Exchange rate dynamics and balance

European Journal of Business and Management
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online)
Vol.5, No.29, 2013

www.iiste.org

Exchange Rate Dynamics and Balance of Payments Repositioning
in Nigeria
Prince Umor C. Agundu1* Waleru Henry Akani2 Fred Barivure Kpakol3
1.

Department of Banking & Finance, Rivers State University of Science & Technology, Port Harcourt,
Nigeria

2.

Department of Banking & Finance, Rivers State University of Science & Technology, Port Harcourt,
Nigeria

3.

Finance/Political Administration Consultant, Port Harcourt, Nigeria
* agundup@yahoo.com

Abstract
The study examines foreign exchange dynamics in the Nigerian economy in relation to balance of payments,
using time series drawn from the publications of the Central bank of Nigeria (CBN), Debt Management Office
(DMO) and National Bureau of Statistics (NBS). The regression method was adopted in data analysis, facilitated
by software package for social sciences (SPSS). The statistical results justified the alternate hypotheses, thus
affirming that the foreign exchange proxies specified in this study are significant predictors of variations in
balance of payments. In explaining the variations in the current and capital accounts of balance of payments, the
predictor coefficients are positive for exchange rate and external reserves but negative for external debt. This
analytical manifest is traditional as a favorable exchange rate (positively) stimulates trade and capital flows. Also,
an increase in external reserves (positively) boosts the confidence of foreign investors and this fundamentally
mirrors the strength and depth of liquidity in the global economy. It is a critical factor of foreign investment
interest in the economy. Furthermore, a nation’s external indebtedness apparently (negatively) conveys a profile
of macroeconomic weakness and flakiness. It is, therefore, vitally imperative for more auspicious management
systems to be institutionalized for the close monitoring stabilization of favorable profiles of exchange rate,
external reserves and external debt. This will advance and sustain a more attractive, competitive and productive
Nigerian economy.
Keywords: Foreign exchange, International investment, Nigerian economy
1. Introduction
For several years, the Nigerian economy witnessed high level volatility in foreign exchange dynamics, which
aggravated the nation’s balance of payments. Basically, adequate foreign exchange is required in the economy
for the servicing of external debts, importation of raw materials, machines and spares and upgrading of industrial
infrastructure for sustainable development. Against this backdrop, the concern of many scholars and economy
watchers has to do with the dynamics of foreign exchange, being contingent on the market forces of demand and
supply, as well as their critical linkages with balance of payments. Also of immense interest is the trend of
balance of payments between trading nations, which underscore financial and real investments cooperation for
economic cooperation and sustainable development. Some research works had examined changes in exchange
rate over the years, with emphasis on short-run equilibrium tendency. They also address the implications of
foreign exchange dynamics on international finance and investment profiling (Loto, 2011; Lipsey & Chrystal,
2004). Considering Nigeria’s macroeconomic context, this study examines foreign exchange dynamics in
relation to balance of payments.
Strategically, foreign exchange management systems are designed to help economic actors respond favorably to
address shocks and fluctuations in international business cycles, hence the emphasis on market efficiency and
macroeconomic stability. The proxies of foreign exchange dynamics in this study are also relevant in the analysis
of balance of payments plausibility and financial integration possibility. The key objectives of foreign exchange
management system in the Nigerian nation, therefore, holistically seek to address macroeconomic anomalies and
forge new international trade frontiers for sustainable development. This overriding poise inspires
macroeconomic policy interjections which tend towards liberalization, and underscore transient features of
market determined exchange rates. Competitive (aggressive) trade reforms are also vigorously pursued, which
complementarily bring about substantial reduction in import tariffs to the admiration of foreign investors. In the

