Impact Of Exchange Rate Variations On Nigeria’s Balance Of Trade
Impact Of Exchange Rate Variations On Nigeria’s Balance Of Trade
Trade, either national or international has been known to be a major contributor to economic growth and development. Nigeria’s international trade involves exports and imports. Exports are basically made up of primary agricultural products and crude oil, while imports are composed of food, chemicals, other manufactured goods and machinery equipments, spare parts. Thus, it is the differences between merchandise exports and imports that constitute Nigeria’s balance of trade.
A country’s balance of trade is said to be positive (favourable) when the income earned from it’s exports exceeds its incurred expenditure on imports, and negative (unfavourable) when the reverse is the case, (Essien, 1995: 256).
Exchange rate is the rate at which one country’s currency can be exchange for an other, thus, it is the price of one currency in terms of an other, (Auyanwu, 1995: 387). The exchange rate of a particular currency plays a key role in international economic transactions.
The importance of any exchange rate is derived from the fact that it connects the price system o f two different currencies, making it possible for international traders to make direct comparison of prices of traded goods, (Anyanwu, 1995: 388). Though if effects on the volume of exports and imports exerts a powerful influence on a country’s balance of trade. The aim of this study is to examine the impact of exchange rate variations on Nigeria’s balance of trade, from 1976-2004.
Before the colonial era, rural Nigeria had fairly complex organisation. These social organisations were predominantly peasant communities, producing a variety of commodities mostly to satisfy their needs with little surpluses for exchange with other communities. Trading among the various communities was broadly based on barter terms and agriculture involved the production of food crops for subsistence.
The coming of the colonialists introduced a money economy among the peasant communities. This provided an incentive for the peasant farmers to produce more cash crops for sale and eventual export to Western Europe.
The various Nigerian communities produced a diversity of crops and this was a reflection of their diverse physical e environment. Food crops include Yam, Cocoa yam, cassava (growth mostly in the South) while cash crops included palm oil (from the East).
According to Helleiner (1966) export production accounted for about 57% of Nigeria’s Gross Domestic Product (GDP) in 1992. Oil palm products alone accounted for between 85% and 90% of the total volume of exports during the same period.
The growth of the Nigeria agricultural sector was however, not smooth. The period between 1929 and 1945 was a difficult one for the export sector. The Great Depression of the 1930’s was marked by fluctuations in the world commodity prices especially primary commodity prices. These disturbances lasted till the end of the war. Although the volume of Nigeria’s export commodity increased during this time the value did not increase proportionately to the volume.
Another period of export boom for Nigeria was between 1945 and 1954. The world economy was just recovering from the effects of the Second World War and demand for primary products to revitalize the industries of the advanced countries destroyed during the war also increased. Prices of primary products rose to higher levels. Another important factor which led to rapid increase in commodity price especially after 1945, was the threat of another world war with the outbreak of the Korean War in 1950. The Nigeria export sector gained tremendously from these disturbances. However, after 1954, the export boom gave way to another period of price instability.
The reliance of the economy on agricultural products and the instability o f cash crop prices and agricultural incomes led to the establishment of marketing Boards with monopolistic powers to buy these crops from the farmers and sell them in overseas. The role of the marketing Boards was very important especially in stabilizing farm incomes and generating funds for the execution of development projects in the country.
In spite of the importance of these crops and agriculture as a whole, the methods of production remained and are still primitive with the hoe and cutlass as the major implements. The existence of these methods can be attributed to the activities of the colonial masters who made the attempt to alter the production technology in this sector as long as agricultural products were being made available.
Since independence the role of agricultural products in the economy has been on the downward trend especially its contribution to GDP. Its share to GDP fell from 61.50% in 1963/ 64 to 14.63% in 1983. This situation has been partly due to the emergence of oil as an important commodity and partly to the poor performance of the sector.
STATEMENT OF THE PROBLEM
Evidence of exchange rate depreciation has dominated Nigeria’s exchange rate structure, for the period, 1976-2004. The depreciation would normally be expected to bring about a positive change in Nigeria’s balance of trade. But the depreciation has resulted in the reduction of the value of the country’s exports, causing deterioration in balance of trade.
