Trade balance, exchange rate movements and economic growth in Nigeria: a disaggregated approach

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Department of Economics, University of Uyo

Uyo, Akwa Ibom State

Trade balance, exchange rate movements and economic growth in Nigeria: a disaggregated approach

Nigeria

Annotation

The influence of trade balance and exchange rate movement on economic growth in Nigeria, as well as the determinants of the exchange rate, is examined in this study for the period 1981 to 2020. The study follows the autoregressive distributed lag approach to estimate the four models specified in the study. In Model I, total trade is observed to have a positive and significant effect on economic growth, while the exchange rate exerts a negative and significant effect. A unit percent increase in total trade balance leads to a 0.0039% increase in economic growth, while a unit percent increase in exchange rate leads to a 0.0510% decrease in economic growth. In the second model, both oil trade balance and exchange rate exert a negative and significant effect on economic growth. A unit percent increase in oil trade balance and exchange rate leads to a 0.0113% and 0.0758% decrease in economic growth, respectively. In the third model, the non-oil trade balance exerts a negative and significant effect on economic growth, while the exchange rate exerts a negative but insignificant effect on economic growth. Finally, Model IV, which captures the determinants of the exchange rate in Nigeria, reveals that economic growth, external reserves, inflation, and total trade balance are the major drivers of the exchange rate in Nigeria since they exert a significant effect. It follows from the findings that stimulating domestic production to boost non-oil exports will help to ensure exchange rate stability that will promote growth within the Nigerian economy.

Keywords: exchange rate, economic growth, balance of trade, international trade.

Анотація

Досягнення сприятливого платіжного балансу є однією з основних макроекономічних цілей країни. Досягти цього означає розпочати ефективну політику, яка сприятиме експорту та перешкоджає надмірному імпорту. Такий акт гарантує, що країна досягне сприятливого торгового балансу, який не буде загрожувати балансу поточного рахунку.

У цій статті ми дослідили вплив торговельного балансу та зміни обмінного курсу на економічне зростання в Нігерії, а також детермінанти обмінного курсу за період з 1981 по 2020 рр. Дослідження виконане з застосуванням авторегресивного розподіленого підходу з затримкою для оцінки чотирьох моделей.

У моделі I спостерігається позитивний і значний вплив загальної торгівлі на економічне зростання, тоді як обмінний курс має значний негативний вплив. Збільшення загального торгового балансу призводить до зростання економічного зростання на 0,0039%; тоді як збільшення на один відсоток обмінного курсу призводить до зниження економічного зростання на 0,0510%.

Друга модель дозволила виявити негативний та істотний вплив на економічне зростання балансу торгівлі нафтою і валютного курсу. Збільшення балансу торгівлі нафтою та обмінного курсу на один відсоток призводить до зниження економічного зростання на 0,0113% та 0,0758% відповідно.

У третій моделі виявлено, що ненафтовий торговий баланс чинить негативний і значний вплив на економічне зростання, натомість обмінний курс чинить негативний, але незначний вплив на економічне зростання.

Нарешті, Модель IV, яка фіксує детермінанти обмінного курсу в Нігерії, показує, що економічне зростання, зовнішні резерви, інфляція та загальний торговий баланс є основними чинниками обмінного курсу в Нігерії. З отриманих висновків випливає, що стимулювання внутрішнього виробництва для збільшення ненафтового експорту допоможе забезпечити стабільність обмінного курсу, що сприятиме зростанню економіки Нігерії.

Introduction

Achieving a favorable balance of payments is one of the core macroeconomic goals of a nation. To achieve such implies embarking on sound policies that will promote exports and discourage excessive imports. Such act ensures that the country achieves a favorable trade balance that will not strain the current account balance. The rising demand for imported products in Nigeria has continued to wreak havoc on the population, forcing the currency to depreciate in recent years. Furthermore, the persistent current account deficits that have required a country to demand more foreign currency than it obtains from export sales have had a negative impact on the economy. The consequences of this practice include, but are not limited to, currency devaluation, trade diversion, job loss in the importing country's home country, low per capita income, and a worse living standard for the inhabitants (Onakoya, Aworinde and Yinusa, 2019). This shows that volatility in trade balances and currency rates may stymie inclusive growth.

