BALANCE OF PAYMENT DETERMINATION: THE MONETARY APPROACH
BY
OMORUYI BENEDICTA EFOSA
SSC1104837
DEPARTMENT OF ECONOMICS AND STATISTICS,
FACULTY OF SOCIAL SCIENCE,
UNIVERSITY OF BENIN,
BENIN CITY.
OCTOBER, 2015
BALANCE OF PAYMENT DETERMINATION: THE MONETARY APPROACH
BY
OMORUYI BENEDICTA EFOSA
SSC1104837
BEING A RESEARCH PROJECT SUBMITTED TO THE DEPARTMENT OF ECONOMICS AND STATISTICS, FACULTY OF SOCIAL SCIENCE , UNIVERSITY OF BENIN , BENIN CITY
IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR THE AWARD OF BACHELOR OF SCIENCE (B.sc) IN ECONOMICS AND STATISTICS
OCTOBER, 2015.
CERTIFICATION
This is to certify that this project work was carried out by OMORUYI BENEDICTA EFOSA with the matriculation number SSC11O4837,in the department of ECONOMICS AND STATISTICS faculty of social science, university of Benin, Edo state in fulfillment of the award of a bachelors degree in economics and statistics.
________________________ __________________
Mrs. Eseosa Sowemimo Date
Project Supervisor
_________________________ ___________________
Dr. (Mrs.) E.I. Izilein Date
Project Co-ordinator
_________________________ _________________
Prof.Anthony Monye-Emina Date
Head of Department,
Economics and Statistics
DEDICATION
This research work is dedicated to God Almighty for his infinite love, grace and mercies upon me, throughout this project and this academic programme in general. I also dedicate it to my family, for their great love and support, may God bless them always.
ACKNOWLEDGEMENT
I wish to express my sincere gratitude to God almighty for the successful completion of this project. My special gratitude goes to my project supervisor, MRS ESEOSA SOWEMIMO for her support, invaluable contributions, corrections, and patience throughout the duration of this project work. May God bless you, Amen.
In addition, I am profoundly grateful to my parents ENGR AND MRS W.U OMORUYI for all their sacrifices, contributions, prayers and support throughout my stay in the university. May God bless you.
My appreciation specially goes to my wonderful siblings; Engr. Hope Omoruyi, Mr. Ernest Omoruyi, Dr. Osamudiamwen Omoruyi and Godswill Omoruyi for their immeasurable love and support, may God bless you. Also to Ryan Ernest-Omoruyi, God bless you too.
Special thanks also goes to Dr Uchechukwuka Onyinye Iyere, Mr Erickson Eribo, Mr. Nosakhare Arodoye and Mr Frank Ogbiede for all the encouragement and advice. May God bless you all richly.
This will not be complete if I fail to mention my FRIENDS, Ngozi Njokede, Stephanie Iroghama, Dubem Enaruna, Onyejebose Onwaduegbo, Chioma Ekemezie, Ososewenle Esehien, Onyesomnazu Obikwame, Benjamin Okoye and Oyemwen Imuetiyan. May God bless you all always. This gratitude extends to my roommates Opeoluwa, Bunmi, Blossom, Felicia, Nonye, Cynthia, Annie and Blessing. God Bless you all too.
TABLE OF CONTENT
Title page - - - - - - - - - - ii
Certification - - - - - - - - - iii
Dedication - - - - - - - - - - iv
Acknowledgement - - - - - - - - v
Table of content - - - - - - - - - vi
Abstract - - - - - - - - - - viii
CHAPTER ONE: INTRODUCTION
1.0 Introduction - - - - - - - - - 1
1.1 Background to the Study - - - - - - 1
1.2 Statement of the Problem - - - - - - 4
1.3 Research Questions - - - - - - - 6
1.4 Objectives of the study - - - - - - - 7
1.5 Research Hypothesis - - - - - - - 7
1.6 Significance of the study- - - - - - - 8
1.7 Scope of the study - - - - - - - - 9
1.8 Limitation of the study - - - - - - - 10
CHAPTER TWO: LITERATURE REVIEW
2.1 Conceptual Clarification - - - - - - - 11
2.2 Theoretical Literature - - - - - - - 34
2.3 Empirical Literature - - - - - - - 43
2.4 Exchange rate Fluctuations and Nigeria’s Balance of Payment 48
CHAPTER THREE: THEORITICAL FRAMEWORK AND MODEL SPECIFICATION
3.1 Theoretical framework - - - - - - - 53
3.2 Model specification - - - - - - - 56
3.3 Estimation of Model’s Technique - - - - - 62
3.3.1 Statistical Tests - - - - - - - - 62
3.4 Sources of Data - - - - - - - - 66
CHAPTER FOUR: PRESENTATION AND SUMMARY OF RESULTS
4.1 Presentation of Results - - - - - - - 67
4.2 Summary of Results - - - - - - - 75
4.3 Hypothesis Testing - - - - - - - 78
4.4 Policy Implication of Findings- - - - - - 79
CHAPTER FIVE: SUMMARY OF FINDINGS, RECOMMENDATIONS AND CONCLUSION
5.1 Summary of Findings - - - - - - - 81
5.2 Policy Recommendations - - - - - - 82
5.3 Conclusion - - - - - - - - - 84
BIBLOGRAPHY- - - - - - - - - 85
APPENDIX - - - - - - - - - 88
ABSTRACT
Exchange rate volatility is a widely discussed topic amongst others in economics and finance as it is relevant in virtually every sector in the economy.
