Jurnal Ekonomi & Studi Pembangunan Volume 19, Nomor 1, April 2018, hlm. 35-40 DOI: 10.18196/jesp.19.1.4297 Exchange Rate Fluctuations And Nigeria's Capital Account (Odusanya, Adesoye, Gbadamosi) 35 EXCHANGE RATE FLUCTUATIONS AND NIGERIA'S CAPITAL ACCOUNT Ibrahim Abidemi Odusanya, Adesola Bolaji Adesoye, Ayinla Idris Gbadamosi Department of Economics, Olabisi Onabanjo University, P.M.B. 2002, Ago-Iwoye, Nigeria Correspondence E-mail: ibrahim.odusanya@oouagoiwoye.edu.ng Abstract: This paper examines the effect of exchange rate fluctuations on the capital account in Ni- geria from 1980 to 2015. The data used for the study were retrieved from the Central Bank of Nige- ria Bulletin. The study employed Johansen co-integration test, Error Correction Model (ECM) and Fully Modified Ordinary Least Square (FMOLS). Evidence from the study shows that exchange rate has no effect on the capital account. As a result of the study, production in the Nigerian economy must be encouraged through availability of domestic credit while market determined interest rate should be encouraged to stimulate economic growth and investment Key Words: exchange rate, nominal domestic credit, balance of payments JEL Classification: C22, F31, F32, F41 INTRODUCTION The strong foreign exchange rate and sur- plus balance of payments are some of the key fac- tors of a nation’s development. They are factors essential for comparing a country’s relationship with other nations. Inflation rate, foreign direct investment, external reserve, external debt, and interest rate among other variables determine the exchange rate of a country, which directly or indi- rectly affect the balance of payments and the Ni- gerian economy at large. In 1973 and 1979, the exchange rate was relatively stable as due oil boom. However, Nigeria started recording huge balance of payments deficits and very low foreign reserve in the mid-80s. This was evident after the introduction of the Structural Adjustment Pro- gram (SAP), which led to continued depreciation of the naira with a view to achieve a realistic ex- change rate that would facilitate improved mac- roeconomic performance and diversify the pro- ductive base of the economy. Following the adoption of the Structural Adjustment Program (SAP) in 1986, the country has moved away from a pegged to a flexible ex- change rate regime. Despite the efforts of the Ni- gerian government to maintain a relatively stable rate of exchange, the naira has continued to de- preciate before and after the introduction of the guided deregulation of 1994 when the exchange rate was 21.886 naira against the US dollar. Dur- ing the global financial crisis in 2008, the ex- change rate of the naira further depreciated to N150.01 at the end of 2009 (Aliyu, 2009). As at the last quarter of 2017, one US dollar exchanged for 305 naira. Nigeria’s foreign trade structure did not satisfy the conditions for a successful balance of payments policy because of the over reliance on importation, low level of production and ex- portation of goods. Exportation of crude petrole- um and agricultural produce, whose prices are predetermined in the world market with low im- ports and export price elasticity of demand, char- acterized the country’s foreign structure. All of these have contributed to the worsening position of the balance of payments (BOP). Exchange rate management in Nigeria has been very poor. It has been pernicious to trade, with the country being a consistent net importer. 36 Jurnal Ekonomi & Studi Pembangunan Volume 19, Nomor 1, April 2018: 35-40 The fluctuations in exchange rate do exert on the current and capital account balances (Kan- dil, 2009). The current and capital account deficit may be beneficial to developing countries if for- eign debt complements low capital formation of the internal economy and consequently stimulates economic growth. On the other hand, empirical evidence shows that running a large and persis- tent current and capital account deficit may be risky and even detrimental to the economy. Given the fact that Nigeria is still fulfilling a number of loan obligations to international financial organi- zations, it is quite apt and imperative to examine how movements in the country's exchange rate affect the