The Guardian newspaper of August 24, 2020 had the front page headline titled “Naira Crashes 108 per cent against CFA,” by Geoff Iyatse. In a similar vein, one has read, or heard of other pronouncements, in the past that the naira depreciated by hundreds of percentage points.
The CFA is the currency used by the Franco-phone groups of countries in West Africa and Central Africa. It has a strong link to the French franc.
The reported crash of the naira relates to the West African CFA.
The important question is whether the naira actually crashed by 108 per cent. By “crashed,” the author meant that the naira depreciated, invariably brought about by the market forces of demand for and supply of foreign exchange under a flexible exchange rate system.
If the monetary authority/government had deliberately reduced the value of the Naira, then the currency would have been said to be devalued. However, the effects of depreciation/devaluation are the same.
For the purpose of enlightenment, this article will show that the naira did not crash or depreciate by 108 per cent and that it is not possible for a currency to depreciate by more than 100 per cent considering what the exchange rate is as a relative price. Depreciation by 100 per cent or more makes the currency useless, that is, it has no value in terms of foreign currency.
Generally, the nominal exchange rate, or simply exchange rate, is a relative price. It is the price of one currency in terms of another currency.
If we consider the naira and the US dollar, the current exchange rate in the foreign exchange market is about N385 to US$1, that is, N385 exchange for one US dollar. This is actually the dollar exchange rate as it shows the units of naira that can buy one US dollar.
From this exchange rate, we can obtain the naira exchange rate, which shows the units of dollar that exchange for N1 as US$1/N385. This gives us US$0.0026 or 0.26 cents.
What is clear then is that the exchange rate can be expressed in two ways: One, as the price of foreign currency in terms of the units of the local currency or two, as the price of local currency in terms of the units of a foreign currency. Both approaches yield the same implications.
In this regard, the Naira is said to depreciate when more of it is required to purchase a unit of dollar or less units of the dollar is required to purchase one naira. In both cases the naira loses value in terms of dollar.
Of note is that when we express the exchange rate in terms of the amount of dollars that exchange for the Naira, we can easily see the proportion by which the naira has depreciated or appreciated (reduced/increased) in terms of dollar.
The value of the naira is determined by how many units of dollar that exchanges for it. In the Nigerian foreign exchange market, the approach of units of naira per dollar is used. This approach tells us immediately by how much the price of international goods has risen/fallen relative to domestic prices.
We can calculate the rate of depreciation with either of the two definitions of exchange rate. But it is easier to understand the depreciation or appreciation (increase in the value of the currency) of the naira using the definition of CFA per naira.
In the report on the naira crash by 108 per cent over a five-year period, it was stated that the exchange rate moved from 33 kobo or N0.33 to CFA1 or N1 to CFA 3.03 in August 2015 to CFA 0.6888 to N 1.0 in August 2020.
This means that the value of the naira during the period, in terms of CFA, reduced from 3.03CFA in 2015 to 0.6888 CFA in August 2020.
In this case, the rate of depreciation/devaluation is simply the exchange rate in 2020 minus the exchange rate in 2015 divided by the exchange rate in 2015, that is, (0.6888 – 3.03) / 3.03 which equals -77.3 per cent.
If we calculate the depreciation with the units of naira per CFA, the rate of depreciation will be units of naira per CFA in 2020 minus units of CFA per naira in 2015 divided by the units of naira per CFA in 2020. The rate of depreciation would be the same: -77.3 per cent.
As depreciation/devaluation means loss of value for a national currency in terms of a foreign currency, it can easily be shown that as larger and larger quantities of naira are exchanged for one CFA, that is, continuous depreciation/devaluation of the Naira, its foreign exchange value also gradually reduces.
Consequently, the purchasing power of the naira in terms of imported goods and services becomes smaller and smaller. However, the cumulative depreciation/devaluation moves closer and closer to 100 percent, that is, in asymptotic manner. Assuming that the currency loses 100 per cent of its value, it then becomes useless. Thus, there cannot be depreciation of a currency by more than 100 percent.
* Obadan is a Professor of Economics and Chairman, Goldmark Education Academy, Benin City. He is also the former Director-General, National Centre for Economic Management and Administration, Ibadan, Nigeria. E-mail: firstname.lastname@example.org; Tel.: 08023250853