AN EXAMINATION OF THE IMPLICATIONS OF EXCHANGE RATE AND NAIRA DEVALUATION ON NIGERIA ECONOMY DEVELOPMENT

ABSTRACT

The study assessed empirically the implications of exchange rate and Naira devaluation on Nigeria economy development from 1985 to 2015. Data on GDP, Exchange rate, Naira Depreciation, foreign direct investment (FDI), inflation rate, imports, exports, trade openness, final consumption expenditure (FCE), interest rate, and government expenditure were obtained from the different issues of the CBN Statistical Bulletin. Data series were assessed for stationarity with the aid of the ADF test. Bound test was conducted and the model was estimated within the ARDL framework supported by the relevant post estimation diagnostic tests. The bound test showed that there was long run relationship among the study variables. Model estimation revealed that import, lag of trade openness, FDI, lag of exchange rate, naira devaluation, interest rate and inflation significantly affected the growth of the economy in the short run. In the long run, economic growth was affected by trade openness, FDI, exchange rate, government expenditure and interest rate. It was concluded that the exchange rate as at 2015 did not affect economic growth in the short run but its one year lag did, while exchange rate and Naira depreciation had negative effect on the growth of the Nigerian economy in the long run. To achieve growth in the economy, effective exchange rate management system alongside expansionary fiscal policy and encouragement of importation of capital goods are recommended.

Key Words: Exchange Rate, Naira Depreciation, Economic Growth, Nigeria.

CHAPTER ONE

INTRODUCTION

1.1 Background Of The Study

Economic growth and development universally play host to three core fundamentals of short and long-run economic targets for the achievement of a stable and sustainable growth, employment, and a bare minimum inflation rate with a favourable trade point. The realizations of the above economic targets and profitability have propelled, nations over time to adopt monetary and fiscal policies to regulate the shift in the aggregated demand curve. Empirical research bare and recognized an economic world that in her earlier epoch witness economic depressions in 1910 and 1930s herein refer to as the “Great Economic Depression” which negatively impacted on the global economy with particular effect on domestic currencies. Which, therefore, propel nations to adopt devaluation as the last resort and as a key to economic lift. In the contemporary era, devaluation has been contained in line with the traditionalist argument as a macroeconomic policy tool for most developing economies of the world. The International Monetary Fund (IMF) and World Bank clinching to currency devaluation as a medium to domestic firms protection against external competition and increase net export boost (Genye, as cited in Ayen, 2014 p.103). Nations in conjunction with economic theories and in line with the traditionalist argument consensually cuddle devaluation as a fiscal policy and as a medium of domestic economic enhancement in the long-run by means of net export stimulation to economic diversification, increase domestic international competitiveness, trade balance expansion, employment generation and balance of payment alleviation so long as the MarshallLerner conditions are gratified. The Marshall-Lerner condition holds that; devaluation enhances expansion where the sum of price elasticity of demand for export and the price elasticity of demand for imports is greater than unity (>1) (Acar as cited in Ayen 2014 p.103). The Nigerian economy over the decade has been recognized to be a mono-cultural and oil-driven. With oil funding 95 percent of foreign earnings, 80 percent to GDP, an above 90 percent of total export valued at $47.8 billion consequently placing Nigeria as the 49th largest exporter and import at $39.5 billion placing Nigeria as the 53rd largest importer universally (Observer of Economic Complicity, 2015). Nigeria in the modern era is not immune from global economic and financial crisis. Nigeria, therefore, is currently trapped in the web of exchange rate volatility driving the adoption of devaluation as a feasible way out of the financial and economic quagmire (Akindiyo and Olawole 2015). Currency devaluation clinches to the fiscal policy which focal point on a calculated cutback in the value of the domestic currency to maximize gains in trade (Aiya, 2014). Cooper, as cited in Momodu and Akani (2016) currency devaluation, is likewise reflected to be a shocking policy embraced by the government. Hence, most governments reject devaluation in line with their economic pattern. Devaluation occurs where there are trade and payment deficits. With Thailand, China, Mexico, Czech Republic devaluing strongly, willingly or unwillingly, due to deficits in trade exceeding 8% of GDP (Momodu and Akani 2016). Nigeria in 1973 cuddles her first currency devaluation at 10% in response to U.S. devaluation of the same year at foreign exchange reserves growth at 773.5% in 1974. According to International Monetary Fund, report 2015 (IMF) nations can devalue their currency to correct "elementary disequilibrium" in trade and balance of payments. Todaro in 1982 augured that “devaluation is unhealthy for economic development since valued currency equally worsens trade and balance of payment.

