THE IMPACT OF DEVALUATION OF NAIRA ON NIGERIA’S BALANCE OF PAYMENTS (AN ECONOMETRIC ANALYSIS)
The objective of this study is to access
the impact of devaluation of the naira on Nigeria’s balance of payment.
Before the dominance of the oil sector, particularly between 1960-1970,
the balance of payment was less erratic. However, since 1970, the
balance of payment has swunged at one time or the other from a position
of strength to that of the weakness with a decline in foreign exchange
earnings. This has been attributed to the global glut in the petroleum
industry and the relatively high expenditure on impact by Nigeria
because of work domestic supply capability.
The major finding of this study was
various exchange regime adopted by Nigeria government so far. A review
of the effect of the different exchange rate system reviews that the
fixed exchange rate system, which characterized the military regimes in
Nigeria resulted in over-valuation of the naira relative to other
currency and hence resulted in self distortion in macro economic
variables. The flexible exchange rate system, on the other hand, was
resorted to during the SAP to restore the real value of naira. At
present, the Dutch auction system is being used to determine the
exchange rate in Nigeria.
In an attempt to correct the serious
disequilibrium in the external sector of the economy, the control system
was replaced with a market based system with inception of SAP in June,
1986. The main achievement of the new system are the elimination of
payment arrears, the increase in domestic capacity utilization due to
the increase in the local source of raw materials, elimination of the
over-valuation of the naira exchange management.
However the problems of the dependence
on the oil sector for foreign earnings, continuous depreciation of the
naira and the attendant inflationary expectation are yet to be resolved
TABLE OF CONTENTS
1.0 Historical background of the study
1.2 Statement of the problems
1.3 Research objectives
1.4 Research hypothesis
1.5 Model specification
1.6 Significance of the study
1.7 Scope and limitation of the study
1.8 Sources of data collection
1.9 Organization of the study
CHAPTER TWO: LITERATURE REVIEW
2.0 An overview of devaluation of the naira on Nigeria’s Balance of Payment
2.1 Empirical evidence of devaluation on naira
2.2 Theoretical framework for devaluation of the naira
2.3 The implication of devaluation of the naira on Nigeria’s Balance of Payment
2.3.1 Reasons for devaluation
2.3.2 Short-run effect of devaluation of the naira on the Nigeria’s Balance of Payment (Influence of import Structure)
2.4 Exchange rate regimes in Nigeria economy
2.5 Exchange rate management before SAP 1980-June 1986
2.6 Management of exchange rate under SAP July 1986-1990
2.7 Appraisal of the exchange rate management
2.8 Trend and profile of Nigeria’s Balance of Payment
2.9 Approaches to Balance of Payment.
CHAPTER THREE: RESEARCH METHODOLOGY AND METHOD OF DATA COLLECTION
3.1 Sources and nature of data collection
3.2 Model specification and description of variables
3.3 Analysis of the technique
DATA ANALYSIS AND INTERPRETATION OF RESULT
4.1 Statement of hypothesis
4.2 Sources and nature of data
4.3 Specification of data
4.4 Data presentation
4.5 Model specification
4.6 Empirical result and interpretation of the regression results
4.7 Presentation of regression at a glance
SUMMARY, CONCLUSION AND POLICY RECOMMENDATIONS
5.0 Summary and conclusion
5.1 Major findings
5.2 Policy recommendation
1.0 BACKGROUND TO THE STUDY
Prior to 1958, when Nigeria exported
crude oil for the first time, Nigerian economy had relied on export of
cash crops for her foreign exchange. It was only in the early 1970’s
when oil boom of the mid 1970s and the resulting favourable balance of
payments position led to an era of liberal food import policy. Import
restrictions were lifted in some cases and import duties were either
abolished or reduced in others. The short spell of depression in the oil
market in the late 1970s gave rise to tightening of food import tariffs
and import prohibition, which was again relaxed as the oil market
situation improved the total government revenue to N98.2 billion (NNPC
publication, September 1978).
The period 1981-1986 was one of economic
depression and balance of payment crisis. Trade controls were
reintroduced to correct the severe distortion. Huge tariffs or outright
bans were imposed on most food imports. Export bans and duties were also
reviewed to address principally the domestic inflation problem.
Centralized marketing was reinforced to increase government revenue.
The 1986 budget introduced the trade
liberalization regime as a component of the structural adjustment
programme (SAP). The regime included abolition of the import licensing
system, reduction of import restrictions, modification of advance
payment of import duties, overhauling of custom and excise duty
schedules, establishment of tariff review board, allowance of
domiciliary accounts operation, abolition of export prohibition,
dissolution of commodity boards, and establishment of an export
development fund, guarantee scheme, insurance scheme and export
promotion zone. The main objectives of SAP include the following:
- To restructure and diversify the productive base of the economy in order to reduce dependence on the oil sector and imports.