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Nigerian scene, the apex bank equally undertakes measures to ensure adequate and timely availability of bank
credit for trade finance at competitive interest rates. It also puts forward those policies that are meant to create
appropriate institutional frameworks for greater national export drive. Similar endeavor like this in the past
culminated in the establishment of export-import bank, export processing zones and special free trade/economic
zones. Collectively, these institutions work to ensure safety, liquidity and optimality in the management of the
nation’s foreign exchange and allied trading profiles in the international market arena. In this study, therefore, the
variables adopted as proxies of foreign exchange dynamics are exchange rate, external reserves, and external
debt; while the current and capital accounts of balance of payments are designated as the criterion variables. The
study specifically has as its objectives:
To examine the extent to which the current account of balance of payments is related to exchange rate,
external reserves and external debt; and
To examine the extent to which the capital account of balance of payments is related to exchange rate,
external reserves and external debt.
These research objectives logically elicit the following hypotheses:
Ho1:

The current account of balance of payments is not significantly related to exchange rate, external
reserves and external debt; and

Ho2:

The capital account of balance of payments is not significantly related to exchange rate, external
reserves and external debt.

2.
Literature Review
In Nigeria, research works relating to foreign exchange dynamics and balance of payments generally underscore
the overriding goal of sustainable macroeconomic stability. Among the scholarly contributions are the works of
Obaseki (2000) and Alihu (2007), who fundamentally examined Nigeria’s foreign exchange management
regimes as well as mechanisms of fixing the critical challenges associated with foreign exchange vagaries and
vicissitudes in the economy. Their studies equally addressed foreign exchange dynamics and established that
Nigeria’s external trade policies have not significantly achieved many expected strategic macroeconomic targets.
In contemporary analytical discourse, three theories on which these research adventures anchor are:
Mint parity theory,
Purchasing power parity theory, and
Balance of payments parity
The mint parity theory is associated with international gold standards, where the currency in use was made of
gold or converted into gold at a fixed rate. Thus, the value of the currency unit was defined in terms of certain
weight of gold, and the apex bank of the country bought and sold gold at the specified price. The rate at which
the standard money of the country was converted into gold was the mint price of gold. The actual rate of
exchange, therefore, prevailed around mint parity relative to the cost of shipping gold between two countries.
The exchange rate under the gold standard was still subject to and operationally determined by the forces of
demand and supply between the gold points. The purchasing power parity (PPP) theory seeks to determine the
exchange rate between countries under inconvertible paper currency system. The purchasing power parity, thus,
represents the quotients of purchasing power of the different currencies. Equilibrium exchange rate between two
inconvertible paper currencies is attained where there is equality of purchasing power, anchored on relative price
levels. In the balance of payments theory, favorable balance of payments is expected to raise exchange rate as
driven by the demand and supply of foreign exchange. The rate of foreign exchange may also be associated with
seasonal trade fluctuations in export and import commodities.
Consequently, foreign exchange dynamics continue to pose strategic challenges to economic management and
administration in developing economies coupled with the intrigues of conducting trade within global policy
infrastructure. It has equally been observed that the introduction of Dutch Auction System in Nigeria has not
shown appreciable efficiency over the years as the market is highly characterized by exchange rate instability,
insignificant premium and declining reserves (Ogbonna, 2010; Nnanna, 2004; Onoh, 2002). In the face of scarce
foreign exchange resources, the apex bank of the nation closely monitors the use of periodic releases of foreign
exchange to ensure that appropriation and application by various sectors are in line with strategic economic

