The Impact Of Devaluation Of Naira On Nigeria’s Balance Of Payments (An Econometric Analysis)

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The Impact Of Devaluation Of Naira On Nigeria’s Balance Of Payments (An Econometric Analysis)


The objective of this study is to access the impact of devaluation of the naira on Nigeria’s balance of payment. Before the dominance of the oil sector, particularly between 1960-1970, the balance of payment was less erratic. However, since 1970, the balance of payment has swunged at one time or the other from a position of strength to that of the weakness with a decline in foreign exchange earnings. This has been attributed to the global glut in the petroleum industry and the relatively high expenditure on impact by Nigeria because of work domestic supply capability.

The major finding of this study was various exchange regime adopted by Nigeria government so far. A review of the effect of the different exchange rate system reviews that the fixed exchange rate system, which characterized the military regimes in Nigeria resulted in over-valuation of the naira relative to other currency and hence resulted in self distortion in macro economic variables. The flexible exchange rate system, on the other hand, was resorted to during the SAP to restore the real value of naira. At present, the Dutch auction system is being used to determine the exchange rate in Nigeria.

In an attempt to correct the serious disequilibrium in the external sector of the economy, the control system was replaced with a market based system with inception of SAP in June, 1986. The main achievement of the new system are the elimination of payment arrears, the increase in domestic capacity utilization due to the increase in the local source of raw materials, elimination of the over-valuation of the naira exchange management.

However the problems of the dependence on the oil sector for foreign earnings, continuous depreciation of the naira and the attendant inflationary expectation are yet to be resolved.

Table of Contents

Chapter One


  • 1.0 Historical Background of the Study
  • 1.1 Introduction
  • 1.2 Statement of the Problems
  • 1.3 Research Objectives
  • 1.4 Research Hypothesis
  • 1.5 Model Specification
  • 1.6 Significance of the Study
  • 1.7 Scope and Limitation of the Study
  • 1.8 Sources of Data Collection
  • 1.9 Organization of the Study
  • References

Chapter Two:

Literature Review

  • 2.0 an Overview of Devaluation of the Naira on Nigeria’s Balance of Payment
  • 2.1 Empirical Evidence of Devaluation on Naira
  • 2.2 Theoretical Framework for Devaluation of the Naira
  • 2.3 the Implication of Devaluation of the Naira on Nigeria’s Balance of Payment
  • 2.3.1 Reasons for Devaluation
  • 2.3.2 Short-run Effect of Devaluation of the Naira on the Nigeria’s Balance of Payment (Influence of Import Structure)
  • 2.4 Exchange Rate Regimes in Nigeria Economy
  • 2.5 Exchange Rate Management Before Sap 1980-june 1986
  • 2.6 Management of Exchange Rate Under Sap July 1986-1990
  • 2.7 Appraisal of the Exchange Rate Management
  • 2.8 Trend and Profile of Nigeria’s Balance of Payment
  • 2.9 Approaches to Balance of Payment.
  • References

Chapter Three:

Research Methodology and Method of Data Collection

  • 3.0 Introduction
  • 3.1 Sources and Nature of Data Collection
  • 3.2 Model Specification and Description of Variables
  • 3.3 Analysis of the Technique
  • References

Chapter Four:

Data Analysis and Interpretation of Result

  • 4.0 Introduction
  • 4.1 Statement of Hypothesis
  • 4.2 Sources and Nature of Data
  • 4.3 Specification of Data
  • 4.4 Data Presentation
  • 4.5 Model Specification
  • 4.6 Empirical Result and Interpretation of the Regression Results
  • 4.7 Presentation of Regression at a Glance

Chapter Five:

Summary, Conclusion and Policy Recommendations

  • 5.0 Summary and Conclusion
  • 5.1 Major Findings
  • 5.2 Policy Recommendation
  • Bibliography
  • Appendix

Chapter One


1.0 Background to the Study

Prior to 1958, when Nigeria exported crude oil for the first time, Nigerian economy had relied on export of cash crops for her foreign exchange. It was only in the early 1970’s when oil boom of the mid 1970s and the resulting favourable balance of payments position led to an era of liberal food import policy. Import restrictions were lifted in some cases and import duties were either abolished or reduced in others. The short spell of depression in the oil market in the late 1970s gave rise to tightening of food import tariffs and import prohibition, which was again relaxed as the oil market situation improved the total government revenue to N98.2 billion (NNPC publication, September 1978).

