ABSTRACT
This study evaluated the effect of exchange rate devaluation on balance of payment in Nigeria, using data spanning from 1981 – 2014. The study utilized sufficient theoretical and empirical works to create sound background knowledge about exchange rate and balance of payment, to empirically investigate the desired phenomena, the study adopted the error correction mechanism and the co-integration analysis to test for short – run and long – run relationship between our variables under the OLS framework.in the course of this findings there exist a long run relationship between exchange rate and balance of payment in Nigeria. The study revealed that exchange rate has a negative but significant relationship with balance of payment in Nigeria while the control variables (foreign direct investment and trade openness) have a positive and significant relationship with balance of payment in Nigeria for the period under review. By implication this study suggests that the higher the naira devalues the higher the balance of payment deficit in the Nigerian economy gets.
It was thus recommended that to reduce the excessive balance of payment deficit, there is need for government to discourage over-reliance on imported goods and the promotion of domestic export produce is very imperative.
CHAPTER ONE
INTRODUCTION
- Background Of Study
Exchange rate is the price of one country’s currency in relation to another. In the era of trade liberalization, appropriate policy mix that ensures an effective rate of exchange is imperative because its variation has economic implications. Variation in exchange rate is important endogenous factor that affects economic performance due to its impact on macro-economic rate policy and on appropriate exchange rate are crucial conditions for improving economic performance (Chang & Tan 2008).
According to Otaki (2005) balance of payment is a systematic record of all economic transactions, visible as well as invisible in a period between one country and the rest of the world.
Right from time immemorial, a country’s exchange rate and balance of payment is usually regarded as the sum of indices by which a nation’s strength can be measured especially its economic strength. Paul (1996) defines balance of payments as an accounting record to all monetary transactions between a country and the rest of the world. These transactions include payments for the country’s exports and imports of goods, services and financial capital, as well as financial transfer. It summarizes the international transaction for a specific period usually one year and is prepared in single currency for the country concerned.
Nzotta (2004) defines foreign exchange as the value of foreign nation’s currency in terms of the home nation currency. In finance, the exchange rates (as also known as the foreign exchange rate or forex rate) between two currencies specify how much one currency is worth in terms of the other.
Devaluation is tall in a fixed exchange rate, which reduces the value of a currency in terms of other currencies. This study is set out to determine how the reduction value of a currency with respect to the currency of another country affect the record of all monetary transactions between a country and another, whether visible or invisible in a period of time. This is very important because no nation can exist on its own no matter how independent or self-sufficient it can be, it is important to have a relationship with other nations which can be characterized by goods and services going one way and foreign exchange going the other way. When accessing the nation involved, a record of gains and losses may have been kept. As such a nation’s foreign exchange and balance of payments can help slowdown, accelerate or decelerate walking growth progress and development. This will also have a positive or negative effect on the citizens since it deals mainly with economic relations. (Nzotta 2004)
Our nation Nigeria is currently facing serious problems regarding its foreign exchange rating (which is very low in comparison to other countries) and it’s Balance of payment which is clearly in disequilibrium and in a deficit. As a result of this the government is retrogressing and the citizens clearly suffering. It is in a bid to discover why this is so and how this can be solved that this study as pertinent.
1.2 StatementOf The Problem
According to Otaki (2005) Foreign exchange and balance of payment are the key factors of a nation’s life. They are also factors to look into when comparing a country’s relationship with other nations. These factors directly or indirectly affect a host of other factors which are of severe importance in any nation. Consequently these factors can be seen as essential to the growth and development of the nation. Currently these two factors can be said to have crippled the Nigeria economy and made life uncomfortable and unbearable for it citizens. These factors have brought the country to a level where growth and development appear to be an illusion.
Currently the nation’s exchange rate has fallen so low due to unfavorable nature of the competing power of the nation’s currency with foreign currencies of the world.
Nigeria has in the recent times been experiencing persistent instability on her overall balance of payment and this has provoked serious concern and question on the potential causes of this imbalance. Nigeria, like any other country, aims at maintaining a stable equilibrium in the balance of payments as one of the objectives of macroeconomic policy (Soludo, 2003). Organizations such as the International Monetary Fund (IMF), and the World Bank, have directed a great deal of attention to stable balance of payments situations in a given economy as the ideal situation. Owing to the nature of Nigeria’s export and import, there existed a persistent Balance of Payments deficit in the economy.
