Photo Credit: Nairametrics.com
As your friend who really likes you, I want to give you a gift. You have an option to choose between the Nigerian Naira and the U.S Dollars. Which one will you choose?
Most of us will choose U.S Dollars of course. The reason is obvious:
On 11th March 2020, the foreign exchange (FX) rate of the Nigerian Naira was N367 for each $1 at the parallel market (operated by the Bureau De Change or BDC). By 23rd April 2020, the Naira became N416 per $1. This means the Naira is depreciating, i.e. the value of your Naira when compared to other currencies is decreasing.
A typical demonstration is this:
Let’s assume that in January 2020, you made plans for your yearly travel. You have planned to travel from Abuja to New York in the last week of April 2020 using Emirates. The price of your flight ticket according to Emirates website is $1,800 (to and fro). As at January 2020, the FX rate at the parallel market was N360/$1. Hence, you will need N648,000 to purchase your ticket. Good. You currently have N500,000 so you will save up an extra N148,000 from your salary before April. By April, you will purchase your flight ticket and leave. Great plan!
But before the last week of April 2020, naira devaluation occurs. The FX rate is now N416/$1. You now need a whooping sum of N748,800 to pay for your flight ticket. So you need to save up an extra N100,800 to pay for the ticket. It may take another two months for you to save this up. What if naira weakens further to N500/$1 in the next two months? This means you would become poorer, and perhaps, you will have to cancel your travel plans until further notice.
That is the consequence of having a weak currency. But this is not the only consequence. Manufacturers often need U.S dollars to import raw materials which they eventually process into finished goods. Naira devaluation implies that they will need more naira which will be converted to dollars, to purchase those raw materials. These manufacturers pass the extra cost to final consumers by increasing the cost of the finished goods. Ultimately, this would lead to an increase in the prices of products in the market (i.e. inflation), and will affect consumers who buy these products.
Naira devaluation causes an increase in prices of goods and services sold in dollars (such as the flight ticket). It also leads to a hike in inflation. Thus, Naira devaluation decreases your purchasing power and therefore, makes you poorer.
For this reason, you must begin to think about how to protect or hedge your funds (in Naira or any other currency) against devaluation. The U.S dollar is one of the strongest currencies across the globe. To protect your assets, you should diversify by investing in dollar-denominated fixed income instruments or stocks.
Still craving? Watch out for next week’s article on “How to hedge your funds against devaluation.”
Article Credit: Hephzber Ifunanya Nwoka (Investment Banker)