The period 1981-1986 was one of economic depression and balance of payment crisis. Trade controls were reintroduced to correct the severe distortion. Huge tariffs or outright bans were imposed on most food imports. Export bans and duties were also reviewed to address principally the domestic inflation problem. Centralized marketing was reinforced to increase government revenue.

The 1986 budget introduced the trade liberalization regime as a component of the structural adjustment programme (SAP). The regime included abolition of the import licensing system, reduction of import restrictions, modification of advance payment of import duties, overhauling of custom and excise duty schedules, establishment of tariff review board, allowance of domiciliary accounts operation, abolition of export prohibition, dissolution of commodity boards, and establishment of an export development fund, guarantee scheme, insurance scheme and export promotion zone. The main objectives of SAP include the following:

  1. To restructure and diversify the productive base of the economy in order to reduce dependence on the oil sector and imports.
  2. To achieve fiscal and monetary balance of payment viability over the period.
  3. To lesson the dominance of unproductive investment in the public sector, improve the sector’s efficiency and enhance the growth potential of the sector.

The main element of accomplishing the objectives of SAP in Nigeria was the adoption of the realistic exchange rate regime through the adoption of the second tier foreign market: SFEM, FEM, IFMS Bureau de change etc.

The intention here was to remove the over valuation of the naira through the market forces of demand and supply to determine the realistic exchange rate of the naira.

Between 1975 and 1985 the naira was considered to be over value. In fact the structural problems of foreign exchange scarcity, liquidity problems, over invoicing of import can be traced back to this over valuation. It was hoped that these structural problem would be gotten rig if a realistic exchange rate could be achieved so that incentives can be created for non-oil exports, capital flow can be discouraged and most of all balance of payment can be solved.

1.1 Introduction

The deterioration of Nigeria’s balance of payments since the late 1970’s has in one way or the other been associated with the exchange rate. This has led to a number of heated debates as to whether Nigeria should devalue her currency or not as proposed by the International Monetary Fund (IMF). The arguments have been based on the fact that the naira was over valued (Aboyade 1982).

The exchange rate represents the price at which purchases and sales of foreign currency (or claims on it such as cheques and promissory notes) take place. It is the price of one currency in term of another currency. Within a minimum period of less than two months, the naira has cascaded from 116 to 165 to a dollar in the parallel market, losing 49 in the process. All steps taken so far to firm up the naira, or at least stop the slide have, at best, remained unsuccessful. However, the Central bank of Nigeria, explained that it had deliberately allowed the Nigeria’s foreign exchange market to adjust to the global shock in the oil market.

Foreign exchange resources are derived and expended in the course of effecting economic transactions between the residents of the country and the rest of the world. In this sense there is a line between foreign exchange transaction and the balance of payments.

While foreign exchange transaction reflect cash flows arising from international operations, the balance of payment looks at the actual operations, the balance of payment looks at the actual movement of goods, services and changes in financial assets and liabilities. When adjustment is made to cash flow statement arising from International transaction in foreign exchange they are brought to balance of payment standard. The state of foreign exchange reserves has implication for the ability to finance temporary payment difficulties. Since the down turn in oil export began in 1981, Nigeria’s external trade transaction has been facing a lot of problems;

The recession which accompanied the collapse of oil fortunes had considerably reduced activities in an economy with a high import dependency ratio. Central Bank records indicate that foreign exchange of inflow dropped from $26 billion in 1980 to $12 billion in 1984 and to low as $7 billion in 1986 (CBN Economic and financial review 1987).