The problem to be investigated in this study is to determine if the variations (depreciation or appreciation) in exchange rate have an effect (positive or otherwise) on Nigeria’s balance of trade.
OBJECTIVE OF THE STUDY
The objective of the study aims at determining the influence of Nigeria’s balance of trade variations visa-vis fluctuations in the Naira exchange rate with other international currencies.
STATEMENT OF THE HYPO THESIS
The study thus hypotheses as follows:
H0: b0 0: There is no significant relationship between exchange rate variation and variations in Nigeria’s balance of trade.
H1: bi = 0: There is a significant relationship between exchange rate variation and variations in Nigeria’s balance of trade.
SIGNIFICANCE OF THE STUDY
The study will be useful to policy makers, researchers as well as serve as a reference paper for researchers.
SCOPE/ LIMITATIONS OF THE STUDY
This research is limited to the performance of the balance of trade with respect to exchange rate variations covering the time frame 1976-2004.
Since the sources of data to be used for the study are secondary in nature, this research work may not be free from the problem of inconsistencies and in adequacies of statistical information on the variables used, for the period covered.
The study is concerned with the impact on Nigeria’s balance of trade variations in the naira/US Dollar exchange rate. For this reason; a simple regression analysis will be used to examine the strength of the relationship between the two variables, exchange rate and balance of trade.
The ordinary least-squares (OLS) method will be use in estimating the parameters with a single equation model.
In this chapter we shall examine the effect of exchange rate variation on balance of trade under theoretical and empirical literature.
THE THEORITICAL LITERATURE
The conceptual view of exchange rate
By exchange rate, we mean the price at which one currency is exchanged for another currency. To put it another way, it is the price of one currency in terms of another currency. Therefore, it is conventional to define the exchange rate as the price of one unit of the foreign currency in terms of the domestic currency. The exchange rate between the dollar and the pound sterling simply refers to the number of dollars that are needed to purchase a pound. To this effect we say that the exchange rate between the dollar United State and the pound sterling (United Kingdom) from the United States recipient is expresses as $2.50 = ₤ 1. On the other hand, the Briton would express it as the number of pounds required to get one America dollar. Consequently, the above exchange rate would be shown as ₤ 0.4 = $1. Usually, the exchange rate of $ 2.50 = ₤ 1 or ₤0.40 = $1 will be maintained in the world foreign exchange market by arbitrage. Specifically, arbitrage refers to the purchase of a foreign currency in a market where its price is low and to sell it in some other market where its price is high. Thus, the effect of arbitrage is to remove the differences in the foreign exchange rate of currencies. This will ensure that that there is a single exchange rate in the world foreign exchange market. For example, if the exchange rate is $ 2.48 in the London exchange market and $ 2.50 in the New York exchange market, foreign operators known as arbitruents will buy pound in the London market and sell in the New York markets. By so doing, they will make a profit of 2 percent on each pound. As a result of this action, the rate of pounds in terms of dollars will rise in the London markets and arbitrage will have to come to an end (Jighan, 2000)
The concept of balance of trade
various Scholars have given different conceptual meanings to the balance of trade. The dictionary of economics and commerce defines balance of trade as “the relationship between a country’s payments from imports of goods and its receipt from the export of goods. In other words, the items contained in a country’s balance of payment include the total exports and imports of goods and services.
Balance of trade is one of the various items recorded in the current account section of balance of payments. It records a surplus when merchandise exports exceeds merchandise imports and a deficit when merchandise imports exceeds merchandise exports. In order words , it is the difference between merchandise export and import.
Evaluating the concept of trade, Husted et al, 1992. 319) have noted its importance and indicated that balance of trade is often used to justify a need to protect the domestic market from foreign competition.
Exchange rate variations and balance of trade:
Exchange rate variations are the frequent changes in exchange rate in the foreign market.
According to (Hyman 1996:810) exchange rate variation involves currency appreciation and depreciation. He goes further to explain that exchange rate appreciation occurs “when there is an increase in the number of unit of one’s nations currency that must be given up to purchase each unit of another nations currency”. Thus a currency like Naira is said to have appreciated when there is an increase in the amount required to purchase a unit of dollar. In order words, it occurs, when there is low supply of a currency in relation to the demand for it.
