of the dollar in Nigeria is determined by a number of factors, including:

Demand and supply:

This is the most basic reason any student of economics can think of. Remember in secondary school when we had to plot graphs showing demand and supply?

 In economics, a law states that the price of a good or service is determined by the interaction of supply and demand.

For example, during the scarcity of Naira, there was a high demand for the currency, and the POS people had to increase their withdrawal charge. As high as #500 to withdraw #2000. 

In summary, the price of the US dollar in Nigeria is determined by the quantity of US dollars that flow into the country as well as the quantity of US dollars demanded by Nigerians.

Interest rates:

 Interest rates are yet another significant element influencing the value of the dollar. Higher interest rates in Nigeria attract international investors, which may cause the value of the naira to appreciate in relation to the US dollar.

Let's me it down with an example:

Suppose the interest rate in Nigeria is 10%, while the interest rate in the United States is 2%. An international investor has a choice: they can invest their money in a Nigerian savings account and earn 10% interest, or they can invest in a US savings account and earn only 2% interest.

Given the higher interest rate in Nigeria, many investors may choose to invest here. To do so, they need to exchange their US dollars for Nigerian naira to make the investment. This increased demand for the naira (Nigerian currency) would lead to an appreciation of the naira's value relative to the US dollar. In other words, you would get more US dollars in exchange for a certain amount of naira.

Conversely, if interest rates were higher in the United States compared to Nigeria, international investors might prefer to invest in the US, leading to a decrease in the value of the naira relative to the US dollar. This demonstrates how interest rates can have a direct impact on currency exchange rates and, by extension, the value of a country's currency.

Inflation: 

The rate at which the cost of goods and services is increasing is known as inflation. A devaluation of the naira against the dollar might occur as a result of investors finding the naira less appealing due to higher inflation in Nigeria.

Government intervention:

 The Nigerian government has the ability to manipulate the foreign exchange market in order to affect the value of the dollar. To stabilize the naira or encourage economic growth, for instance, the government can buy or sell dollars.

Other factors that can affect Exchange rates are:

Political instability: 

Nigeria's political unrest may cause a decrease in international trust and investment, which may cause the naira's value to depreciate against the US dollar.

Economic health:

The price of the dollar may also be impacted by the general state of the Nigerian economy. Foreign investment is more likely to be drawn to a robust economy with low unemployment and rapid economic growth, which could result in the naira strengthening against the dollar.

Speculation: 

Speculators who predict that the US dollar will appreciate more against the Nigerian naira will sell their naira and purchase dollars. As a result, the naira is under pressure, and the demand for dollars rises. 

The naira loses value when additional speculators follow suit, causing the exchange rate to fluctuate. Put more simply, you receive less US dollars for the same amount of Naira. By affecting currency rates and starting a self-fulfilling loop based on their expectations, speculators' actions have the potential to depreciate the naira.

It is important to note that the price of the dollar in Nigeria is constantly fluctuating due to the interaction of all of these factors.