To further complicate the problem of external trade, Nigeria accumulates huge foreign debts servicing burden and worsened relation between the country and its traditional trade creditors. The consequence of this is considerably reduced inflow of foreign capital.

The balance of payment problems of the country in the late 1960s largely dictated the trade policies in the 1970s. The policies in the 1970s also sought to promote domestic production and generate revenue for government expenditure. There was considerable restriction and regulation of the trade sector before liberalization (i.e. between 1970 and 1985). Import duties and tariffs were quite high (as much as 70% in 1975) to discourage imports. There were also quantitative restrictions on some food imports through import licensing. On the other hand, the focus of export policy was on cash crops (export crops), with the primary purpose being to raise revenue and to moderate farmers’ returns and domestic food prices. Main export policy instruments were export duties, sales taxes and centralized marketing. Exchange rate was also administratively determined to ensure cheap imports of raw materials for import-substituting local manufacturing industries.

Before the introduction of the Structural adjustment Programme (SAP). The basic framework for foreign exchange management was the exchange control act of 1962 which was reinforced by the economic stabilization (Act of 1982). The pitfalls of this exchange control led to its abandonment.

The SAP objectives include the achievement of equilibrium in the balance of payment and fiscal viability among others. Under the new dispensation, the framework for foreign exchange market (FEM) was conceived as a mechanism for the determination of an appropriate exchange rate for the naira in order to reduce the pressure in foreign exchange resources and stabilize the balance of payment.

Since the inception of the FEM system in September, 1986, the naira has undergone substantial devaluation. This research project aims at examining the implications of the devaluation of the naira on the Nigeria balance of payment.

1.2 Statement of the Problem

The oil boom of the 1970’s brought with it fundamental changes in Nigerian economy. The first is the over-dependence of the economy on crude petroleum export as the main foreign exchange earning and government revenue. By 1980 the oil sector which accounted for 22% of the gross domestic product (GDP) provided 80% of the government revenue and over 96% of export earning (CBN 1987).

Secondly, the competitiveness of the agricultural sector in the international market was eroded by the over -valued naira exchange rate, inadequate pricing policies, rural urban migration and the neglect arising from so called oil syndrome.

Thirdly, the structure of the policy incentives and control encouraged import-oriented production and consumption pattern with little incentives for non-oil exports.

From about mid-1981, the world oil market started to collapse and with the collapse an economic crisis emerged in Nigeria. The result decline in oil export and price was reflected in decline in foreign exchange receipt and government revenue.

Thus external reserves fall sharply and debt mounted in the face of rising imports, balance of payment deficits wideness and effort at containing the adverse development created some other serious problems such a s economic depression, rising prices and unemployment.

1.3 Research Objectives

The aim and objectives of this research is as follows:

  1. To examine the effects of devaluation of the naira on Nigeria balance of payment position.
  2. To consider the exchange rate management in Nigeria and its effects on the balance of payments. Particularly, before and under the structural adjustment programmes (SAP period).
  3. To suggests way and means of improving the balance of payment and overall economic growth and development of the country.

1.4 Research Hypothesis

  1. Ho: There is no significant relationship between the devaluation of naira and economic growth of the country
    H1: There is significant relationship between the devaluation of naira and the economic growth of the country.
  2. Ho: There is no significant relationship between the devaluation of naira and the equilibrium balance of payment.
    H1: There is significant relationship between the devaluation of naira and the equilibrium balance of payment.
  3. Ho: There is no significant relationship between the exchange rate and economic growth.
    H1: There is a significant relationship between the exchange rate and economic growth.

1.5 Model Specification

The first and most important step an econometrician has to take in attempting any study is to express the relationship existing among the variables under discourse in mathematical form. The developed estimating equation will be of assistance to know how well the estimating equation actually describes the relationship between the variables.