An exchange rate policy's aims include selecting an acceptable exchange rate and guaranteeing its stability. Efforts have been made throughout the years to achieve these goals via the use of various approaches and possibilities to create efficiency in the foreign exchange market. Nigeria's exchange rate arrangements evolved from a fixed regime in the 1960s to a pegged system between the 1970s and the mid-1980s, and eventually to different forms of the floating regime beginning in 1986 with deregulation and the implementation of the structural adjustment program (SAP). Since the SAP, the most prevalent floating system in Nigeria has been a managed floating exchange rate regime with no clear commitment to protecting any specific parity (Akpan and Atan, 2015).

The Dutch Auction System (DAS) was re-introduced on July 22, 2002, following the failures of the variants of the flexible exchange rate mechanism (the Autonomous Foreign Exchange Market, AFEM, launched in 1995 and the Inter-Bank Foreign Exchange Market, IFEM, implemented in 1999) to assure exchange rate stability. The DAS was designed to accomplish three goals: reduce the parallel market premium, save diminishing foreign reserves, and create a realistic naira exchange rate (Akpan and Atan, 2015). The DAS aided in the stabilization of the naira exchange rate, the reduction of the widening premium, the conservation of foreign reserves, and the reduction of authorized dealers' speculative inclinations. Since 2003, the foreign exchange market has remained largely stable.

The external reserve position, which could guarantee adequate funding of the market by the CBN; reduce inflationary pressures; instrument autonomy of the CBN and its prompt deployment of monetary control instruments in support of the DAS, as well as the bi-weekly auctions as opposed to the previous fortnightly auctions, thus assuring a steady supply of foreign exchange, were among the conditions that facilitated the re-introduction of DAS in 2002 (Mordi, 2006).

On February 20, 2006, the CBN introduced the Wholesale Dutch Auction System (WDAS) to further liberalize the market, reduce the arbitrage premium between the official interbank and bureau de change parts of the markets, and achieve convergence. This was intended to solidify the retail Dutch Auction System's gains as well as broaden the foreign currency market in order to provide a realistic naira exchange rate. Authorized dealers were allowed to deal in foreign currencies on their own accounts for resale to their clients under this system. Presently, the exchange rate regime follows the managed float system. Could these variants of exchange rate exert some degree of influence on the exchange rate of Nigeria? Figure 1 displays the exchange rate movements in Nigeria.

Fig. 1. Exchange rate movements in Nigeria, 1981 to 2020

The period 1981 to 1997 was posed with a somewhat stable exchange rate. It averaged N2.40/$1 between 1981 to 1989 but rose significantly to an average of N18.53/$1 between 1990 to 1998. Thereafter, the exchange naira-dollar exchange rate faced a tremendous depreciation by rising from N21.89/$1 in 1998 to N92.69/$1 in 1990. This was followed by a further depreciation till date. Between 2000 to 2010, exchange rate averaged N127.48/$1 with the highest of N150.30/$1 as at 2010; while between 2011 and 2020, it averaged N235.16/$1 with the highest being N358.81/$1 as at 2020 (CBN, 2020). Could it be that this drastic depreciation of the currency is as a result of the declining exports and the attendant unfavorable trade balance which may have a deteriorating effect on economic growth over the years? Figure 2 reflects the nature of trade balance and economic growth of Nigeria. In Figure 2, the oil trade balance is reflected in Panel I, non-oil trade balance in panel II, total trade balance in Panel III, and growth rate of real GDP in panel IV.

Fig. 2. Trends of trade balance and real GDP growth rate

In panel I, the behavior of oil trade balance is portrayed. It is observed that oil trade balance in the 1980s was minimal and stable till 1993 where it started to rise sharply due to high demand for oil in the international oil market. Meanwhile, there have been series of fluctuations in the oil trade balance due to shocks in the international oil market. Panel II captures the non-oil trade balance where it is observed that the nation has been witnessing negative non-oil trade balance over the years. Though it was minimal in the 1980s and 1990s, the trend has been discouraging right from 2000 where the non-oil trade balance declined sharply till 2020, reaching an all-time low of -17,183,926.74 billion naira (CBN, 2020).

In panel III, the trend of total trade balance is presented. It is noticed that it was negative from 1981 to 1983, before recovering steading till 1997 before it plunges to -85,562.00 billion naira as at 1998. Thereafter, the nation enjoyed an all-time sixteen years' favorable trade balance from 1999 till 2014 averaging 3,016,923.94 billion naira within the same period. Subsequently, the country also moved into a two-year negative trade balance for 2015 and 2016 before a recovery in 2017 and 2018. Due to the covid-19 pandemic and its attendant economic crisis, the country moved into a negative total trade balance of -8,168,415.84 billion naira in 2020 (CBN, 2020).