- To achieve fiscal and monetary balance of payment viability over the period.
- To lesson the dominance of unproductive investment in the public
sector, improve the sector’s efficiency and enhance the growth potential
of the sector.
The main element of accomplishing the
objectives of SAP in Nigeria was the adoption of the realistic exchange
rate regime through the adoption of the second tier foreign market:
SFEM, FEM, IFMS Bureau de change etc.
The intention here was to remove the
over valuation of the naira through the market forces of demand and
supply to determine the realistic exchange rate of the naira.
Between 1975 and 1985 the naira was
considered to be over value. In fact the structural problems of foreign
exchange scarcity, liquidity problems, over invoicing of import can be
traced back to this over valuation. It was hoped that these structural
problem would be gotten rig if a realistic exchange rate could be
achieved so that incentives can be created for non-oil exports, capital
flow can be discouraged and most of all balance of payment can be
The deterioration of Nigeria’s balance
of payments since the late 1970’s has in one way or the other been
associated with the exchange rate. This has led to a number of heated
debates as to whether Nigeria should devalue her currency or not as
proposed by the International Monetary Fund (IMF). The arguments have
been based on the fact that the naira was over valued (Aboyade 1982).
The exchange rate represents the price
at which purchases and sales of foreign currency (or claims on it such
as cheques and promissory notes) take place. It is the price of one
currency in term of another currency. Within a minimum period of less
than two months, the naira has cascaded from 116 to 165 to a dollar in
the parallel market, losing 49 in the process. All steps taken so far to
firm up the naira, or at least stop the slide have, at best, remained
unsuccessful. However, the Central bank of Nigeria, explained that it
had deliberately allowed the Nigeria’s foreign exchange market to adjust
to the global shock in the oil market.
Foreign exchange resources are derived
and expended in the course of effecting economic transactions between
the residents of the country and the rest of the world. In this sense
there is a line between foreign exchange transaction and the balance of
While foreign exchange transaction
reflect cash flows arising from international operations, the balance of
payment looks at the actual operations, the balance of payment looks at
the actual movement of goods, services and changes in financial assets
and liabilities. When adjustment is made to cash flow statement arising
from International transaction in foreign exchange they are brought to
balance of payment standard. The state of foreign exchange reserves has
implication for the ability to finance temporary payment difficulties.
Since the down turn in oil export began in 1981, Nigeria’s external
trade transaction has been facing a lot of problems;
The recession which accompanied the
collapse of oil fortunes had considerably reduced activities in an
economy with a high import dependency ratio. Central Bank records
indicate that foreign exchange of inflow dropped from $26 billion in
1980 to $12 billion in 1984 and to low as $7 billion in 1986 (CBN
Economic and financial review 1987).
To further complicate the problem of
external trade, Nigeria accumulates huge foreign debts servicing burden
and worsened relation between the country and its traditional trade
creditors. The consequence of this is considerably reduced inflow of
The balance of payment problems of the
country in the late 1960s largely dictated the trade policies in the
1970s. The policies in the 1970s also sought to promote domestic
production and generate revenue for government expenditure. There was
considerable restriction and regulation of the trade sector before
liberalization (i.e. between 1970 and 1985). Import duties and tariffs
were quite high (as much as 70% in 1975) to discourage imports. There
were also quantitative restrictions on some food imports through import
licensing. On the other hand, the focus of export policy was on cash
crops (export crops), with the primary purpose being to raise revenue
and to moderate farmers’ returns and domestic food prices. Main export
policy instruments were export duties, sales taxes and centralized
marketing. Exchange rate was also administratively determined to ensure
cheap imports of raw materials for import-substituting local
Before the introduction of the
Structural adjustment Programme (SAP). The basic framework for foreign
exchange management was the exchange control act of 1962 which was
reinforced by the economic stabilization (Act of 1982). The pitfalls of
this exchange control led to its abandonment.
The SAP objectives include the
achievement of equilibrium in the balance of payment and fiscal
viability among others. Under the new dispensation, the framework for
foreign exchange market (FEM) was conceived as a mechanism for the
determination of an appropriate exchange rate for the naira in order to
reduce the pressure in foreign exchange resources and stabilize the
balance of payment.
Since the inception of the FEM system in
September, 1986, the naira has undergone substantial devaluation. This
research project aims at examining the implications of the devaluation
of the naira on the Nigeria balance of payment.
1.2 STATEMENT OF THE PROBLEM
The oil boom of the 1970’s brought with
it fundamental changes in Nigerian economy. The first is the
over-dependence of the economy on crude petroleum export as the main
foreign exchange earning and government revenue. By 1980 the oil sector
which accounted for 22% of the gross domestic product (GDP) provided 80%
of the government revenue and over 96% of export earning (CBN 1987).