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priorities. This foreign exchange management strategic template facilitates the realization and sustenance of
favorable balance of payments position anchored on stability of the auspicious exchange rate of the nation’s
currency to other major currencies in the global arena. In Nigeria in particular, it is considered quintessential to
accentuate efficient and effective management of foreign exchange dynamics in view of the macroeconomic
connect with external reserves. Where the process runs smoothly, the economy stands to harness critical
advantages, including:
Availability of liquidity for settlement of international transactions especially in periods of temporary
constraints on the balance of payments of the nation;
Sustenance of reasonable import level in the face of high domestic propensity to import;
Maintenance of high level of reserves required to create high level confidence in the nation’s currency;
Supply of the desired quantum of foreign exchange for intervention in the market in order to keep the
exchange rate stable; and
Enhancement of the country’s international credit worthiness rating, as balance of payments represents
a veritable line of defense of a country’s strategic credibility.
Conventionally, a good level of reserve serves as notice to the international community that a country’s
economic prospects are good. It also creates the environment for attracting international investors’ confidence
besides serving as buffer against external shocks and international financial market volatility (Ali & Yusuf, 2011;
Onoh, 2007). A constructive foreign exchange management system gives a country the favorable trading position
which further increases her stock of external reserves. The increase in reserves equally provides additional
cushion against sudden developments such as sharp drop in prices of major exports. It also gives a country
adequate time to adjust expenditure patterns to externalities without destabilizing the economy. In the light of
these, intermittent intervention by the apex bank in the affairs of the external sector is justified in terms of the
desire to realize these strategic macroeconomic targets and further sensitize public authorities to be more
constructively involved in the funding of their foreign exchange markets (Imegi, Idoniboye, Maxwell & Okon,
2008; Gbosi, 2005). These issues as they concern the Nigerian economy are examined in this study with critical
analysis of current and capital accounts of balance of payments (the criterion variables) in relation to exchange
rate, external reserves and external debt (the predictor variables).
3.
Research Methodology
In this study, the secondary data required for analysis are drawn from the publications of the Central Bank of
Nigeria (CBN), Debt Management Office (DMO), and National Bureau of Statistics. The time series of 23-year
frame (1980-2008) are analyzed with the aid of software package for social sciences (SPSS), the main statistical
tool being regression method (Kpakol, 2013). The analytical functions are as follows:
CUA = ao + a1 EXR + a2EXTR + a3 EXTD + u
CAA = ao + a1 EXR + a2EXTR + a3 EXTD + u

…
…

[Equation 1]
[Equation 2]

Where:
CUA = Current account of balance of payments
CAA = Capital account of balance of payments
EXR = Exchange rate
EXTR = External reserves
EXTD = External debt
The time series relating to the designated analytical variables are presented in Tables 1, 2, 3 and 4:

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Table 1: Nigeria’s Balance of Payments (Current Account)
Years
Current Account (Nm)
1986
8,006.6
1987
17,138.2
1988
31,586.1
1989
59,112.0
1990
79,810.1
1991
51,969.8
1992
93,680.5
1993
-34,414.7
1994
-52,304.3
1995
188,084.8
1996
240,180.0
1997
268,899.4
1998
-331,435.2
1999
46,336.2
2000
713,023.9
2001
108,996.0
2002
-117,035.3
2003
704,560.0
2004
2,056,326.3
2005
4,046,521.3
2006
3,374,806.1
2007
2,703,753.8
2008
4,150,489.2
Source: CBN, DMO & NBS Publications (various years)

Table 2: Nigeria’s Balance of Payments (Capital Account)
Years
Capital Account (Nm)
1986
-1,900.9
1987
-16,743.3
1988
-18,447.3
1989
-30,221.9
1990
-49,246.2
1991
-27,482.9
1992
-138,755.6
1993
-23,060.6
1994
11,252.8
1995
-4,254.0
1996
-290,200.5
1997
-263,360.2
1998
116,720.5
1999
-366,820.7
2000
-390.356.3
2001
-77,294.6
2002
-437,210.9
2003
-855,899.2
2004
-914,214.1
2005
-2,572,984.1
2006
-968,461
2007
-324,689.1
2008
-668,212.8