As pointed out by Obi et al. (2016) cited in Alasha (2020), Nigeria aspires to become one of the world's leading developed economies by 2050. Meanwhile, the present economic situation seems to raise question on the possibility of reaching such goal. The non-trade balance is fast deteriorating and the international oil market is faced with shocks leaving the nation at a cross-road. Coupled with the Covid-19 pandemic, the socio-economic situation of the country is declining. Since no economy can exist in isolation, the need for international trade becomes sacrosanct. Meanwhile, Nigeria is facing international trade issues coupled with currency depreciation.

Nigeria's currency has recently seen the worst depreciation in its history; the drop in her exchange rate has been attributed to the depletion of her reserves, which has been prompted by the worldwide drop in oil prices (Yusuf, Oyegoke, Gylych and Haruna. 2019). Nigeria, a single-product exporter heavily reliant on crude oil sales, has seen a drop in foreign exchange earnings and is currently struggling to satisfy the demands of its teeming import-dependent population. The unusually wide gap between parallel market and official naira rates is a source of worry for the monetary authorities, who have tried a variety of initiatives to resolve the issue to little avail.

Although it has long been assumed that some key macroeconomic variables determine a country's optimal real exchange rate, and various theories abound as to what typically determines exchange rates, the recent decline of exchange rates has occurred in some cases without any corresponding link to existing macroeconomic fundamentals (Yusuf et al., 2019). This explains why exchange rate determination has recently gained in popularity and attention, as it appears to be one of the most significant topics in the theoretical area of monetary economics. Understanding what drives exchange rates is more important than ever, since knowing its drivers, particularly in a developing country like Nigeria, may help the sovereign monetary authority make better policy decisions.

Review of Related Literature

Theories of Exchange Rate

Three basic approaches are used to explain the link between the exchange rate and trade balances in the theoretical literature - the trade or elasticity approach, the absorption approach, and the monetary approach. Consistent with the elasticity approach, the effect of devaluation on trade balance is determined by the elasticity of imports and exports. This theory's proponents believe that a short-term shift in the exchange rate may be dominated by transactions, resulting in a decline in the trade balance. In the long term, this phenomena changes, and the quantities of exports and imports adapt, resulting in an increase in their elasticities and, as a result, a quantity change. As quantity changes, the international price of the devaluing country's exports falls, but the price of imported items rises, lowering demand (Eke, Eke and Obafemi, 2015).

The absorption approach, developed by Sidney Alexander and popularized by Miles, contends that depreciation of a country's currency may cause the terms of trade to deteriorate, shifting expenditure away from foreign goods and toward domestically produced goods, thereby improving the country's trade balance. It was created in response to the elasticity approach's more restrictive assumptions, and it emphasizes the macroeconomic impact of currency depreciation (Eke et al., 2015).

The monetary approach, developed by Robert Mundell and Harry Johnson, became fully developed in the 1970s and views exchange rate-trade balance relations as a purely monetary phenomenon, positing that money plays an important role in the long run as both a disturbance and an adjustment in a country's balance of payment (Eke et al, 2015). Consistent with this idea, the exchange rate is controlled by the intersection of two nations' supply and demand for money. The monetary model is based on the idea that devaluation decreases the actual worth of cash balances and/or changes in relative prices of traded and non-traded products, resulting in an improvement in the trade balance and the balance of payments (Eke et al., 2015).

International Trade Theories

The theory of trade relevant in this study are the “absolute cost advantage” (ACA) and “comparative cost advantage” (CCA). The ACA is a classical economist's international trade theory. The ACA theory of international trade was developed by Adam Smith. Smith (1776) stated in his research of international trade that trade between countries is beneficial. Consistent with the theory, a nation has an absolute advantage in producing a product when it is more efficient than any other country. As a result, if two countries specialize in producing different items (in which each has a distinct edge) and trade with one another, both countries will have more of both products accessible for consumption (Effiong and Okon, 2020). Consequently, trading relationships are mutually advantageous. International trade interactions, according to Smith, will result in mutually beneficial exchanges that will contribute to economic advancement. This traditional view promotes international trade as a driver of economic growth and progress (Effiong and Okon, 2020).