In the model specified below, we intend to investigate the relationship between balance of payment, exchange rate and economic growth of the Nigerian economy.

Model One

Y = b0 + b1X1 + b2X2 + b3X3 + b4X4 + µ


  • Y = real GDP
  • X1 = Inflation rate
  • X2 = Volume of exports
  • X3 = Volume of imports
  • X4 = Exchange rate
  • B1, B2, B3 and B4= coefficient of associated variables
  • µ = Stochastic error term
Model Two

Y = b0 + b1 X1+ b2X2+ µ


  • Y = Balance of payment
  • X1 = Inflation rate
  • X2 = Exchange rate
Model Three

Y= B0 + B1X + µ


  • Y = Gross Domestic Product
  • X = Exchange rate

1.6 Significance of the Study

This study is important because it will help the CBN to determine whether to continue operating the market mechanism system with the overall economic objectives which it aims at achieving.

These objectives are meant to maintain a healthy balance of payment position, determine an appropriate exchange rate of the naira and price stability. This will help to achieve a reasonable level of economic growth.

The objectives of the exchange rate policies as summarized by lirsch (1972) include.

  1. Adjustment process; The adjustment process whereby the regime should help to promote a satisfactory working of the adjustment of payment of imbalances.
  2. Promotion of the world trade, employment real income and economic development. This means that exchange rate regime should help to support elimination restrictions and maintenance of a multilateral system of payment.
  3. Support appropriate economic and financial policies of countries such as healthy balance of payment position, price stability, full employment and a reasonable level of economic growth; therefore, if the above objectives are not achieved, then there is no for the country to continue with the operation of the market mechanism system of the exchange rate.

1.7 Scope and Limitation of the Study

This research is limited to the balance of payment and exchange rate management between 1983-2007. This study therefore examined the exchange rate management in Nigeria and its effects on the balance of payment within the period under review.

1.8 Sources of Data Collection

The statistical data used for this research will be an intensive library research. This include books, relevant journals, newspapers, magazine, seminar papers, essential secondary data collected from economic researches such as CBN publications, Federal Office of Statistics (FOS), Financial and Economic Review of the CBN.

1.9 Organization of the Study

This research is divided into five chapters.

  1. Chapter one is the historical background, general introduction, the statement of problems, objectives of the study, research hypothesis, scope and limitation; sources of data, organization of the study are examined in this chapter.
  2. Chapter two is the literature review which includes the theoretical and empherical review of different approaches to balance of payments and devaluation.
  3. Chapter three provides the research methodology and method of data collection. This analysis will be based on secondary data obtain from CBN Economic and Financial Review, publications, textbooks and journals.
  4. Chapter four contains the method of data analysis, data analysis and interpretations.
  5. Chapter five being the last chapters contains the summary, findings, policy recommendation and conclusions.

Chapter Five

Summary, Conclusion and Recommendations

5.1 Summary

This research examined the implication of the devaluation of the Naira on Nigeria’s balance of payment during the period of 1983-2007. The main objective of devaluation is to lower the prices of export in terms of foreign currency to encourage exports and discourage imports thus improving the overall balance of payments. During the pre SAP era, the 1962 exchange control was the basic framework for exchange rate management in Nigeria. The Act made provision for measures designed to increase foreign exchange and preserve the nation’s foreign exchange reserves. The administration of the exchange rate led to the over-valuation of the exchange rate of naira and a massive outflow of foreign exchange due to mass import. With the introduction of SAP, a market determined system replaced the administered exchange rate. The objectives of SAP include the achievement of balance of payment equilibrium and fiscal policy viability, and sustained economic growth. To achieve a balance of payment equilibrium and fiscal viability market, determined exchange rate mechanism was developed with the commencement of foreign exchange autonomy through the foreign exchange market in September 1986. Complementary and fiscal policies were also introduced to enable the naira attain realistic level. This led to the devaluation of the naira exchange rate.