Secondly, the competitiveness of the
agricultural sector in the international market was eroded by the over
-valued naira exchange rate, inadequate pricing policies, rural urban
migration and the neglect arising from so called oil syndrome.
Thirdly, the structure of the policy
incentives and control encouraged import-oriented production and
consumption pattern with little incentives for non-oil exports.
From about mid-1981, the world oil
market started to collapse and with the collapse an economic crisis
emerged in Nigeria. The result decline in oil export and price was
reflected in decline in foreign exchange receipt and government revenue.
Thus external reserves fall sharply and
debt mounted in the face of rising imports, balance of payment deficits
wideness and effort at containing the adverse development created some
other serious problems such a s economic depression, rising prices and
1.3 RESEARCH OBJECTIVES
The aim and objectives of this research is as follows:
- 1. To examine the effects of devaluation of the naira on Nigeria balance of payment position.
- 2. To consider the exchange rate
management in Nigeria and its effects on the balance of payments.
Particularly, before and under the structural adjustment programmes (SAP
- 3. To suggests way and means of improving the balance of payment and overall economic growth and development of the country.
1.4 RESEARCH HYPOTHESIS
Ho: There is no significant relationship between the devaluation of naira and economic growth of the country
H1: There is significant relationship between the devaluation of naira and the economic growth of the country.
Ho: There is no significant relationship between the devaluation of naira and the equilibrium balance of payment.
H1: There is significant relationship between the devaluation of naira and the equilibrium balance of payment.
Ho: There is no significant relationship between the exchange rate and economic growth.
H1: There is a significant relationship between the exchange rate and economic growth.
1.5 MODEL SPECIFICATION
The first and most important step an
econometrician has to take in attempting any study is to express the
relationship existing among the variables under discourse in
mathematical form. The developed estimating equation will be of
assistance to know how well the estimating equation actually describes
the relationship between the variables.
In the model specified below, we intend
to investigate the relationship between balance of payment, exchange
rate and economic growth of the Nigerian economy.
Y = b0 + b1X1 + b2X2 + b3X3 + b4X4 + µ
Y = real GDP
X1 = Inflation rate
X2 = Volume of exports
X3 = Volume of imports
X4 = Exchange rate
B1, B2, B3 and B4= coefficient of associated variables
µ = Stochastic error term
Y = b0 + b1 X1+ b2X2+ µ
Y = Balance of payment
X1 = Inflation rate
X2 = Exchange rate
Y= B0 + B1X + µ
Y = Gross Domestic Product
X = Exchange rate
1.6 SIGNIFICANCE OF THE STUDY
This study is important because it will
help the CBN to determine whether to continue operating the market
mechanism system with the overall economic objectives which it aims at
These objectives are meant to maintain a
healthy balance of payment position, determine an appropriate exchange
rate of the naira and price stability. This will help to achieve a
reasonable level of economic growth.
The objectives of the exchange rate policies as summarized by lirsch (1972) include.
- Adjustment process: The adjustment process whereby the regime
should help to promote a satisfactory working of the adjustment of
payment of imbalances.
- Promotion of the world trade, employment real income and economic
development. This means that exchange rate regime should help to support
elimination restrictions and maintenance of a multilateral system of
- Support appropriate economic and financial policies of countries
such as healthy balance of payment position, price stability, full
employment and a reasonable level of economic growth; therefore, if the
above objectives are not achieved, then there is no for the country to
continue with the operation of the market mechanism system of the
1.7 SCOPE AND LIMITATION OF THE STUDY
This research is limited to the balance
of payment and exchange rate management between 1983-2007. This study
therefore examined the exchange rate management in Nigeria and its
effects on the balance of payment within the period under review.
1.8 SOURCES OF DATA COLLECTION
The statistical data used for this
research will be an intensive library research. This include books,
relevant journals, newspapers, magazine, seminar papers, essential
secondary data collected from economic researches such as CBN
publications, Federal Office of Statistics (FOS), Financial and Economic
Review of the CBN.
1.9 ORGANIZATION OF THE STUDY
This research is divided into five chapters.
Chapter one is the historical
background, general introduction, the statement of problems, objectives
of the study, research hypothesis, scope and limitation; sources of
data, organization of the study are examined in this chapter.
Chapter two is the literature review
which includes the theoretical and empherical review of different
approaches to balance of payments and devaluation.
Chapter three provides the research
methodology and method of data collection. This analysis will be based
on secondary data obtain from CBN Economic and Financial Review,
publications, textbooks and journals.
Chapter four contains the method of data analysis, data analysis and interpretations.
Chapter five being the last chapters contains the summary, findings, policy recommendation and conclusions.