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Table 3: Exchange Rates of N to $
Years
Naira to $
1986
2.02
1987
4.02
1988
4.54
1989
7.39
1990
8.04
1991
9.91
1992
17.30
1993
22.05
1994
21.89
1995
21.89
1996
21.89
1997
21.89
1998
21.89
1999
92.69
2000
102.11
2001
111.94
2002
120.97
2003
129.36
2004
133.50
2005
132.15
2006
128.65
2007
125.83
2008
118.57
Table 4: Nigeria’s External Debt and External Reserves (Nm)
S/No
Year
EXTD
1
1986
41,452.4
2
1987
100,789.1
3
1988
133,956.3
4
1989
240,393.7
5
1990
298.614.4
6
1991
328,453.8
7
1992
544,264.1
8
1993
633,144.4
9
1994
648,813.0
10
1995
716,965.6
11
1996
617,320.0
12
1997
595,931.9
13
1998
633,017.0
14
1999
2,577,374.4
15
2000
3,097,383.9
16
2001
3,176,291.0
17
2002
3,932,884.8
18
2003
4,478,329.3
19
2004
4,890,269.6
20
2005
2,695,072.2
21
2006
451,461.7
22
2007
428.1
23
2008
491.0

EXTR
3,587.4
4,643.3
3,272.7
13,457.1
34,953.1
44,248.6
13,992.5
67,245.6
30,455.9
40,353.2
174,309.9
262,198.5
226,702.4
546.0
1,090,148.0
1,181,652.0
1,013,514.0
1,065,303.0
2,232,837.0
3,647,998.7
5,425,375.6
6,055,717.0
7,025,727.7

4.
Findings & Discussion
Harnessing the available time series and subjecting them through the regression analytical apparatus, the

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statistical results are presented in Tables 5 and 6:
Table 5: Test of Research Hypothesis one (RH1)
Dependent Variable: CUA
Method: Least Squares
Variable
Coefficient
Std. Error
t - Statistic
C
-91942.72
234595.5
-0.391920
EXR
27068.62
5748.957
4.708440
EXTR
0.057003
0.084173
0.677217
EXTD
-0.606341
0.146319
-4.143958
R-squared
0.757195
Mean dependent var.
Adjusted R-squared
0.718857
S.D. dependent var.
S.E. of regression
742410.0
Akaike info criterion
Sum squared resid.
1.05E+13
Schwarz criterion
Log likelihood
-341.3446
F-Statistic
Durbin-Watson Stat.
1.306109
Prob. (F-Statistic)

Prob.
0.6995
0.0002
0.5064
0.0006
800351.7
1400169.
30.02996
30.22744
19.75089
0.000005

R2 = 0.76; Explanatory capacity = 76%
F-Statistic = 19.75; P-Value = 0.00
t - Statistic = 0.39; P-Value = 0.70
Source: Research Data (SPSS-aided)
Highlights:

Table 6: Test of Research Hypothesis Two (RH2)
Dependent Variable: LOG (CAA)
Method: Least Squares
Variable
Coefficient
Std. Error
t – Statistic
C
7.496309
1.261333
5.943162
LOG (EXR)
0.578196
0.202160
2.860085
LOG (EXTR)
0.342695
0.095053
3.605292
LOG (EXTD)
-0.093835
0.071487
-1.312626
R-squared
0.871805
Mean dependent var.
Adjusted R-squared
0.846166
S.D. dependent var.
S.E. of regression
0.764260
Akaike info criterion
Sum squared resid.
8.761393
Schwarz criterion
Log likelihood
-19.60603
F – Statistic
Durbin-Watson stat.
1.304335
Prob. (F - Statistic)

Prob.
0.0000
0.0119
0.0026
0.2090
12.35947
1.948584
2.484846
2.683675
34.00305
0.000001

