THE IMPACT OF DEVALUATION OF NAIRA ON NIGERIA’S BALANCE OF PAYMENTS (AN ECONOMETRIC ANALYSIS)

ABSTRACT

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

CHAPTER ONE

1.0     Historical background of the study

1.1     Introduction                  

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       

References           

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. 

References

CHAPTER THREE: RESEARCH METHODOLOGY AND METHOD OF DATA COLLECTION

3.0     Introduction

3.1     Sources and nature of data collection

3.2     Model specification and description of variables

3.3     Analysis of the technique

References

CHAPTER FOUR:

DATA ANALYSIS AND INTERPRETATION OF RESULT

4.0      Introduction       

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

CHAPTER FIVE:

SUMMARY, CONCLUSION AND POLICY RECOMMENDATIONS

5.0     Summary and conclusion       

5.1     Major findings     

5.2     Policy recommendation

Bibliography        

Appendix

CHAPTER ONE

INTRODUCTION

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:

1. To restructure and diversify the productive base of the economy in order to reduce dependence on the oil sector and imports.
2. To achieve fiscal and monetary balance of payment viability over the period.
3. 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 solved.

1.1    INTRODUCTION

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 payments.

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 foreign capital.

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 manufacturing industries.

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 unemployment.

1.3    RESEARCH OBJECTIVES

The aim and objectives of this research is as follows:

1. 1.          To examine the effects of devaluation of the naira on Nigeria balance of payment position.
2. 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 period).
3. 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

H_o:    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.

H_o:    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.

H_o:    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.

MODEL ONE

Y = b₀ + b₁X₁ + b₂X₂ + b₃X₃ + b₄X₄ + µ

Where;

        Y              =      real GDP

        X₁                   =      Inflation rate

        X₂             =      Volume of exports     

        X₃             =      Volume of imports

        X₄             =      Exchange rate

        B_1, B_2, B₃  and B₄= coefficient of associated variables

        µ              =      Stochastic error term

MODEL TWO

Y = b₀ + b₁ X₁+ b₂X₂+ µ

Where;

Y      = Balance of payment

X₁       = Inflation rate

X₂     = Exchange rate

MODEL THREE

 Y= B₀ + B₁X + µ

Where;

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 achieving.

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.

1. Adjustment process:  The adjustment process whereby the regime should help to promote a satisfactory working of the adjustment of payment of imbalances.
2. 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 payment.
3. 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 exchange rate.

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.