capital account component of the BOP. Thus, contrary to earlier studies, this paper specif- ically examines the effects of exchange rate on capital account in Nigeria. The paper is divided into five sections. Section 2 reviews relevant liter- ature. In section 3, we present data and the meth- odology of the study. Section 4 contains our re- sults while section 5 concludes the paper. Frenkel (2004) examined aggregate em- ployment behaviour in response to real exchange rate movements in Argentina, Brazil, Chile and Mexico between 1980 and 2003. Real exchange rate has long-run negative impact on current ac- count component of the balance of payments. Isard (2007) found evidence that the alignments of exchange rates have a critical influence on the rate of growth of per capita output in low-income countries and the balance of payments difficulties. Obaseki (2000) and Aliyu (2007) examined Nige- ria’s foreign exchange management regimes as well as mechanisms of fixing the critical challeng- es associated with foreign exchange in the econ- omy. Their studies equally addressed foreign ex- change dynamics and established that Nigeria’s external trade policies have not been significantly achieving expected macroeconomic targets. Ozturk and Acaravci (2010) used autoregressive distributed lag model to investigate the Thirlwall hypothesis for South Africa. The study found evi- dence in support of the Thirlwall hypothesis. Thus, equilibrium income was equal to the actual income growth. In addition, imports were co- integrated with relative prices and equilibrium growth rate. Patricia and Osi (2010) examined the balance of payments equilibrium in the West Af- rican Monetary Zone. The results of within- country effects and the cross-country effects indi- cate that interest rate and growth in output play a significant role in achieving a favourable balance of payments. Oyovwi (2012) offered empirical evidence on the impact of real exchange rate volatility on Nigeria’s import and the balance of payments. The result indicated that real exchange rate vola- tility had no significant effect on Nigeria’s im- ports and balance of payments. Imoisi (2012) ex- amined the trends in Nigeria’s balance of pay- ment. The results indicate a significant relation- ship between balance of payments, exchange rate and interest rate. Agundu, Akani and Kpakol (2013) investigated exchange rate dynamics and balance of payments repositioning in Nigeria, us- ing the multiple regression and log linear meth- ods of data analysis covering the period 1986- 2008. The findings showed that the current and the capital account of balance of payment have significant relationship with exchange rate, exter- nal reserves and external debt. Umoru and Odjegba (2013) analysed the re- lationship between exchange rate misalignment and balance of payments (BOP) mal-adjustment in Nigeria using the vector error correction mod- eling technique and Granger Causality tests. Ex- change rate misalignment has a positive impact on the Nigeria’s balance of payments position. The Granger pairwise causality test result indicat- ed a unidirectional causality running from ex- change rate misalignment to balance of payments adjustment in Nigeria. Odili (2014) studied the effect of exchange rate and balance of payments Exchange Rate Fluctuations And Nigeria's Capital Account (Odusanya, Adesoye, Gbadamosi) 37 using autoregressive distributed lag modeling in Nigeria. A statistically significant positive rela- tionship exists between exchange rate and balance of payments in the long-run while the relation- ship is insignificant in the short run. Odili (2015) examined effects of exchange rate trends and vol- atility on imports in Nigeria. It was found that exchange rate trends had positive and significant effect on imports in the long-run. RESEARCH METHOD Model Specification To examine the effect of exchange rate fluctua- tions on balance of payments in Nigeria, the mod- el of Oladipupo and Onotaniyohuwo (2011) was adapted: BOP = f(EXRT,MS,ROUT,PRICE,INTR,INF, DOMC) ………………………………… (1) Where BOP is balance of payments, EXRT is ex- change rate, MS is money supply, ROUT is real output, PRICE is price level, INTR is interest rate, INF is inflation rate and DOMC is nominal