Hyman also indicates that exchange rate depreciation occurs “when there is a decrease in the number of unit of one’s nations currency that must be given up to purchase each unit of another currency”. It shows that depreciation makes the supply of a currency large in relation to the demand for it.
The effect of exchange rate variations (depreciation or appreciation) on balance of trade, though the (Husted et al, 1993: 321). (Hyman 1996:813) also noted that when the Naira appreciates, other things being equal, domestic goods and services becomes more expensive in terms of dollar. This trends to decrease the foreign demand for Nigeria goods and services and to decrease the net exports, (deficit in balance of trade).
Similarly, when the Naira depreciates, domestic goods and services becomes cheap in terms of dollar, this will lead to the increase in foreign demand of Nigeria goods and services to increase the balance of trade surpluses as exports grows more than import.
According to (Obaseki, 1993:61), there are various measures of the exchange rate derived from the elasticity, portfolio balances, purchasing power parity and monetary approaches to exchange rate determination. The traditional flow model according to (Olisadebe, 19991: 158) presumes that exchange rate is determined simply by the forces of demand and supply for foreign exchange and concludes that exchange rate is in equilibrium when supply is equals to demand. To him a current account imbalance can be offset by a net flow of capital in the opposite direction for instance, a current account surplus is financed by acquisition of financial assets abroad or outflow of capital. Similarly, a deficit is financed by an inflow of capital. The goes further to assume that the current account is determined by relative prices and real income. An increase in domestic prices relative to foreign prices leads to exchange rate depreciation.
This is because increase in domestic price level adds to costs thereby making exports costly and less competitive, consequently the supply of foreign exchange is constrained on the other hand, import becomes higher because countries finds such demanding countries to export to further more, the model posits that an increase in domestic interest rate relative to the foreign interest rate causes an appreciation through induced capital flows.
Following the model, a depreciation of the exchange rate tends to increase the real income which results in an increase in demand for imports which have a negative effect on the current account and hence on the balance of trade but without offsetting any increase in capital inflow owing to the fact that exports do not increase in the same direction.
Devaluation and Balance of Trade
Devaluation is defined by (Anyanwu, 1995:387) as reducing the value of a currency in terms of other currencies. It is different from depreciation which is the reduction in the value of a currency, which occurs when the supply for a country’s currency is large in relation to the demand.
Anyanwu indicates that several factors like poor performance of direct foreign investment, speculative activities and sharp practices of authorized dealers in the foreign exchange market and problem of fragile export base has caused the countries depreciation of the Naira. Unlike depreciation, devaluation requires a deliberate action on the part of monetary authorities, (Anyanwu, 1993:324). The purpose of devaluation is to stimulate exports and to discourage imports.
According to (husted et al 1993:400), devaluation is normally a response to a persistent growing balance of trade deficits. Explaining this, Husted et al noted that if the prices of imports rises, fewer import will be demanded. At the same time, the lower price of domestic exports to foreigners will increase the demand for exports. With the combination of a higher demand domestic exports and lower demand for domestic imports will bring about an improvement in balance of trade.
The variant of this according to Husted et al is the slow responses of demand to new prices in the short-run so that the quantities traded do not change much. Using the concept of elasticity, they indicates that, if demand for imports is inelastic, there would be relatively, unresponsive attitude to higher prices of imports and put that such behaviour is not unreasonable since it takes time to find good substitutes for the new higher priced imported goods, which takes place during devaluation.
They also stress that substitution will eventually occur, but in the short run buyers may continue to buy imports in large quantities so that new higher prices results in greater rather than smaller domestic imports values after devaluation. The same explanation where also given for inelastic exports.
DETERMINATION OF EXCHANGE RATE
Three approaches are often used in the determination of exchange rate. They are the traditional flows, the portfolio balance and the monetary models. The traditional flow views exchange rates as the product of the interaction between the demand for supply of foreign exchange. The portfolio balance model views exchange rate as the result of the substitution between money and financial assets. The major limitations of the traditional flow and portfolio balance models include the over-shooting of the exchange rate target and the fact that the substitutability between money and financial assets may not be automatic. This led to the development of the monetary approach. The monetary approach is predicated on the importance of money. It identifies exchange rate as a function of relative shift in money stock, inflation rate as a proxy and domestic output between an economy and a trading partner economy.
