Effect of Currency Devaluation in Developing Countries, a Case Study of Nigeria
CHAPTER ONE
Objective of the Study
The fundamental objectives of this study play host to the implication of naira devaluation to the development of the Nigerian economy.
- Is there a link between exchange rate and real economic variables?
- What are the root causes and consequences of disequilibrium in the price of the naira?
- Is devaluation an appropriate long term solution to structural disequilibrium in the balance of payment?
CHAPTER TWO
REVIEW OF RELATED LITERATURE
Currency Devaluation
Momosu and Akani (2016) affirmed currency devaluation to be an endogenous factor affecting economic performance generally, where the required factors to aid achieve its positive benefits are not available. Yilkal, (2014) perceives devaluation as a deliberate reduction in the value of the currency in a particular nation in relation to other currencies of nations partaking international trade within the framework of the fixed exchange rate to boost growth.
Okaro (2017) currency devaluation is habitually triggered when there is a deficit in trade balance and balance of payment (BOP/BOT) with the 2016-2017naira devaluation in Nigeria associated to shocks springing out from the declining oil price and external economic and financial shocks.
Aiya as cited in Akindiya and Olawole (2015), currency devaluation cuddles acceptance in Nigeria during the Babangida led administration in 1986 designed to achieve a pragmatic exchange and economic growth.
Akindiyo and Olawole (2015) recognize three key traditional approaches to currency devaluation as follows: The elasticity approach, The absorption approach, and The monetary approach.
The Exchange Rate Transmission Mechanism
The link between exchange rate and real economic variables presents important basis for how concerned analysts and policy makers would be with the subject of appropriate valuation of currency units. From the traditional theory of output determination in an open economy, exchange rate exerts influence on national income through the net export variable. As Iyoha (2003) put it, Exchange rate is a channel through which monetary policy impacts key macroeconomic aggregates like output and employment. Accordingly, an increase in exchange rate or reduction in value of local currency is thought to increase the economy’s global competitiveness resulting in increased foreign investment and exports, demand for domestic good, employment and national output. This is clearly in consonance with mechanism for attainment of classical equilibrium. However, a stretch to extreme of theory implies that this will be followed by decline in exchange rate or strengthening of local currency value as result of higher exports and foreign exchange earnings. This will tend to upset earlier equilibrium giving rise to boom-burst cycles and swing in external balance. Strict reliance on the market for sustainable equilibrium would appear to be untenable. In fact, as Kim and Roubini (2000) put it within the model theoretic framework, the exchange rate appreciates in response to a monetary shock; after a few months, it depreciates over time in accordance with certain market parity conditions. Here the complex interaction of such macroeconomic variables as inflation rate, interest rate, oil and non-oil exports, balance of payments as they are transmitted to output through exchange rate is explored in this paper.
CHAPTER THREE
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RESEARCH METHODOLOGY
Research Design
The study embraced the ex-post facto research design. With data from secondary nature by annualized time series from the CBN Statistical Bulletin 1999-2016. A combination of descriptive statistics, regression and Augmented Dickey-Fuller (ADF) test used for unit root test was adopted with an array of analytical tests conducted on the regression model to ensure that the key assumptions underlying the Classical Linear Regression Model (CLRM) were not violated in the test.
CHAPTER FOUR
ANALYSIS
Table 1: Description of the Characteristics of the Variables under Study
CHAPTER FIVE
SUMMARY, RECOMMENDATIONS AND CONCLUSION
This investigation analysis the implication and affiliation of devaluation with emphasis on Nigeria economic development. The fundamental intent is to evaluate the impact to development in Nigeria. The OLS Regression technique signifies the prime technique of estimation pooled with an array of other universal/customary and diagnostic tests. Economic growth proxide by (GDP) shows a positive affiliation with the exchange rate and inflation while, public debt and external debt negative affiliation. The R2 explained 92% of the variation in GDP in the model by the explanatory variables. The positive affiliation embraces a theoretical viewpoint that devaluation boosts economic growth in developed and developing economies. By implication, it is hard to consider or embrace devaluation in Nigeria since its adoption and implementation has always left the economic and investment climate us worse than before since the needed requirements to ensure it impactful benefits are not adequately provided in Nigeria. The argument of this research paper is that rather than Nigeria embracing devaluation as last resort in the event of economic and financial imbalances, government at all levels ought to review other possible solution to improve the economic and financial position of the nation. There is then a robust recommendation and activism for all-round economic diversification, real sector reformation, and periodic fiscal and monetary policies review in relation to the changing economic and financial climate in Nigeria. In recommendation for further research the study recommend data expansion to 2016 in line with the current economic and financial policy review embark upon by the present administration that play host to economic and financial recession, which has once again set the stage for argument on devaluation in Nigeria and an tool to remedy the economic and financial upshot.