do- mestic credit. However, to capture the effects of exchange rate fluctuations on capital account component of balance of payments, we have the following model: CPA = β0+β1 log EXRT +β2 log NDC +β3 INFR +β4 INTR + β5 EXTR + μ…………. (2) CPA= Capital account component of balance of payments, β1,β2,β3,β4,β5 are the parameters es- timates while μ is the stochastic term. Akaike in- formation criteria (AIC) and Schwarz information criterion (SIC) were used to determine the opti- mal lag length for the model. Estimation Techniques The study employed Johansen co-integration test, Error Correction Model (ECM) and Fully Modi- fied Ordinary Least Square (FMOLS) to show the proportion of the variable effect on the capital ac- count components of the balance of payments. RESULTS AND DISCUSSION Unit Root Test Given the peculiar non-stationarity of most time series, the Augmented Dickey Fuller test is used to confirm the order of integration of the series. Table 1. Unit Root Test Result Variables ADF Critical Value @ 5% Order of Integration(ADF) CPA -4.686015 -2.963972 I(1) EXTR -4.150587 -2.957110 I(1) INFL -4.890132 -2.963972 I(1) INTR -8.010686 -2.963972 I(1) LNDC -6.045828 -2.954021 I(1) LEXR -4.954605 -2.963972 I(1) The results show that all of the series are station- ary at first difference. The test statistics for current account, exchange rate, nominal domestic credit, interest rate, inflation rate and external reserve are all higher than the 5% critical value. There- fore, the null hypothesis of a unit root is rejected and they are all integrated of order one, I (1). Co-Integration Test The results of the co-integration tests in table 2 indicates the existence of one co-integrating equa- tion in the model. The null hypothesis of no co- integration is rejected. 38 Jurnal Ekonomi & Studi Pembangunan Volume 19, Nomor 1, April 2018: 35-40 Table 2. Unrestricted Co-integration Tests Unrestricted Co-integration Rank Test Hypothesized Trace 0.05 Max-Eigen 0.05 No. of CE(s) Statistic Critical Value Statistic Critical Value None * 111.0439 95.75366 35.42503 40.07757 At most 1 * 75.61889 69.81889 28.64444 33.87687 At most 2 46.97445 47.85613 27.85902 27.58434 At most 3 19.11543 29.79707 10.59879 21.13162 At most 4 8.516645 15.49471 6.132158 14.26460 At most 5 2.384488 3.841466 2.384488 3.841466 Therefore, the variables converge in the long run, thereby depicting the existence of long run relationship among the capital account, ex- change rate, nominal domestic credit, interest rate, inflation rate and external reserve. Error Correction Model Table 3. Parsimonious Error Correction Model Estimation Variables Coefficient Standard Error t-Statistics p–Value D(CPA(-1) 0.284090 0.310601 0.914644 0.3748 D(CPA(-2)) 1.064452 0.407615 2.611412** 0.0196 D(EXTR(-1) 7.28E-05 0.000646 0.112725 0.9117 D(EXTR(-2) 0.000710 0.000818 0.867192 0.3995 D(LEXR(-1) -84725.90 25232.89 -3.357757*** 0.0043 D(LEXR(-2) -29943.23 20670.61 -1.448590 0.1680 D(INFL(-1) 365.9251 276.0100 1.325768 0.2048 D(INFR(-1) 91.74485 373.6152 0.245560 0.8094 D(LNDC(-1) -16264.73 23630.33 -0.688299 0.5018 D(LNDC(-2) -32255.49 23417.07 -1.377435 0.1886 D(INTR(-1) 15594.97 4643.022 3.358798*** 0.0043 D(INTR(-2) 4997.937 1715.766 2.912948** 0.0107 D(LEXR(-3) -85199.92 20336.83 -4.189439*** 0.0008 D(LNDC(-3) 0.015888 0.018456 0.860825 0.4029 C 36453.51 13102.20 2.782244** 0.0140 ECT(-1) -0.709044 0.225473 -3.144690*** 0.0067 *,**, *** imply significance at 10%, 5% and 1% level respectively Table 3 shows the result of the parsimoni- ous error correction model for the effect of ex- change rate fluctuations on capital account using a parsimonious approach. This was set at lag 3 in accordance with lag selection to show the time lag it takes the capital account to converge back to equilibrium from disequilibrium. Based on the result, the error correction term has the correct sign (negative) meaning that about 70.90 percent of the errors being corrected yearly. It implies that the adjustment takes place relatively quickly. It also implies that when there is any disturbance, convergence to equilibrium is relatively high with 70.90 percent of adjustment occurring in the first year. Consequently, for an initial error of 1 per- cent, 70.90 percent of the error would