It is important to know that the purchasing power parity (PPP), is a major component of the monetary approach. The (PPP) between two currencies as provide by Gustav casel is defined as the amount of purchasing power. The (PPP) is long-term approach used in the determination of equilibrium exchange rate. It is often applied as a proxy for the monetary model in exchange rate analysis (CBN, 1998).
In a free market, the exchange rate is determined by the demand for the supply of foreign exchange. But the equilibrium exchange rate is the rate at which the demand for exchange for exchange rate equals to supply of exchange rate. To put in another way, it is the rate which clear the market for foreign exchange. Generally, there are two conventional methods used in the determination of the equilibrium exchange rate. The rate of exchange between Dollars and pound can be determined either by the demand or supply of Dollars. Here, the price of the Dollars is pound, or by the demand and supply of pounds while the price of pounds is Dollars.
It is important to known that demand for foreign exchange is a derived demand for Dollars. It arise from the importation of American goods and services into Nigeria and from capital movement from Nigeria to the United States. Actually, the demand for Dollars implies a supply by American goods and services and make capital transfers to the United States.
Our next task is to explain how equilibrium exchange rate determined in the foreign exchange market. A diagram is used below to simplify our analysis, we assume we live in a two country world, Nigeria and the United states. It is assumed that Nigeria demand only Dollars and they supply Naira when they buy goods and services from the United states. In the same way, the demand for Naira occurs only when the American residents buy Nigerian goods. As can be seen from the diagram, the demand for Naira slopes downwards to the right. This is because fewer Dollars have to be given up for each Naira. This makes it cheaper to buy Nigerian goods. In the same manner, the supply curve of Naira slopes in upward. As more Dollars can be obtained for a Nigerian Naira, It becomes cheaper to buy American goods.
The equilibrium exchange rate is determined by supply and demand and labeled “E”.
Causes of Changes in the Exchange Rate
As earlier mentioned, the exchange rate between countries changes as a result of changes in demand or supply in the foreign exchange market. According to Jhigan (2000), the factors which causes changes in the demand and supply of exchange rate are change in prices, changes in exports and imports, capital movement, influence of banks, influence of speculation, social change influence, structural influence and political conditions. Are discussed below.
(i) Changes in prices: One of the factors that causes changes in the exchange rate is change in prices. It is argued that changes in the relative price levels will cause changes in the exchange rate. For example, if the price level, in Britian rises relative to United States price level this will lead to a rise in the price of British goods in pound. Here, British goods will become expensive in the United States. To this effect, there will be a reduction in British exports to the United States. On the other hand, the American goods will become cheaper in Britain. American exports to Britain will increase and the demand for Dollars will increase.
(ii) Changes in Exports and Imports: Exports are goods we sell to other countries while imports are goods we buy from other countries. Generally, the demand and supply of foreign exchange are influenced by changes in exports and imports. If the value of a country’s exports exceeds the value of its imports, the demand for its currency will increase thereby making the exchange rate lower. On the contrary, if imports are higher than exports, the demand for foreign currency will increase. To this effect, the rate of exchange will change against the country.
(iii) Capital movement: both short-run and long-run capital movements can also influence the exchange rate. Specially, capital inflows will appreciate the value of a country’s currency. Under this condition, the exchange rate moves in favour of the country. On the contrary, capital outflows will depreciate the value of the country’s currency thereby causing the exchange rate to change against it.
(iv) Influence of Banks: It is important to know that banks also affect the exchange rate through their operations. Prominent among these include purchase and sales of drafts, letters of credit and exchange dealings in bill of exchange. Specifically, these banking operations usually influence the demand and supply of foreign exchange. For example, if commercial banks issue a large number of drafts and letters of credit on foreign banks, this will lead to an increase in the demand for foreign currency. As a result of these transactions, the inter-bank rate will obviously influence the exchange rate.