R2 = 0.87; Explanatory capacity = 87%
F-Statistic = 34.0; P-Value = 0.00
t - Statistic = 5.94; P-Value = 0.00
Source: Research Data (SPSS-aided)
In Table 5 which relates to Research Hypothesis One (RH1), the coefficient of determination (R2) is 0.76. This
indicates that the dynamics of exchange rate, external reserves and external debt explain 76% of the variations in
current account of balance of payments in Nigeria, in the period under consideration. In Table 6 which relates to
Research Hypothesis Two (RH2), the coefficient of determination (R2) is 0.87. This indicates that the dynamics
of exchange rate, external reserves and external debt explain 87% of the variations in capital account of balance
of payments in Nigeria, in the period under consideration. The F - Statistic in each hypothetical case, also affirms
the overall model fit at 95% confidence level. Furthermore, the t – Statistic of 5.94 is significant and indicates
that balance of payments is significantly related to the foreign exchange dynamics. Categorically considering the
hypothetical specifications, it is clearly established that:
Highlights:

The current account of balance of payments is significantly related to exchange rate, external reserves
and external debt; and
The capital account of balance of payments is significantly related to exchange rate, external reserves
and external debt.

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These analytical revelations are crucial to repositioning foreign exchange management systems for sustainable
efficiency and efficacy. With respect to exchange rate dynamics, various management systems/regimes had
sought to achieve fundamental macroeconomic objectives including increase in domestic production, boost in
non-oil exports, improved export competitiveness while reducing the demand for imports, and higher confidence
in the nation’s currency. However, the criticality of such national targets in relation to the exchange rate
dynamics remains vitally relevant in furtherance of the macroeconomic task of attaining and sustaining favorable
balance of payments stability, low unemployment rate, auspicious general price level, and competitive economic
growth rate. The pursuit of these objectives, though quite challenging in the face of fluctuations in the exchange
rate, had actually aggravated many nation’s fortunes and balance of payments profiles. This is the quintessential
thrust of policy redirection and systemic repositioning as the nations brace up for more competitive growth and
development imperatives in the global economy.
5.
Conclusion
In the early 1980s, the Nigerian government closed the nation’s borders to allow old currency (the naira) notes to
be replaced with new ones. Exchange control and related regulations were also designed to forestall possible
repatriation of the Nigerian naira which may have been smuggled to foreign countries. The measures were to
further address the challenges bordering on future convertibility of the naira to other major currencies of the
world. Subsequently, particularly from 1984 through 1986 and 1990, Nigeria recorded surplus balance of
payments. Paradoxically, this was discovered not to have conventionally resulted from export expansion but due
to adverse economic vicissitudes which compelled the government to adopt very severe import restriction
measures. The prevailing exchange rates then, were expected to contribute towards a more favorable balance of
payments, by efficiently and effectively promoting growth in non-oil exports and boosting the nation’s current
account, but all to no avail. The austere circumstances of the time evolved and eventually culminated in the
enunciation and introduction of a structural adjustment program (SAP). Although real wages and government
social commitments to the populace continued to decline, the intervention program was endorsed by the World
Bank as veritable blueprint for the restoration of national economic viability, stability and sustainability, with a
view to regaining strategic relevance in the domestic and international economic arena.
This study, therefore, examined the relationship between foreign exchange dynamics and balance of payments in
Nigeria; the proxies being exchange rate, external reserves, and external debt for the predictor variables as well
as current and capital accounts for the criterion variable. The study covered a 23-year period (1986- 2008), time
series drawn from the publications of the Central bank of Nigeria (CBN), Debt Management Office (DMO) and
National Bureau of Statistics (NBS). Two research hypotheses were formulated and tested using multiple
regression and log linear methods of data analysis, aided by software package for social sciences (SPSS). The
analytical outcomes are quite revealing, viewed against several contemporary theoretical submissions and
contributions (Nwidobie, 2011; Richardson, Edeme & Sunday, 2009; Ojo, 2008). The variations in balance of
payments are significantly explained by the dynamics of exchange rate, external reserves and external debt (the
predictor variables).
It is, therefore, recommended that the current and capital accounts of the balance of payments should be closely
monitored in view of their significant relationship with foreign exchange dynamics. The apex bank should
intermittently intervene to ensure that there is relative stability in the exchange rate in order to achieve favorable
account balances. Exchange rate volatility should not make the forecasting of future trends of the accounts an
exercise in futility. There should be a more conscientious national disposition towards institutionalizing:
Highly functional exchange rate management system;
Highly robust external reserves management system; and
Highly constructive external debt management system.
With respect to the management of Nigeria’s external reserves, relative tightening while the monetization regime
and strategic financing budget deficits are shortfalls are controlled to avert further adverse effects on the critical
accounts. Market determined exchange rates should be relatively adopted and sustained to make the prevailing
policy framework more efficient and effective in promoting export growth. The country should also target higher
economies in non-oil export lines in order to boost the accounts and by extension enhance the nation’s balance of
payments. For exports which are not critically susceptible to the influence of domestic policies, more
competitive trade policy should be pursued to reinvent a robust non-oil export profile that drive the nation’s
quest for economic diversification and vantage balance of payments. A more acceptable and competitive
exchange rate should prevail in lieu of the equilibrium exchange rate to check the overbearing operations of

