Understanding Devaluation: A Primer

Post Summary

Devaluation is when a country lowers the value of its currency to boost its economy and make its products cheaper for others to buy. This can also make things from other countries more expensive at home.

Have you ever wondered what “devaluation” means? This Remitly guide explains how changes in the value of a currency can affect you. When a currency loses value, it matters a great deal to anyone sending money abroad.

What Is Devaluation?

Devaluation happens when a country’s government or central bank intentionally lowers the value of its currency relative to foreign currencies. In other words, a country’s leaders decide to make its money worth less compared to money from other nations.

This policy tool can affect everything from international trade to your personal remittances. Why? Because when a currency undergoes devaluation, it purchases fewer goods and services abroad.

Why Do Countries Devalue Their Own Currency?

Countries may decide to devalue their currency for several reasons:

  • Boosting Exports: By making their goods cheaper on the global market, they can sell more abroad.
  • Reducing Trade Deficits: Cheaper exports can mean more sales overseas, which can help balance a country’s trade.
  • Debt Management: Countries with debt that’s repaid in foreign currencies find it easier to do so when their own currency is less valuable.

How Devaluation Affects You

If you’re sending money to your family in another country, devaluation can be a double-edged sword:

  • You might get more value for your money if the currency in the receiving country has been devalued.
  • However, your family might find that prices locally have increased, especially for imported goods, which can diminish the real value of the money you send.

Imagine that you’re sending money from the United Kingdom to Nigeria. If you’re sending money from a country with a stronger currency, such as the British pound, you might notice you can send more money when converted to your home country’s currency. However, this doesn’t always mean more buying power. That’s because your relatives back in Nigeria need more naira to buy ordinary items.

The effect of devaluation also extends beyond the country’s borders. Here’s an example, looking at monetary policy in Nigeria.

Case Study: The Nigerian Naira

What’s happening with the Nigerian Naira? The Naira has been through quite a journey, especially recently. Devaluation has hit the Naira hard.

Why Devalue the Naira?

The Central Bank of Nigeria (CBN), based in the capital city of Lagos, has occasionally devalued the Naira. This means they officially reduce its value compared to other currencies, like the US dollar.
They hope to boost the Nigerian economy by making exported goods cheaper and more attractive to foreign buyers. This strategy can stir up demand and spark economic growth.

How Does This Affect Nigerians?

When the Naira loses value, it’s a mixed bag. For companies in Nigeria that sell things abroad, it could mean more sales. But it also means that importing goods from other countries becomes more expensive.

For everyday Nigerians, this could lead to increased prices for things they buy regularly.

Basically, when a currency is devalued, it can create economic pressure and shortages of essential goods inside the country. It can make it harder to budget, to save, invest, and even to pay taxes.

Devaluation in Action

Last year, the exchange rate in the official market saw the Naira get weaker compared to the dollar.

Meanwhile, over in the parallel market (that’s where currencies are traded unofficially), the rates were even lower, showing just how pressured the Naira really is.

What’s the IMF and World Bank’s Role?

The International Monetary Fund (IMF) and the World Bank often step in to offer advice or financial help when countries like Nigeria face economic challenges. They work with the CBN and Nigerian government, including Bola Tinubu, the current president of the West African nation.
Their strategies include managing interest rates and subsidies to control inflation and stimulate economic activities.

Economists from institutions like the IMF and the World Bank are keeping a close eye on Nigerian economic changes. They analyze things like inflows of foreign currency and how much liquidity (or available cash) is in the Nigerian economy.

Looking Ahead: Rebounds and Growth

Despite the challenges, there’s hope that the Naira might rebound. If the CBN’s strategies work, and with support from foreign investors attracted by cheaper Nigerian goods, there could be signs of recovery and economic growth. This would mean better stability for the Naira in the forex (foreign exchange) markets and potentially more robust economic conditions in Nigeria.

Why Naira Devaluation Matters

The fluctuations of the Naira are crucial for international businesses, investors, and anyone interested in the dynamics of global financial markets.

The value of a currency like the Naira can influence everything from market rates in the FMDQ to the price of imports that might end up on shelves in South Africa or America.

10 More Global Examples of Currency Devaluation

Nigeria isn’t the only country to experience devaluation.