be corrected in the first year. Bannerjee et al (1998) noted that a highly significant error correction term is further proof of a stable long-term relationship. Granger (1986) also noted that the existence of a significant Exchange Rate Fluctuations And Nigeria's Capital Account (Odusanya, Adesoye, Gbadamosi) 39 error is evidence of causality in at least one direc- tion. In terms of the significance of the individual variables, one and two year lagged external re- serve has positive effects on the capital account component of the balance of payments but it is statistically insignificant. In addition, one and two year lagged inflation rate has no effect on the cap- ital account. Meanwhile, one and two year-lagged interest rates have significant positive effect on the capital account. Even though one and three year-lagged exchange rates have significant nega- tive effect on capital account, it is insignificant for the two year lagged period. In addition, while one and two year lagged period of nominal domestic credit have statistically no effect on capital ac- count, it has positive effect on the capital account component of the balance of payments for the three year lagged period. Furthermore, interest rates for one and two year lagged period have statistically no effect on capital account. Table 4. Long Run Coefficient of the Effect of Exchange Rate Fluctuations on Capital Account Dependent Variable: CPA Method: Fully Modified Ordinary Least Squares (FMOLS) Variable Coefficient Std. Error t-Statistic Prob. LEXR 3793.387 3976.883 0.953859 0.3486 EXTR -0.000626 0.000189 -3.307258*** 0.0027 LNDC 6265.805 4128.127 1.517832 0.1407 INFL 0.717687 0.087198 8.230574*** 0.0000 INTR -5363.433 882.0220 -6.080838*** 0.0000 C -104692.2 100578.4 -1.040901 0.3072 *** Implies significance at 1% Table IV indicates the effect of exchange rate on capital account. Exchange rate, nominal domestic credit, inflation rate, interest rate and external reserve were regressed on capital account in order to determine the long run effect of the variables. The study also shows that exchange rate, nominal domestic credit and inflation rate have a positive effect on capital account while interest rate and external reserve have negative effect on the capital account. Obviously, the rela- tionship between exchange rate, inflation rate and external reserve and the capital account does not conform to postulations in economic theory. However, the relationship between of nominal domestic credit, interest rate and the capital ac- count are in tandem with theoretical expectation. In term of the significance of the individual varia- bles, inflation rate, interest rate and external re- serve are statistically significant at 1 percent while exchange rate and nominal domestic credit are not significant. CONCLUSION The result from the estimation of the model indicates that exchange rate and nominal domes- tic credit have positive association with the capi- tal account in Nigeria. From the result, it shows that higher exchange rate improves the capital account. That is, as exchange rate depreciates (falls), the capital account does not improve. However, nominal domestic credit improves the capital account of balance of payment compo- nents. More so, the results also show that an in- crease in external reserves worsens the capital account of balance of payments, while an increase in inflation and interest rates does not worsen the capital accounts. From our findings, it has become imperative for the government to formulate poli- cies towards curbing inflationary tendency, en- courage market-determined interest rate that would stimulate production, consumption and investment in order to increase the country’s ex- ternal reserve thereby bringing about favorable 40 Jurnal Ekonomi & Studi Pembangunan Volume 19, Nomor 1, April 2018: 35-40 balance of payments position. More so, the do- mestic credit rates have to be efficiently managed by the monetary authority to encourage and im- prove our balance of payments position and proper means of monitoring has to be introduced towards ensuring that available credit is being channeled to the right sector in order to improve the capital account. 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