(v) Influence of speculation: In economic and finance, speculation has to do with uncertainty. To this affect, the growth of speculative activities will also influence the exchange rate. Generally, speculation causes short-run fluctuations in exchange rate. Available evidence however, indicates that the international money market always encourage speculation in foreign exchange.
(vi) Stock exchange influence: To a large extent, stock exchange operations in foreign countries may exert significance influence on the exchange rate. For example, if stock exchange help in the sale of securities, debentures or shares to foreigners, the demand for the domestic currency will rise on the part of the foreigners. There will be a rise in the exchange rate. The reverse will be the case if foreigners purchase securities, debenture or shares through the domestic stock exchanges.
(vii) Structure influences: Another factor that may influence the exchange rate of a country is structural changes. Structural changes may bring about changes in consumer demand for goods and services. The structural changes may tend to increase foreigners demand for domestic products. This will lead to an increase in exports and a high demand for domestic currency. As the value of the domestic currency appreciates, this will bring about an increase in the exchange rate.
(viii) Political Conditions: The political situation of a country may have a significant impact on the exchange rate. If a country is political stable, foreigners will like to invest their funds in that country. The inflow of foreign capital will lead to an increase in the demand for domestic currency. This will further lead to a rise in exchange rate in Favour of the country. On the contrary, if a country is politically unstable, foreigners will be discouraged to invest in that country. Therefore, this will lead to a decline in the inflow of foreign capital. As a result, the exchange rate will move against the country Jhigan (2000).
Exchange Rate Policy Measures in Nigeria
It is important to know that economic objectives are usually the main consideration in determining the exchange rate. During the period, 1982 -1984, ad hoc administrative measures were employed in the determination of exchange rate in Nigeria. This is usually referred to as the era of exchange control. For example, from 1982 – 1983, the Nigeria currency was pegged to the British pound sterling on a 1:1 ratio. Before then, the Nigerian Naira has been devalued to move independent of the sterling. At that time, the Naira appreciate progressively to source imports cheaply to implement development projects. This encouraged reliance on import which subsequently led to the depletion of the nation external reserves. 1981, this policy was changed to that of gradual depreciation of the Naira against the Dollar or the pound sterling depending on whichever was stronger. Unfortunately, the policy could not sufficiently reverse the sustained pressure on the external sector. Apart from those policy measures discussed above, the CBN applied the bascket-off-currencies approach from 1979 as the guide in the determination of the exchange rate movement. During that period, the exchange rate was determined by the relative strength of the currencies of the country’s trading partners and the volume of trade with such countries. Specifically, weights were attached to these countries’ currencies with the Dollar and sterling on the exchange rate mechanism (CBN, 1994).
A realistic and sustainable exchange rate for the naira. On exchange rate in particular, a market-determine exchange rate mechanism was adopted in 1986. as Gbosi (1994), put it, a major foreign exchange rate policy adopted in 1986 was the introduction of the second-Tier Foreign Exchange Market (SFEM) for buying and selling foreign exchange at market determined rates. The exchange rate in a free market environment is determined by the interplay of the market forces of supply and demand. According to Odozi (1987), the SFEM which commence on September 20, 1986. As earlier mentioned, the major objective of the SFEM was to established a realistic and sustainable market determined exchange rate for the Naira. This will have the effect of reducing the demand for foreign exchange to available supply and also to reduce the pressure on the balance of payments. The operational framework of the SFEM was the Dutch Auction system which was introduced in April, 1987. Under this framework, the central Bank called for bids from all authorized foreign exchange dealers. Specifically, it used the marginal rate as the market exchange rate.
The first and second foreign exchange were abolished after sometime. However, in response to the continued depreciation of the Naira, the Dutch Auction method was re-introduced in December, 1990 and through part of 1991. In an effort to further stabilize and find an appropriate exchange rate for the Naira, a floating exchange rate system was adopted in March, 1992. Under the floating exchange rate regime, the foreign exchange market was completely deregulated. Foreign exchange leakages from authorized dealers to the parallel market were greatly curtailed. Since then, the CBN had joined the foreign exchange market both as a buyer and a seller. This would enable the CBN to influence the exchange rate of the Naira directly. Other exchange rate policy measures adopted in Nigeria included deliberate supervision of inter bank foreign exchange auction which depended on the overall external reserve position of the country and its goals.