Over the past 30 years, several countries have intentionally devalued their currency to manage economic challenges. These include Asian, African, and Latin American nations.

  1. Argentina (2002) — Unpegged the peso from the U.S. dollar during a severe economic crisis.
  2. Zimbabwe (2009) — Abandoned its currency amidst hyperinflation, effectively rendering it worthless.
  3. Venezuela (2013-2020) — Experienced ongoing devaluation of the Bolivar because of hyperinflation and economic policies.
  4. Egypt (2016) — Devalued its currency, the Egyptian pound, as part of an IMF loan agreement to overhaul its economy.
  5. Turkey (2018) — The lira plummeted amidst economic turmoil and political tensions with the U.S.
  6. India (1991) — Devalued the rupee during a balance of payments crisis.
  7. China (1994, 2005, 2015) — Strategically devalued the Chinese yuan at key points to boost export competitiveness.
  8. Brazil (1999) — Moved from a fixed to a floating exchange rate regime during a financial crisis.
  9. Malaysia (1997) — Let the ringgit depreciate during the Asian Financial Crisis.
  10. Mexico (1994) — Devalued the peso during the “Tequila Crisis” to stabilize its economy.

How the Foreign Exchange Market Works

The foreign exchange market, or Forex for short, is like a giant global shop where countries buy and sell their money. Imagine you’re in New York, and you have dollars, but you need yen because you’re going to Japan. You can go to this market to exchange your dollars for yen. It’s not just people traveling who use it, however. Big businesses and banks swap huge amounts of money every day to do business in other countries or invest.

In this market, the price of money—how many Japanese yen you can get for your American dollars, for example—changes all the time, just like the prices of things in a store go up and down. The official exchange rate between two currencies changes daily, in some cases. The cost of wire transfers and other money transfers can be affected by that, though you can get the total cost by looking at fees.

Understanding this market’s fundamentals helps businesses and countries make better decisions about when to buy or sell different types of money. The foreign exchange market helps keep money moving around the world.

Devaluation, Global Economics, and Currencies: Frequently Asked Questions

What is depreciation?
Depreciation is when the value of a country’s currency goes down compared to others. This differs from devaluation because it happens due to market forces, not because the government decided to change the value.

What is revaluation?
Revaluation is the opposite of devaluation. It happens when a country’s government decides to increase the value of its domestic currency against foreign currencies. This can make imports cheaper but might hurt the country’s exports.

Why do countries fix their exchange rates?
Some countries choose to fix their exchange rates, which means they set the value of their currency at a certain level against another currency, like the U.S. dollar or the Chinese yuan. This can make the value of its currency more predictable.

What is a currency war?
A currency war happens when several countries try to lower the value of their currencies at the same time. They want to make their exports cheaper, but it can lead to tensions between countries.

How does a weak currency affect a country’s economy?
If a country’s currency is weak, it can buy less from other countries, which makes imports pricier. However, it can also mean that the country’s exports are cheaper for others to buy, which can help to grow the country’s economy.

What does GDP mean?
GDP stands for Gross Domestic Product. It measures all the goods and services a country produces in a year. It’s used to show how big a country’s economy is and how it’s doing overall.

What is purchasing power?
Purchasing power means how much you can buy with a certain amount of money. If inflation is high, your money buys less, and your purchasing power goes down. When a currency is strong, you usually have more purchasing power.

How do tariffs impact the price of imports?
Tariffs are taxes that countries put on imported goods. This makes these goods more expensive to buy, which can protect domestic industries from foreign competition but also raise prices for consumers.

What is the current account?
The current account is part of a country’s balance of payments. It includes the trade balance (exports and imports of goods and services), net income from abroad, and net current transfers. It shows if a country is spending more money overseas than it is earning.

Why are financial markets important?
Financial markets allow people and companies to buy and sell securities like stocks and bonds, currencies, and commodities. They help determine the prices for these assets based on supply and demand.

How does currency value affect domestic goods?
The value of a country’s currency influences the cost of domestic goods. If the currency is strong, it can make raw materials and parts from other countries cheaper, lowering the cost to produce domestic goods. But if the currency is weak, those materials cost more, and it can drive up prices for goods made in the country.