Consistent with the CCA trade theory, international trade benefits participating nations even if they have an absolute advantage in production. David Ricardo proposed this theory in 1817. In keeping with the CCA theory, even if a nation has an “absolute advantage” in producing two items over others, trade with the other country will still result in higher output for both countries than if the more efficient producer handled everything alone (Effiong and Okon, 2020). Consequently, the country with the absolute advantage in manufacturing both items would continue to produce both, but less of the one it will trade for, directing resources to the development of the one in which it has a comparative advantage (Viner, 1937 cited in Effiong and Okon, 2020).

Empirical Literature Review

The empirical literature relating to exchange rate, trade and economic growth has been conducted at both country-specific and cross-country bases. In a cross-country analysis conducted by Polterovich and Popov (2002), foreign exchange reserve accumulation was shown to be positively linked with GDP per capita growth and the level of the real exchange rate. Berg, Ostry, and Zettelmeyer (2008) investigated the elements that contribute to the sustainability of growth episodes in both emerging and established nations. They discovered that overvaluation of the real exchange rate has a negative impact on the length of growth.

Onafowora and Owoye (2008) used quarterly data from January 1980 to April 2001 to assess the influence of currency rate fluctuation on Nigerian exports to the United States. They used cointegration and the VECM framework. Empirical evidence suggests that in the long term, a unique cointegrating vector relating real exports, real foreign income, relative export prices, and real exchange rate volatility exists. Furthermore, heightened volatility in the real exchange rate exacerbated uncertainty regarding profit margins, which has a considerable negative impact on exports in both the short and long run. Their findings also demonstrate that increases in trade terms and actual foreign income have a favorable impact on export activity. Most crucially, they discovered that the post- 1986 structural adjustment period's trade liberalization and economic reform measures aided Nigeria's export performance. Overall, the findings imply that measures aiming at obtaining and maintaining a stable competitive real exchange rate might help to increase Nigeria's exporting operations.

Using data from developing nations, Levy-Yeyati and Sturzenegger (2009) constructed two measures of foreign exchange intervention and discovered that they are positively connected (in separate regression models) with GDP growth and the level of the real exchange rate. The authors interpret the findings of these two studies as evidence that central banks in developing nations accumulate foreign currency reserves in order to maintain undervalued real exchange rates and therefore boost growth (Rapetti, Skott & Razmi, 2011).

Omojomite and Akpokodje (2010) examined the impact of exchange rate adjustments on Nigeria's trade performance from 1986 to 2007. The study was conducted in light of the fact that exchange rate reform (combined with trade policy reforms) was part of Nigeria's economic reform program, which was expected to diversify the economy's export base from oil to non-oil exports through competitiveness in the relative price of non-oil exports, as well as reduce imports, particularly of consumer goods. When the value of the country's currency is decreased through depreciation, it finds a tiny beneficial effect of exchange rate adjustments on non-oil exports. However, even after the implementation of exchange rate changes, the structure of imports, which is pro-consumer products, remained unaltered.

Oyinlola et al. (2010) used exports and imports functions to analyze the long-run and short-run effects of exchange rate and price changes on trade flows in Nigeria. On quarterly data from 1980Q1 to 2007Q4, the limits testing (Auto regressive distributive lag model) technique to cointegration was used. The findings show that relative prices, domestic and foreign income, nominal effective exchange rates, and the stock of external reserves all have a significant impact on Nigeria's trade flows, both in the short and long run. The results also demonstrated that, in the long term, devaluation is more successful than relative pricing in changing import demand in both baseline and enhanced models. In the case of export demand, however, the opposite is true.

Shehu and Youtang (2012) investigated the link between exchange rate volatility (ERV), trade flows, and economic development in Nigeria, a small open country. The empirical analysis is based on time series data from 1970 to 2009 and using time series econometrics technique. The findings show that ERV has a considerable impact on Nigerian trade flows. Their findings suggest the preference for a variable exchange rate regime over a fixed regime since it allows for larger trade flows to Nigeria. They advocated for the efficient diversification of the Nigerian economy by encouraging more manufacturing enterprises to produce enough to fulfil the demand of both domestic and regional West African markets, followed by the complete implementation of a floating exchange rate system.