Recent developments in the foreign exchange market show that the flexible exchange rate regime was not able to establish a realistic and sustainable exchange rate for the Naira. For example, at the end of December, 1993, about 80.00 was exchanged for US $1.00 in the official foreign exchange market. In the parallel market, the rate was about 100 to the Dollar. In order to reverse the situation, the Nigeria Government abandoned some of its liberalization policies in 1994. the flexible exchange rate system continue until January, 1994 when the fixed exchange rate system was re-introduced with the pegging of the Naira to the U.S Dollar. Several policy measures were used in the pursit of these objectives. They included maintaining parity with the British pound sterling and the U.S Dollar. Fixing the Naira exchange rate independently with the Dollar and sterling depending on their relative strength. Specifically, as announced in the 1994 Budget, 22.00 was fixed to the US. Dollar (CBN,1994).
The re-introduction of the fixed exchange rate system was hailed by many scholars including outstanding Nigerian economists. The contention was that this would actually stabilize Nigeria’s foreign exchange earnings and also establish a realistic exchange for the Nigeria. Total foreign exchange earnings in 1994 were projected at US $8.13 million. Out of this amount US $6,189 million or 76.2 percent was expected to be earned from official sources. The oil sector was to account for about US $4,875 million or 60.2 percent on the sum on the basis of the assumption that oil production and prices would remain stable. The projected earnings of US $1,932 million from the private sector was to be wholly retained by the sector.
The fixed exchange rate system adopted in 1994 did not stabilize the external sector. Kalu (1994), has summarized the general features of the foreign exchange market in Nigeria in 1994 in this way. Specifically, developments in the foreign exchange market pointed to a continuing serious financial gap facing the Nigeria economy. The persistently and remained unstable. The parallel market premium was over 100 percent in an environment characterized by multiple “unofficial” rates of exchange, the normal definition of an imperfect and segmented market. The low level was attributable to a severe imbalance between the supply and demand for foreign exchange at the indicated prices. The unavailable denoted clearly an inappropriate market mechanism as manifested in the incidence of the three or four rates of exchange within a single economy. The foreign exchange crunch will become severe with the fall in the international oil prices without a compensatory net positive capital inflow into the economy. As earlier mention, the fixed exchange rate regime of 1994 apparently did not achieve its intended objectives. On the Naira exchange rate in particular, at the end of December 1994, 85 was exchange for US $1.00. In the parallel market, the rate was about 105 to the Dollar. Consequently, the government decide to adopt “guided deregulation” of the foreign exchange market in 1995.
In his 1995 Budget speech, the Head of State, General Sani Abacha, announced that there was a change in policy regarding the nation’s exchange rate regime. The official exchange rate of the Naira was also fixed at 22 to US $1.00. However, the following measures were to apply with effect from January 1995.
1. The 1962 Exchange control Act was to be abolished with immediate effect.
2. There would be an inter-bank foreign Exchange market (IFEM) and there would be no regular bidding on allocation of foreign exchange at the Central Bank of Nigeria at least for that time. Rather the CBN would hold the official foreign exchange to meet priority Government obligations, strengthen the external reserves and intervene in, and influence the (IFEM) in order to ensure reasonable stability in the market (CBN, 1995). Available evidence shows that the various exchange rate policies adopted by the government has not stabilized the Naira exchange rate. For example, at the end of May, 2003, about 140 was exchanged for US $1.00. In the so-called black market, it was almost 150 to the Dollar (Gbosi, 2003. 106).
(Ukpolo 1987:158), also adopts the concept of elasticity in showing the effect of devaluation on balance of trade. He noted that if foreign demand for the devaluing country’s exports possesses a price elasticity that is greater than unit, the proportionate drop in the foreign price of exports will be less than the proportionate rise quantity, so that the foreign exchange values of export will increase. However, if the elasticity of exports with respect to foreign prices is less than unity, the negative price effect which will result as price of exports fall will dominate the positive quantity effect that will occur, thus creating a reduction in the value of exports.