On the other hand, since money is the key to exchange i.e. facilitates exchange, the rate at which goods are exchanged for each other depends on the value of money. Similarly, money is the determining factor of exchange between two countries which also depends on the value of each country’s currency. This is because the value of each currency differs depending on the economic situation of each country and other accompanying macroeconomic dynamics. The comparison of different currencies of different countries is needed because of exchange which takes place across international borders through trade. Exchange rate may be described as the price of a particular currency relative to the other. It can also be seen as a medium by which the prices of commodities in two different economies are connected together. According to Obansa, Okoroafor, Aluko & Millicent (2013), exchange rate determines the participation of external sector in cross-border trade. The issues of rate of interest and exchange rate regime have been a major topic of debates in international finance and in developing countries, with more countries liberalizing trade as means or pre-condition to achieving economic growth. One of the main objectives of macroeconomic policy is significant growth in the economy of a country which is measured in terms of continuous growth in national income. Growth is actually perceived to have occurred when the productive capacity of a country improves (Akpan, 2008). Actual production of goods and services stimulates exports and sometimes requires importations (of raw materials) which involves transactions in foreign currencies (Oyovwi, 2012). Jin (2008) showed that the implications of Nigeria’s over-dependence on export of oil is that the economy is highly prone to external shocks because in the event of any major fall in oil price, foreign exchange earnings will decline noticeably and there will be destabilizing effects on exchange rate as there will not be enough stock of foreign currencies to defend the local currency at the foreign exchange market. This major shift in relative prices (exchange rate) would result in a near equal adjustment in the allocation of a country’s local resources and possibly move the economic structure away from the production of exportable commodities (agriculture) into possibly the services sectors. Furthermore, according to Nwosu (2016), exchange rates that emerged after the collapse of Bretton Wood System has been unstable and has made scholars and professionals to be skeptical about its effectiveness in enhancing economic growth. For instance, the naira to US Dollar exchange rate was N4 in 1987 while the real GDP was about N204.8Billion. In 1995, it depreciated to N21 to one US Dollar while the real GDP was N281.4B. As at 2014, the exchange rate was N168 to one USD and the exchange rate depreciated to N365 in 2017. In the light of the above, it is important to evolve a research whose aim is to assess the impact of exchange rate and Naira devaluation on economic growth in Nigeria.

1.2 Statement Of The Problem

Devaluation increases international competitiveness of domestic industries which leads to diversion of consumption of foreign goods to domestic goods (Yilkal, 2014). It is used to encourage exportation, discourage importation and to correct unfavourable balance of payment by making home goods cheaper to foreign countries and foreign goods expensive in the home country. Examining the economy of Estonia, Parts (2013) observed that external devaluation was not going to work for the economy rather, internal devaluation was adopted coupled with other fiscal policy measures and that is why she had a quick recovery from the recent recession and its economy is in better shape than before the crisis. Estonian exports grew 22 percent in 2010 and 25 percent in 2011. This is a result of the rapid increase of high value-added exports by the manufacturing sector, which has also been the main job creator since the crisis. Indeed, export growth has been the main driver of the Estonian economic recovery (Parts, 2013). China achieved its "miraculous" growth as a result of blatant currency manipulation that effectively stole growth from many of its trading partners. Between 1978 and 1993, China's government pushed down the value of the renminbi by nearly two-thirds. In his book, “Devaluing to Prosperity”, Bhalla says the value of the currency then nearly halved again between 1994 and 2011 (Berry, 2012). Nigeria’s GDP was recently rebased with the result placing the country as Africa’s largest economy with an annual GDP of $510 billion. Nigeria’s population and the size of the market has remained an attraction for FDI inflow with the current population estimate projected at 183 million people in 2015 (growing at a projected growth rate of 2.82%). The country is currently ranked the 7th most populous country in the world and has enjoyed a positive GDP growth rate in the last 10 years and a relatively stable exchange rate regime. Between the first quarter of 2013 and the last quarter of 2014 Nigeria posted an average GDP growth rate of 5.8%, a single digit inflation of 8.2% in the last quarter of 2014 and a relatively stable exchange rate regime. The country is now in dilemma of the effect of further devaluation of naira as the former CBN governor, Sanusi Lamido and some other renowned Nigerian economists are clamoring for it while others like Tella, Teriba and Utomi see this as no solution to the economic problem facing the country. This study seeks to contribute to literature by empirically testing the effectiveness of Naira devaluation in Nigeria which is import driven and only exports crude oil and a few raw materials with low value added. A recent review of crude oil price shows a sharp decline of about 48.5 per cent between 2014 and 2015. Hence the need to know effective this last result tool will be in Nigeria.

