The impact of a depreciating exchange rate

20 years ago the value of the Nigerian Naira was trading at N126 to $1 today the the Naira is now trading at N1626 to $1. That is a depreciation of around 1200%. The Naira depreciated steadily over the last 20 years but suddenly the depreciation accelerated in early 2023. The exchange rate of the Naira and the US Dollar is shown in the diagram.

This sudden fall in 2023 occurred when the Nigerian government relaxed longstanding foreign exchange restrictions which caused holders of Naira to sell them and buy Dollars. The aim of ending the restrictions was to make it easier for Nigerian businesses to access foreign exchange but the depreciation of the Naira has made foreign exchange much more expensive. 

One of Nigeria’s long-term currency problems is its reliance on oil exports to earn foreign exchange. The country has seen a decline in oil revenues over the last 5 years which has reduced its export revenues and the demand for Naira has fallen causing the currency to depreciate. The combination of removing currency controls, and the decline in export revenues and the subsequent depreciation of the Naira has made the currency unstable. This instability makes it attractive to speculators because of the short-term gains they can make from buying and selling the Naira which in turn makes the currency even more unstable. 

Source trading economics: https://tradingeconomics.com

An unstable, depreciating currency has a significant impact on the wider Nigerian economy. As the Naira depreciates it makes imports increasingly expensive. Food price inflation is running at 40% in Nigeria partly caused by the rising cost of imported staples such as wheat and maize. This is a significant problem for low-income households that spend a high proportion of their income on basic food. The depreciating Naira is also a problem for businesses trying to import capital goods and this has a negative impact on investment in the country. 

The depreciating Naira should benefit Nigeria’s exporters who see their goods become cheaper in overseas markets. The problem is that 90% of Nigeria’s exports are oil and gas which has price inelastic demand. When the price of oil and gas decreases due to a depreciating Naira Nigeria will see little benefit in terms of rising oil and gas export revenues. 

The government has responded to the depreciating Naira by increasing interest rates to increase demand and decrease the supply of the currency. From 2012 to 2022 to bank base rate was around 12 to 13% but it now stands at 27% with all the costs borrowers have to incur and no sign yet this has stopped the Naira from depreciating.

Some possible questions to discuss with a class

1. What is an exchange rate?

2. What does a depreciation in the value of the Nigerian Naira against the US Dollar mean? 

3. Why has the value of the Naira depreciated against the US Dollar?

4. Discuss the consequences of a depreciation of the value of the Naira against the US Dollar. 

Aim of the blog

On the Economics site, we publish an economics blog every two weeks with the aim of covering the most up-to-date economic issues that are interesting to teachers and students. Each blog is written to make it accessible to IB students so they can make links between the topics they cover in the course and real-world economic events. The blogs are then developed into IB Paper 1, 2 and 3 style examination questions. 

The following links are blog posts we have published in the last few months.