On the import side, Ukpolo notes that the price of imports is increased by depreciation, which results to a reduction in the quantities of imports, as importers would have to give up more home currencies to purchase a unit of imports.
Furthermore, he is of the view that if the demand for imports is perfectly inelastic with respect to price, there will be no significant change in the demand for real foreign exchange. In this situation, the increase in the domestic price imports will offset the depreciation of the exchange rate. In other words, the effectiveness of devaluation on the balance of trade indicated by Ukpolo depends on demand elasticities of imports and exports and pointed out that the sum of the demand elasticities of imports and exports must be greater than one.
However, the Nigeria’s balance of trade has worsened over the years (1976 – 2004) as a result of low elasticities of both the domestic demand for imports and the domestic supply for exports, making the sum of the two elasticities less than one.
The US Trade Deficit puzzle. The US trade deficit is currently at historical high levels, and plausible some correction will take place in the future. Adjustment may occur via a devaluation of the Dollar or a reduction in the US economy’s growth rate with respect to the rest of the world. Which type of adjustment is more likely? How large would the movements of exchange rates and income growth need to be restore balance? Why have US imports not responded as expected to the depreciation of the Dollar?
Methodology, the paper uses quarterly data from 1975 to 2001 to estimate demand and supply function for US import of goods and services. The author develops an empirical strategy for the identification of stable relationships between aggregate US import and measures of exchange rates and income in the United states and the rest of the world. Innovative econometric techniques are used to provide answers.
The findings. During the period under investigation, US exports respond in a state way to changes income of the rest of the world and in the real exchange rate. On the import side, however, the author finds a structural break in the mid 1990s. most likely this is associated with a dramatic fall in the relative price of computers and semi conducts, which have almost doubled their weight in US imports as a result. Interestingly, the exchange rate has a limited impact on trade. A correction of the Us trade deficit will probably require either a reduction in the American economy’s growth rate or an increase in the growth rate of the rest of the world.
Peter J.S, Basudeb B. and Sarita M. investigated the long-and short-run relationships between variations in the real exchange rate US agricultural exports. A long-run analysis is taken within the confines of a contegration testing framework. The main objective of this test os to discover whether the data series need to be differenced, and how many times they must be differenced in order to induce their stationarity. If the data series are found to be integrated of the same order, e.g. (1), then countegration tests can be performed. Error correction models (ECMs) are used to analyze the short-run dynamics departure from the long-run equilibrium relation under investigation. US agricultural exports and the real exchange rate are found to be contegrated. The ECM estimates indicate the existence of a unidirectional causal flow from the real exchange rate to the volume of US. Agricultural exports.
The results of co-integration tests determine the actual form of the data used in all subsequent regression analyses. If the time series are not contegrated, then the first differences form is appropriate for all test variables. Alternatively, the model can be reevaluated and the inclusion of additional test variables may be considered. If, on the other hand, the time series are found to be cointegrated, then an error correction mode estimation method is appropriate.
At this point, a choice must be made between two alternative estimation techniques. The first selection involves running a single regression of the first differences on the right hand side and left-hand side variables. Alternatively, the Engle-Granger two-step estimation procedure can be implemented. In this procedure the focus is on estimating the long-run relationship yielding the error correction term, using either of the two procedure described above yields the long-term and short-term parameters of the model. These parameters can be used to assess policy implication.
When the above time-series methodology is applied to an economic investigation of the relationship between variations in the exchange rate and their impact on agricultural exports, several important observations can be made. First, if both USREV and RER data sets are found to be integrated of the same order, the it is possible to investigate the existence of a long-run relationship between exchange rates and agricultural exports. This investigation can be undertaken within a cointegration testing framework. If empirical evidence of important implications for the relationship between the exchange rate and agricultural exports. Cointegrastion implies the existence of a stable long-run relationship between movements in exchange rates and changes in agricultural exports over longer period of time.
This possibility has important macroeconomic policy implications for the US. agricultural sector. For example, any type of monetary policy which affects the US exchange rate will also have a very impact on the US agricultural sector in the long-run. Establishing the existence of co-integration between USREV and RER data allows investigation of the short-run dynamics of relationship between exchange rate variations and changes in US agricultural export within an ECM testing framework. It also provides information on whether changes in the exchange rate do impact agricultural in the short-run. Consequently, the appreciation of the real exchange rate will reduce the volume of US agricultural exports in the short-run.
