Over the course of a day, the value of the Nigerian Naira (NGN) relative to the US dollar depreciated by 1.4% to N370.00/US$1.00 at the end of November 2018 . As at today, the exchange rate has appreciated to N365.00/US1.00. So why did this happen? This volatility could be linked to a currency shortage in the forex black market, as the central bank did not sell enough US dollars. (compared to the demand for the dollar)
A currency’s value is based on expectations of growth of a country’s economy. Factors such as inflation, deflation, monetary policy, the level of industrial activity, and the current account status of the country indicate the outlook concerning a country’s growth and by extension the value of its currency.
Need to Know
| Currency Volatility | The unpredictable movement of exchange rates in the global foreign exchange. |
| Currency depreciation | The loss of value of a country’s currency with respect to one or more foreign reference currencies |
Now let’s consider a scenario: In the future, how can we protect our cash against volatility if the value of the NGN to the US Dollar keeps depreciating for another 1 year? Here I would highlight a recommendation from the book,” The Top 10 investments for the next 10 years” by Jim Mellon and Al Chalabi that is helpful for protecting cash against volatility:
- Keep 3 months supply of spending money in notes
- Keep 6 months worth of cash in a bank account that pays interest. It doesn’t have to be a high interest yielding account
- Buy a major foreign currency as a long term hedge against the decline of your home currency (e.g the US Dollar)
Your home currency (in this case the NGN Naira) is key because it is the currency with which you will do majority of your transactions. As such you must hold a sufficient amount of it. A systematic allocation such as the one described above can help protecting against the volatility of currency. The rest of your funds outside the allocation described above should be invested wisely.
Key takeaways:
A. The presence of demand and supply in the forex market, means one currency would be perceived as MORE VALUABLE than another currency
B. Investors seek safety first with their cash ( safety against erosion of its value)
C. Consider a foreign currency, such as the US dollar, as a long term hedge
D. Be aware of the fundamentals i.e. future expectations concerning monetary policy, level of industrial productivity (growth), and other key macroeconomic indicators for both your home currency and any other currencies you chose to speculate on