Invariably, Nigeria has paid more to foreign countries than she receives. Thus, the attendant result affects the economy, leading to gross depletion of Nigeria’s Foreign Reserves. It has also attracted reduction in the country’s productive capacities and persistent inflationary pressures. Sequel to the above, articulated efforts have been made by monetary authorities especially, Central Bank of Nigeria (CBN), on how to drastically reduce the Balance of Payment s deficits in the economy. This is usually done through the formulation and implementation of appropriate monetary policy measures.
Over the years, different adjustment mechanisms to balance of payment disequilibrium have been developed, namely, the monetary approach, the Elasticity’s Approach and the Absorptions Approach (Du Plessis et al 1998) Although the monetary policy approach to the balance of payment has been commended by many for explaining the balance of payments, it has been criticized by some scholars as an approach that ignores other parts of international trade in determining the balance of payments (Iyoha,2001).
According to Fleermuys (2005), the monetary approach to the balance of payments has been blamed for disregarding the fiscal and real factors that influence changes in the balance of payments, while concentrating only on monetary factors. The weak position in the country’s current account was due to the deterioration in the services and income account which outweighed the surplus recorded in the merchandise trade and involved net transfer account, Gbosi (2001). In recent years, there have persistent deficit in the country’s balance of payments. Nigeria’s balance of payments recorded remarkable improvement during the period 2004- 2005. However, the situation worsened in 2008 as a result of the global financial and economic meltdown coupled with the falling prices of crude oil in the international oil market (Gbosi 2009). Despite all these measures at correcting balance of payments yielded non significance response of balance of payment to the monetary policy instrument that informed the need to investigate the effects of exchange rate devaluation on Nigeria balance of payments. This work specifically seek to examine the extent at which macroeconomic variables affect balance of payment position in Nigeria.
1.3 ResearchQuestions
The following research questions will guide the researcher.
- Does exchange rate has a significant effect on the Nigeria Balance of payment?
- Is there any long run relationship that exists between exchange rate devaluation and balance of payment in Nigeria?
1.4 Objective OfThe Study
The general objective of this study will be to examine the effect of exchange rate on the balance of payment of a nation with special reference to Nigeria.
The specific objectives intend to:
- To determine the effect of exchange rate on balance of payment in Nigeria.
- To determine the long run relationship between exchange rate devaluation and balance of payment.
1.5 Research Hypothesis
This study is designed to verify the following research proposition.
Null hypothesis (Ho): exchange rate devaluation has not make any positive significant effect on the balance of payment.
Null hypothesis (Ho): there is no long run relationship between exchange rate devaluation and balance of payment in Nigeria.
1.6 Scope Of Study
This study is limited to exchange rate devaluation and its effect on balance of payment with reference to the Nigeria economy. The study will make use of time series data covering the period 1981-2014 spanning a period of 34years.
1.7 Significance Of Study
Exchange rate plays a key role in international economic transaction and it is a key determinants of the balance of payment position of any country’s and which if utilize appropriately will service as nominal anchor for price stability. Therefore, this study which has looked into the relationship between exchange rate devaluation and balance of payment will be beneficial in the following ways:
- The result of the study will be beneficial to government in designing exchange rate policy/ intervention aimed at encouraging exportation of goods and service than import.
- The result of the study will help create more industries thereby reducing poverty, unemployment, and standard of living will improve.
- The study implies that some trade policies that are not beneficial to Nigeria should be reviewed.
- Finally this would contribute to vast empirical literature between or around the world and few existing ones in Nigeria on the effect of devaluation on the balance of payment hence on macro economics.
1.8 Organization Of The Study
This work will be arranged into five chapters. Chapter one serves as general introduction to the study, statement of problems, objective of the study, statement of hypothesis etc.
In chapter two, the literature review is discussed, chapter three handles the research methodology while chapter four deal with the data presentation, analysis and interpretation. Chapter five handles the summary of findings, draws the conclusion and make some useful recommendation.
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