Economic effect of a devaluation of the currency

The Nigerian Naira which over the years have been heavily battered, was for the second time devalued yesterday by the Central Bank of Nigeria after its Monetary Policy Committee meeting, by N13.

This sees the Naira exchanging for N168 to the US dollar. However, financial analysts had long expected this process, after so much pressure no thanks to the continuous fall in the prices of crude oil.

But let's look at the effect of this exercise:

1. Exports cheaper. A devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports

2. Imports more expensive. A devaluation means imports will become more expensive. This will reduce demand for imports.

3. Increased AD. A devaluation could cause higher economic growth. Part of AD is (X-M) therefore higher exports and lower imports should increase AD (assuming demand is relatively elastic). Higher AD is likely to cause higher Real GDP and inflation.

4. Inflation is likely to occur because:

    *Imports are more expensive causing cost push inflation.
    *AD is increasing causing demand pull inflation
    *With exports becoming cheaper manufacturers may have less incentive to cut costs and become more efficient. Therefore over time, costs may increase.

5. Improvement in the current account. With exports more competitive and imports more expensive, we should see higher exports and lower imports, which will reduce the current account deficit.