Adeniran, Yusuf, and Adeyemi (2014) evaluated the influence of exchange rate variations on economic expansion in Nigeria from 1986 to 2013 and discovered that exchange rate fluctuations had a beneficial impact on economic growth. Fapetu and Oloyede (2014) studied the impact of foreign exchange management on Nigerian economic growth. The study's findings demonstrated a long-run association between economic growth, exchange rate, volume of exports, inflation, volume of imports, and foreign direct investment. Ayodele (2014) used the OLS method of multiple regression analysis to empirically evaluate the influence of exchange rates on the Nigerian economy. According to the findings of the analysis, exchange rate depreciation has a negative influence on economic growth because as the rate rises, economic growth suffers.

Khanom, Emu, Uddin, and Farhana (2014) examined the link between the exchange rate and the trade balance of Bangladesh from 1973 to 2011. Their estimated results show that there is a direct link between trade balance and exchange rate. They argue that the real exchange rate is an essential variable in trade balance, and that depreciation will enhance trade balance in the long term, thereby supporting the Marshall-Lerner condition. Wanhui (2014) examines the impact of nominal RMB exchange rate fluctuation on Chinese economic development from 1981 to 2012. The article indicates that exchange rate changes have a favourable long-run influence on import and export commerce.

Akpan and Atan (2015) evaluated the impact of exchange rate changes on Nigerian real output growth. The research investigates the possible direct and indirect association between exchange rates and GDP growth using quarterly data from 1986 to 2010. A simultaneous equations model within a fully specified macroeconomic model is used to determine the link in two methods. An approach known as the “Generalised Method of Moments” was utilized. Consistent with the estimation results, there is little indication of a substantial direct association between changes in the exchange rate and output growth. Rather, monetary variables have had a direct impact on Nigeria's economic growth. These variables have tended to maintain a real exchange rate structure that has been unfavourable to growth. The conclusion is that while reforms in exchange rate management are vital, they are insufficient to resurrect the Nigerian economy. To supplement the approved exchange rate strategy, a substantial program of economic transformation is necessary.

In their analysis, Eke, Eke, and Obafemi (2015) used yearly data to evaluate the influence of currency rates on Nigeria's balance of trade from 1970 to 2012. The study examined the connection using the real exchange rate and the Augmented Dickey Fuller test for unit root, the Johansen test for co-integration, and ECM were the technique of analysis. The co-integration test indicates that trade balances and the variables of interest have a long-term connection. The result indicated that the exchange rate had a considerable negative impact on Nigeria's trade balance over the period. The findings indicated that depreciation of the local currency did not help the country's balance of trade and hence balance of payments condition. As a result, it was advised that steps to stabilize the exchange rate and stop its continued free fall be carefully explored as a policy alternative.

Adelowokan, Adesoye, and Balogun (2015) investigated the impact of exchange rate fluctuation on Nigerian investment and growth between 1986 and 2014. To capture the relationships between the exchange rate, investment, interest rate, inflation, and growth during the period, the study used the VECM technique, cointegration, and ADF statistics for stationarity testing. Their findings indicate that there is a long-run link between the exchange rate, investment, interest rate, inflation, and growth. The study, however, discovered that exchange rate volatility had a detrimental impact on investment and growth. They advocate for the country's development of a sound exchange rate management system in order to facilitate economic growth.

Ali, Ajibola, Omotosho, and Adeleke (2015) examined the influence of Naira real exchange rate misalignment on Nigeria's economic expansion using quarterly data from 2000 to 2014. The estimations of Real Exchange Rate Misalignment (RERMIS) were obtained by analyzing deviations of the actual real exchange rate from a sustainable equilibrium path determined using Edwards' (1989) “Behavioral Equilibrium Exchange Rate” (BEER) technique. The study provided empirical support for RERMIS's detrimental influence on economic growth. This prompted them to advocate for the sustained adoption of market-based exchange rate arrangements to guarantee that the Naira's actual exchange rate follows its path of long-term stability.

The relationship between exchange rate volatility and economic growth in Nigeria was the topic of Amassoma and Odeniyi's (2016) research, with a particular emphasis on the buying power of typical Nigerians and the volume of international transactions. The study, which included econometric approaches such as Multiple Regression Analysis, the ADF test, the Johansen Co-integration test, and the ECM, backed up the conclusions of Adelowokan, Adesoye, and Balogun (2015) on the same issue. The study found that exchange rate variations had a beneficial, albeit minor, influence on economic growth in Nigeria in both the long and short run.