This research sets out to investigate the relationship between exchange rate volatility and Nigeria’s balance of payment .The review of theoretical and empirical literature, provided a basis for the selection and specification of model which was used to show how exchange rate volatility impacts on Nigeria’s balance of payment.
The data used in carrying out this research was sourced from the central bank of Nigeria’s statistical bulletin (2013) and the National bureau of statistics. The sample size employed for the course of this study covers a period of 30years (1983-2013).
The estimation techniques employed in this research include; the Johansen co-integration test for long-run relationship and the short-term error correction mechanism .The Johansen co-integration test shows there’s a long-run relationship between exchange rate and the balance of payment while the error correction model indicates a positive relationship between exchange rate and the balance of payment.
Therefore it was recommended that exchange rate liberalization should be adopted by the monetary authorities in order to promote fairness and attract foreign investment which will ultimately lead to a favourable balance of payment.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The exchange rate is perhaps one of the most widely discussed topics in Nigeria today. This is not surprising given the macro-economic importance, especially in a highly import dependent economy as Nigeria. However, following the fluctuations of the Naira in 1986, a policy was induced by the structural adjustment programme (SAP).This made the subject of exchange rate, a topical issue in Nigeria. The goal of every economy is to be stable, and to have a balanced balance of payment. As result of using the floating foreign exchange determination system, the country achieved that. The country also embarked on devaluation to promote export and stabilise the rate of exchange.
Prior to 1986, Nigeria was on a fixed exchange rate determination system. At that time, Naira was very strong in reference to dollar. The exchange rate was one naira to one U.S dollar that is; #1 =$1.The increasing demand for foreign exchange and the inability of the exchange control system to evolve, an appropriate mechanism for foreign exchange allocation in consonance with the goal of internal balance, made the fixed exchange rate determination system to be discarded in September, 26 1986 while the structural adjustment programme (SAP) came in.
The main objective of the new exchange rate policy (SAP), was to pressure the value of the domestic currency, maintain a favourable external balance alongside the overall goal of macroeconomic stability and to determine a realistic exchange rate for the Naira. It was between 1973 and 1979,that the new SAP policy contributed for more than 70% of the nation''s GDP and played a vital role, in the increase of its balance of payment (BOP).
Nzolta (2004) defines Foreign Exchange as the value of foreign nation’s currency in terms of the home nation currency. In finance, exchange rate between two currencies specify how much one currency is worth in terms of the other.
Devaluation is the fall in fixed exchange rate which reduces the value of a currency in terms of other currencies. What is being discussed in this study however, is determining how the reduction in the value of a currency, with respect to the currency of another country can lead to the fluctuation of exchange rate. It also discusses how this reduction, affect the record of all monetary transactions, between a country and another, whether it is visible or invisible in a period of time. Nigeria is currently facing serious problems regarding foreign exchange ratio (which is very low in comparison to other countries) as well as balance of payment, which is clearly in disequilibrium and in deficit. As a result of this, the Economy is retrogressing and the citizens are clearly suffering.
It is important to know that economic objectives are usually the main considerations in determining the Exchange control. From 1982 – 1983, when Nigeria’s naira has been devalued by 10%, the British pound sterling and the naira was 1:1 ratio. The Central Bank of Nigeria applied a Basket of currency approach from 1979, as the guide in determining the exchange rate which is usually 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 with the American dollars, and the British Pound Sterling on the exchange rate mechanism. After the structural adjustment programme, the Government established the foreign exchange market (FEM), to stabilize the exchange rate depending on the state of the balance of payments, the rate of inflation, domestic liquidity and employment.
Between 1986 and 2003, the Federal Government, experimented with different exchange rate policies. None of them made a remarkable impact in the growth of the economy’s balance of payment, before it was changed. The inconsistency in policies, and lack of continuity in exchange rate policies, aggregated an unstable nature for the Naira’s rate.
Therefore, the Nigeria’s external sector was overheated and fragile and was characterized by over-valuation of the Naira’s exchange rate. It was also characterized by accumulation of trade arrears, continuous decline in foreign exchange earnings and increasing debt service obligations that resulted from excessive debt burden.