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parallel markets. All these well considered and conscientiously applied will meaningfully prevent distortions and
attendant systemic contagion in the economy.
References
Afolabi, L. (1999). Monetary Economics. Lagos: Heinemann.
Ali, M. & Yusuf, I. (2011). Bretton Woods Institutions and the third world: Impacts of the World Bank and the
IMF on the Economy of Nigeria. International Journal of Economic and Development Issues, 10(1&2),
136-148.
Alihu, S. U. R. (2007). Import - export demand functions and balance of payments stability in Nigeria: A cointegration and error correction modeling. Journal of Social and Management Science, 20(2), 116-120.
Anifowoshe, C. A. (1997). Management of foreign exchange: A peep into the next decade. Bullion, 21(4): 17-24.
Gbosi, A. N. (2005). Money, Monetary Policy and the Economy. Port Harcourt: Sodek.
Imegi, J. C., Idonoboye, E. A., Maxwell, C. O. and Okon, M. B. (2008). Monetary control mechanisms and
financial sector viability in Nigeria. Integrated Social and Management Science Journal, 1(1): 98-105.
Kpakol, F. B. (2013). Foreign exchange management and balance of payments in Nigeria (Unpublished Doctoral
Thesis). Rivers State University of Science & Technology, Port Harcourt, Nigeria.
Lipsey, R. O. and Chrystal, K. A. (2004). Economics. London: Oxford University Press.
Loto, M. A. (2011). Does devaluation improve the trade balance of Nigeria: A test of the Marshall Lerner
condition. Journal of Economics and International Finance. 3(11): 231-240.
Nnanna, O. (2004). Foreign Private Investment in Nigeria. Economic and Financial Review, 41(4): 87-95.
Nwidobie, M. B. (2011). Determinants of Nigeria’s non-oil export: 1980-2009. International Journal of Business
Administration and Management. 8(1&2): 94-105.
Obaseki, A. E. (2000). Balance of payments: Issues and crises. Bullion, 20(3): 130-131.
Ogbonna, B. C. (2010). Financial development, trade openness and economic growth in a small open economy:
Evidence from Botswana. Journal of Banking, 4(1): 59-76.
Ojo, J. A. (2008). Impact of tax incentives on foreign direct investment in Nigeria. International Journal of
Investment and Finance, 1(1&2): 34-39.
Onoh, J. K. (2002). Dynamics of Money, Banking and Finance in Nigeria. An Emerging Market, Aba: Astra
Meridian.
Onoh, J. K. (2007). Dimension of Nigeria’s Monetary and Fiscal Policies, Aba: Astra Meridian.
Richardson, U., Edeme, K. and Sunday, O. I. (2009). External debt service: Constraint to sustainable growth in
Sub-Saharan Africa: A further analysis. Journal of Business Administration and Management, 4(2): 7682.

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