The main achievements of the market determined system are the elimination of payment arrears since transaction are on current payment basis, depreciation of the over valued currency, increased local sourcing of raw material, improvement in external reserves capacity utilization and improvement in balance of payments. The improvement in balance of payment is due to the improvement in exports and the relative stability in import caused by the depreciation of the naira exchange rate which favoured exports. However little has been achieved due to the devaluation of the naira. The depreciation of the currency is aimed at diversifying the economy as one of its objectives. This has not seen achieved. The economy still depends on crude oil exports for its foreign exchange earnings. Devaluation has no impact on crude oil because of the OPEC quota and its price which is in dollar. The fluctuation in the price of crude oil reflected in the fluctuation on balance of payments. The high dept service has also affected the balance of payment position. The devaluation has not contributed significantly to agricultural sector. The reason is that agricultural commodities prices are less flexible in the world market to take advantage of devaluation. Not much has been achieved in reducing imports as expected.

The industries in the country are import oriented that is to say that the industries depend most on imported raw materials for production due to the absence of capital goods industries. The continuous depreciation of the naira exchange rate ahs contributed to the rise in the cost of production in the manufacturing sector leading to the overall rise in prices. The traditional problems of exchange rate flexibility such as inflation, coupled with inadequacy of foreign exchange resources, low elasticity of imports has compounded the economics of Nigeria.

To improve the situation new measures such as subsidies on agricultural products and incentives to local industries to stimulate non-oil exports should be intensified, generous incentive should be given to imports substitution industries to encourage local processing of goods. This will lead to an increase in domestic output which will rise the level of foreign exchange and cut down import and finally improve the position of the balance of payment of the country.

5.1 Conclusion

The findings of the study shows the relationship which exists through the analysis of some economic indicators used in the research work, our findings cover the period before, during and after S.A.P.

The findings from the research work show the total effect of economic indicator on devaluation of naira using t-statistic and f-ratio.

5.2 Recommendations

The important issue of that must be addressed by Nigeria economy is how effective a devaluation policy will be in improving the standard of living of its citizens. It is our views that will the present structure of most developing economies, local currency depreciation is not an effective tool for achieving an improvement in foreign exchange earnings because of the reason discussed above. Devaluation can be used constructively in Nigerian economy where these exists a combination of elasticity of supply of export greater than unity and elasticity of domestic demand for import that is greater than unity (O > 1). In order to meet these requirements, the structurally-restricted nature of Nigerian economy has to be dealt with initially.

Policies which aim at diversifying Nigerian economic base on the long run must be implemented. These structural reform type policies should result in an enhancement of the country’s capabilities to produce an economic base that relies on the production of multi-sectorial trading goods for foreign exchange earnings. Only if such an economic structure is attained can there be a strong possibility of sustaining any improvement in balance of payment deficit problems through the use of devaluation and absorption-reduction policies. As Nigerian economy became more diversified, the severe economic crisis that ordinary occurs in one-sector dominant economy would be minimize if alternative uses are found for the resources made available through the adoption of the absorption-reduction policy in combination with devaluation.

It is important to point out, however, that the existence of a balance of payment surplus or deficit in Nigeria economy should not always be viewed as beneficial or detrimental, respectively. The balance of payments situation appropriate to a country must be related to the particular circumstances confronting the economy at a given time. For instance, an economically advanced country such as the United States, with the intent of giving financial assistance for the purpose of encouraging economic progress in Nigeria may need to maintain a surplus in the balance of payment account. However, for Nigeria with to tend vigorously must undertake new development project in order to speed the process of economic growth, the maintenance of a balance of payment surplus is not necessary. It is expected that Nigeria would operate temporarily with a balance of payment deficit, long as the deficit spending is properly channeled into the country’s capital expansion development projects which are designed to improve the balance of payment problem in the long-run. Consequently, the stimulation of an increase in the net foreign exchange earnings through the policy of devaluation must be viewed as a long-run measure with regard to most developing countries with a one-sector dominant economy.

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