The classical view of negative relationship between strength of a currency and economic growth cannot be rejected by empirical evidence in this paper. However the finding of its statistical insignificance implies that perhaps certain extraneous factors may be working to cause static interference on the exchange rate transmission mechanism in the market, and these factors need to be addressed before the process of classical equilibrium can work. It is strongly suggested that these factors lie within the realm of fiscal regime. Accordingly it may be safe to conclude that measures taken in isolation from the monetary end to lower exchange rate will not lead to growth of the economy.
Closely related to the above is that devaluation as a tool cannot be relied upon to grow the economy. Given the prevailing economic structure and in elasticities, devaluation cannot stimulate local production and hence supply of tradable goods for export. It cannot douse in any significant manner the demand for imports without attaining levels that would cause a dislocation to the system; and any devaluation now will create condition for calls for further devaluation in future especially given the state of constant tension between official and parallel markets.
Devaluation may only serve some non-core purposes in the meantime being consequential price and income effects, namely: reflate the naira revenue and fund the skewed budget system to feed into fiscal exuberance which only has nominal effect on the economy. Devaluation will serve to devalue the Nigerian brand and assets and given prevailing structures of the economy, it is doubtful if desired influence on investment decisions would be elicited. Nigerians may need to work harder to settle indebtedness, pay bills to foreigners and sustain production and employment overseas. Accordingly, the costs to devaluation would appear to overwhelm the benefits.
The finding of slightly improved measure of significance of the lag variables only leads us to tentatively conclude that expectations and speculations are reasons for the foreign exchange pressures.
Recommendations
In the light of materials reviewed from literature and empirical findings, the following recommendations are considered helpful in policy formulation and execution:
Devaluation should not be used as a primary policy tool for attainment of macroeconomic equilibrium. Alternative methods should be explored or strengthened.
Monetary authorities should adopt an exchange rate targeting approach which calls for the use of defined fundamental factors to determine equilibrium exchange rate. Thereafter, administrative mechanism may be used to support the market to sustain such a rate by way of occasional intervention. We may call this a managed float system. This would mean non-reliance on the moves of speculators in the determination of exchange rate.
The Central Bank should strengthen the use of trade and exchange control measures to curb illicit and unproductive imports, and encourage diversification in the production of domestic and tradable goods. Such measures include imposition of tariffs and outright ban on a select group of goods in such a manner that protects local businesses without hurting global trade. Accordingly, this protection and incentives should be extended to producers of goods for which the country has comparative advantage and those of high national priority.
Complimentary monetary policy measures to deny liquidity to speculators in the foreign exchange market should be strengthened.
Even more importantly is fiscal-monetary policy convergence in adoption of measures to attain macroeconomic balance without necessarily compromising independence of the monetary authority. In the past, it would appear that the scenario was for ‘the Ministries, Departments and Agencies (MDAs) to create the mess and expect the CBN to clear the mess’. Indeed, given the state of the foreign exchange market today, it can be argued that the fiscal authorities have far reaching role to play in achieving and sustaining equilibrium
Management of expectations must start with monetary and fiscal authorities moving fast to build trust and confidence among market operators. This involves coming up with clear policies, providing leadership, discipline, and integrity. A state of doubt, uncertainty, and opaqueness creates crisis of confidence and expectations and breeds distortion in the market place.
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