RESEARCH DESIGN AND METHODOLOGY
In this chapter we shall examine the framework or design from which this research work shall be carried out, the source of data, data requirements, method of evaluation etc.
SOURCES OF DATA/DATA REQUIREMENT
Data required for this research were obtained from the balance of trade gotten as the difference between total merchandise exports minus imports presented in millions of naira (Local currency) and the exchange rate expressed in Naira in relation to the international currency-the United states Dollar (i.e. Naira/US Dollar exchange rate).
However, the data sources shall be secondary; from the central bank of Nigeria statistical bulletin, federal office of statistics, central Bank of Nigeria Annual report and statement of Account, Journals, Newspapers, Magazines, Internet etc.
This study has undertaken a critical appraisal and an empirical verification of the impact of exchange rate variations on Nigeria’s balance of trade. To this end, therefore, time series data were employed to obtained the empirical result that helped to establish the effect of exchange rate variations on Nigeria’s balance of trade.
We observed from our findings that he exchange rate variations exerts a positive significant relationship between the balance if trade variations in the economy, which is explained on the basis that when exchange rate increases, the level of import will be reduced due to increased prices of import. That is, increase in exchange rate increases prices of imports and thereby reducing imports. It also reduces the prices of exports and consequently increases the volume of exports as well as export revenue. Thus if imports are reduced and exports are increased, the deficit in a country’s balance of trade will be reduced or even completely eliminated and vice versa. The test of the study conforms to our earlier assumption or economic apriori. This was further expressed or elaborated by Devaluation policy during structural Adjustment Programme (SAP), 1986 during Babangida regime.
Conclusively, the researcher finds out based on the various test that there is a positively significant relationship between exchange rate variations and Nigeria’s balance of trade. This conforms to the economic theory of exchange rate and balance of trade.
However, it must be pointed out that some other variables which are not included in the model exerts influence on Nigeria’s balance of trade. Effort could be made to solve balance of trade problem through devaluation of Naira. Therefore, it can be concluded that Nigeria’s exchange rate variation exerts significant influence on the Nigeria’s balance of trade development, coupled with other inherent variables in Nigerian economy shown earlier.
Based on the observation of this study, we hereby recommend as follows:
1. Government should employ policies which aims at diversifying the country’s economic base. These policies should result in enhancing the country’s capabilities to produce on economic base (structure) that relies on the production of multi-sectional tradable goods for foreign exchange earnings, not mono-product economy. This involves increasing the export of primary product and creation of business conditions that will encourage foreign investment for foreign exchange inflows. By so doing, Nigeria’s dependence on the oil sector foreign exchange and the negligence of the agricultural sector will be reduced.
2. The Government should encourage policies that leads to value added exports which will earn more than primary exports. This implies the exportation of semi-finished and finished products. This will increase their competitiveness in the market.
3. Government should implement policies that will enhance capacity utilization to local resources so that our industries will reduce if not eliminate the dependency on foreign materials (tools and equipments) for production so as to enhance a sufficient economic productive base.
4. Nigeria should adopt devaluation as a means of correcting balance of trade problems. Though the previous devaluation adopted in 1986 was not successful, it is because the necessary conditions were not met. The devaluation should be systematically applied such that the conditions necessary for the success would be met.
This condition include:
(i) Demand for import must be elastic so that an increase in price will reduce the volume of imports significantly.
(ii) The demand for the devaluing country’s exports must be elastic so that a fall in price will attract a more than proportionate increase in foreign demand for its products.
(iii) Supply of export products should also be elastic to met increased foreign demand.
(iv) Supply of imports should well be elastic so that reduced demand will lead to a fall in supply of foreign products.
(v) Devaluation must not produce inflation in the domestic economy.
(vi) The economy must be diversified so that there will be many export products.
(vii) Other countries should not retaliate. The effectiveness of devaluation will be greatly reduced if they do.
Impact Of Exchange Rate Variations On Nigeria’s Balance Of Trade