In addition, exchange rate policies in developing countries are often sensitive and controversial, mainly because of the kind of structural transformation required, such as reducing imports or expanding non-oil exports, which invariably imply a depreciation of the nominal exchange rate. Such domestic adjustments, due to their short-run impact on prices and demand, are perceived as damaging to the economy. Ironically, the distortions inherent in an overvalued exchange rate regime are hardly a subject of debate in developing economies that are dependent on imports for production and consumption.

In Nigeria, the exchange rate policy has undergone substantial transformation from the immediate post-independence period when the country maintained a fixed parity with the British pound, through the oil boom of the 1970s, to the floating of the currency in 1986, following the near collapse of the economy between 1982 and 1985 period. In each of these epochs, the economic and political considerations underpinning the exchange rate policy had important repercussions for the structural evolution of the economy, inflation, the balance of payments and real income.

1.3 Objectives Of The Study

The major objective of this research is to determine the implications of exchange rate and Naira devaluation on Nigeria economy development.

The others objectives includes

1. To determine the impact of exchange rate on the growth of Nigerian economy.

2. To determine the impact of Naira depreciation on the growth of Nigerian economy.

3. To make recommendations based on the study.

1.4 Research Questions

The study will be guided by the following questions;

1. What is the impact of exchange rate on the growth of Nigeria economy?

2. What is the impact of Naira depreciation on the growth of Nigeria economy?

1.5 Research Hypotheses

H0: Exchange rate and Naira depreciation have no significant impact on the of Nigeria economy.

Ha: Exchange rate and Naira depreciation have a significant impact on the of Nigeria economy.

1.6 Significance Of The Study

The study is significant as it would add to existing literature on Naira depreciation and exchange rate and how it affects economic growth in Nigeria. It will serve as a guide to further research, academic work and as a self-help study material for those who might wish to firsthand knowledge about Naira devaluation.

It is also hoped that Nigeria policy makers will find it’s a helpful material in the formulation and implementation of policies on devaluation of Naira and how it facilities growth in Nigeria.

1.7 Scope Of The Study

The study covers the implications of exchange rate and Naira devaluation on Nigeria economy development. The study covers the period 1985-2015.

1.8 Limitation Of The Study

Like in every human endeavour, the researcher encountered slight constraints while carrying out the study. Insufficient funds tend to impede the efficiency of the researcher in sourcing for the relevant materials, literature, or information and in the process of data collection, which is why the researcher resorted to a limited choice of sample size. More so, the researcher simultaneously engaged in this study with other academic work. As a result, the amount of time spent on research will be reduced.

1.9 Definition Of Terms

Impact: impact is defined as the action of one object coming forcibly into contact with another or a marked effect or influence.

Naira: The naira (sign: ₦; code: NGN) is the currency of Nigeria. It is subdivided into 100 Kobo.

The Central Bank of Nigeria (CBN) is the sole issuer of legal tender money throughout the Nigerian Federation. It controls the volume of money supply in the economy in order to ensure monetary and price stability. The Currency & Branch Operations Department of the CBN is in charge of currency management, through the procurement, distribution/supply, processing, reissue and disposal/disintegration of bank notes and coins.

Devaluation: In modern monetary policy, a devaluation is an official lowering of the value of a country’s currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate

Economic growth: Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.

SME: small and medium scale enterprise. It is a non-subsidiary, independent firm which employs less than a given number of employees.

Exchange rate: is the rate at which one currency will be exchanged for another

Import: To bring (goods or services) into a country from abroad for sale.

CBN: Central Bank of Nigeria.

Balance of payment: The balance of payments, also known as balance of international payments and abbreviated BOP, of a country is the record of all economic transactions between the residents of the country and the rest of the world in a particular period (over a quarter of a year or more commonly over a year).

Balance of trade: The difference in value between a country’s imports and exports.