Augustine, John, and Emmanuel (2017) investigated the influence of the real effective exchange rate on the trade balances of eight nations using a variety of nonlinear methodologies. The findings of the asymmetric model for long-run cointegration analysis, short-run analysis, and half-lives show that exchange rate depreciation has a considerable impact on trade balance.

Abayomi, Adepoju, and Aasa (2017) used yearly time series data from 1981 to 2014 to investigate the impact of exchange rate changes on economic growth in Nigeria. The unit root test shows that all variables were I(1), however the Johansen cointegration test shows a long run link between economic growth and the explanatory variables. In Nigeria, the Error Correction Model shows a negative short run causality flowing from nominal exchange rate to RGDP and from money supply increase to RGDP. The error correction term implies that 93.55% of deviations from long run equilibrium are rectified. As a result, the study advises that the government create export-oriented policies that would expedite the accumulation of foreign reserves to reverse or, at the very least, reduce exchange rate depreciation.

Onakoya, Aworinde, and Yinusa (2019) studied the existence of an asymmetric cointegrating link between Nigeria's exchange rate, trade balance, and growth from 1960 to 2016. The M-TAR (Momentum - Threshold Autoregressive) and TAR models were used in the study with the key assumption of the possibility of an unequal adjustment process in the disequilibrium. The results reveal that cointegration exists among the three variables in the TAR model. There is also an asymmetric adjustment disequilibrium process. The point estimates indicated that when the trade balance worsens, the adjustment pace slows. According to the asymmetric ECM, trade balance, real exchange rate, and growth all respond to disequilibrium, and the coefficients of domestic income and exchange rate are both negative. The report recommended that the government of Nigeria focus its policy efforts on an import substitution plan that will allow for the local manufacture of currently imported commodities, hence providing long-term employment and the growth of Nigeria's industrial manufacturing sector.

Effiong and Okon (2020) investigated the contributions of foreign trade to Nigeria's economic development from 1981 to 2018. To determine the connections between the variables, the ARDL bounds test for cointegration and OLS approaches were utilized. During the era, the contribution of foreign trade to economic development was determined to be quite low. It was suggested that in order for Nigeria to gain from trade, the economy should be diversified and government institutions and agencies strengthened in order to restore sanity and faith in the system. Trade treaties must be scrutinized to verify that they are, by definition, advantageous to the economy. Alasha (2020) examined the link between exchange rate fluctuations and their influence on Nigerian economic growth. The data in this study was analyzed using ordinary least squares regression. The study indicates that because exchange rate variations have a direct influence on the economy, an effective exchange rate regime must be developed. An effective exchange rate would assist to reduce inflation, improve Nigeria's trade balance, and increase Nigeria's production capacity, all of which are important pointers of good economic progress. This study is therefore an attempt to add to the literature, on the influence of exchange rate and trade balance on economic growth in Nigeria from 1981 to 2020 using the ARDL approach.

Methodology

Model Specification

The model for this study is specified based on a disaggregated approach - total trade balance, oil trade balance, and non-oil trade balance; along with specifying the model that captures the determinants of exchange rate movements.

Model I: Effect of total trade balance and exchange rate on economic growth

RGDP = f(GFCF, LBR, INT, GOVT, ECHR, TTBL) Equation 3.1

Where RGDP captures the growth rate of real gross domestic product, GFCF is the growth rate of gross fixed capital formation, LBR reflects the labour force growth, INT is the interest rate, GOVT is government expenditure as a ratio of GDP, ECHR reflects the exchange rate, and TTBL is the growth in total trade balance measured as the difference between total export and total imports.

Transforming Equation 3.1 to an econometric form;

RGDP_t = Yo +y₁GFCF_t + y₂LBR_t + y₃INT_t + y₄GOVT_t + y₅ECHR_t +

+y₆TTBL_t + lt Equation 3.2

Where Yo is the constant term, у_г to y₆ are the parameters, and p_lt is the error term.

Model II: Effect of oil trade balance and exchange rate on economic growth

RGDP = f(GFCF, LBR, INT, GOVT, ECHR, OTBL) Equation 3.3

Where the variables are as earlier defined and OTBL represents the growth in oil trade balance. Transforming Equation 3.3 into an econometric form;

RGDP_t = 6₀ + 6₁GFCF_t + 6₂LBR_t + 63INT + 6₄GOVT_t + 6c;

ECHR = + 6gOTBL_t + 2t Equation 3.4

Where 6₀ is the constant term, 6₄ to 5₆ are the parameters, and p₂t is the error term.

Model III: Effect of non-oil trade balance and exchange rate on economic growth

RGDP = f(GFCF, LBR, INT, GOVT, ECHR, NTBL) Equation 3.5

Where the variables are as earlier defined and NTBL represents the growth in non-oil trade balance. Transforming Equation 3.5 into an econometric form;

RGDP_t = n₀ +n₁GFCF_t + n₂LBR_t +n₃INT_t + n₄GOVT_t + n₅ECHR_t + n₆NTBL_t

+ q_3t Equation 3.6

Where n₀ is the constant term, ny to n₆ are the parameters, and p_3t is the error term.

Model IV: Determinants of exchange rate movements in Nigeria

ECHR = f(RGDP, INT, ERES,INF, TTBL) Equation 3.7

Where the variables are as earlier defined, INT is interest rate and ERES represents the volume of external reserves. Transforming Equation 3.7 into an econometric form;

ECHR_t = ф₀ + ф₁RGDP_t + Ф2ШТ- + фзERES_t + ф₄ЮТ₁ + ф₅TTBL_t + q_4t

Equation 3.8

Where is the constant term, ф₃ to ф₅ are the parameters, and p_4t is the error term.

Sources of Data

The data is time series in nature which covers 1981 to 2020. The time period so selected has covered significant aspect of the policies of the government in the management of exchange rate and other macroeconomic variables. The data were gotten from Central Bank of Nigeria statistical bulletin and the World Bank database. The data sources are reliable and valid because they are from official publication.

Analytical Technique

Given the fact that our study utilizes time series data which may be influenced by time, we follow the systematic step by step procedure. We start by ascertaining the time series properties of the variables using the augmented Dickey-Fuller unit root test under the constant and linear trend assumption. The unit root test equation, in its general form, is specified as follows:

Equation 3.8

Where M is the time series variable to be tested for existence of unit root, a₀ captures the constant, S captures the coefficient of the trend, t is the time trend, i is the number of lags to be automatically selected based on Akaike Information Criterion (AIC), Д is the difference operator, Я_x is the coefficient to be tested for unit root, Pj captures the augmented portion of the test, and є is the error term. The null hypothesis is that Яx = 1 against the alternative hypothesis that Яx = Ј 0.

We thereafter proceed to detecting the existence of a long run relationship among variables in the model. To do this, the autoregressive distributed lag (ARDL) bonds test for cointegration is being utilized. The existence of cointegration (levels relationship) will then propel us to estimating both the short-run and long run coefficients using the error correction model. The equation for the ARDL model is specified thus;

Equation 4

In Equation 3.10, Р is the dependent variable while Q is captures all the explanatory variables; m and n are the optimal lags for the dependent and explanatory variables respectively; Я_t and y_t are the parameters to be estimated; 0 captures the speed of adjustment of the short-run disequilibrium to long-run equilibrium relationship; ECM reflects the error correction mechanism; and p is the error term that is assumed to be “white-noise”.

trade nonoil export exchange rate nigeria

Empirical Results

Stylized Facts on Trade Balance and Exchange Rate Movements in Nigeria

For the period 1981 to 2020, the core variables of interest have been exhibiting different behaviors (positive and negative) and Table 1 captures such changes.

Table 1

Descriptive Properties of the Series

The descriptive statistics of the key variables of interest, namely: real GDP growth rate (RGDP), growth in total trade balance (TTBL), growth in oil trade balance (OTBL), growth in non-oil trade balance (NTBL), and exchange rate (ECHR) are reflected in Table 2. It covers the mean up to the test for normality using the Jarque-Bera statistic.

Table 2

Correlation Analysis

To check whether the variables correlates among themselves, the correlation matrix in Table 3 reflects the correlation coefficients of the different variables of interest

From Table 3, there is a positive correlation between RGDP and the trade and exchange rate variables. However, such correlation is weak as none of them reaches a meagre 0.50. Also, the trade and exchange rate variables has weak correlation with each other, reflecting the fact that multicollinearity could not be a problem in the model. Total trade balance correlates positively with every other variable, but OTBL and NTBL correlates negatively with ECHR.

Table 3

Model I: Influence of total trade balance and exchange rate on economic growth

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