An Empirical Analysis of the Impact of Exchange Rate Devaluation on Trade Balance of Nigeria: Vector Error Correction Model Approach

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1 Asian Journal of Economics, Business and Accounting 3(3): 1-15, 2017; Article no.ajeba ISSN: X An Empirical Analysis of the Impact of Exchange Rate Devaluation on Trade Balance of Nigeria: Vector Error Correction Model Approach Eze Onyebuchi Michael 1* and Atuma Emeka 1 1 Department of Economics, Ebonyi State University, Abakaliki, Ebonyi State, Nigeria. Authors contributions This work was carried out in collaboration between both authors. Author EOM designed the study, handled the statistical analysis aspect of the literature searches, wrote the first draft of the manuscript and managed the analyses of the study. Author AE managed the economic aspect of the literature searches. Both authors read and approved the final manuscript. Article Information DOI: /AJEBA/2017/33355 Editor(s): (1) Ivan Markovic, Faculty of Economics, University of Nis, Serbia. Reviewers: (1) Vaishali Padake, K. J. Somaiya Institute of Management Studies and Research, India. (2) Neelam Rani, Indian Institute of Management Shillong, India. (3) Peter E. Ayunku, Niger Delta University, Nigeria. (4) Linh H. Nguyen, Vietnam. (5) Senibi Victoria, Nigeria. Complete Peer review History: Original Research Article Received 11 th April 2017 Accepted 29 th April 2017 Published 27 th July 2017 ABSTRACT The study empirically investigated the impact of exchange rate devaluation on trade balance of Nigeria for the period Specifically, it tested the Marshall-Lerner (ML) conditions for Nigeria s case to see whether it is satisfied. ML condition states that nominal exchange rate devaluation improves trade balance of a country. The econometric methods utilized in the analysis include Johansen cointegration technique and vector error correction model (VECM) approach. The variables used in study include trade balance (TB), nominal exchange rate (NEXCR), export (XP) and import (MP). Stationarity test was conducted and found stationarity among the variables after first differencing. The estimation of the cointegration test showed evidence of long run relationship among the variables. Similarly, the study through the application of VECM indicate that nominal exchange rate (NEXCR) has positive and insignificant impact on trade balance (TB). It also showed *Corresponding author: onyimikey88@yahoo.com;

2 that export (XP) has positive and insignificant impact on trade balance, while import has negative and significant impact on trade balance, which implies that ML condition is not satisfied for Nigeria. Based on these findings, the study recommends that government may reconsider its exchange rate devaluation position and stop further devaluation as such policy does not lead to significant improvement in the trade balance of Nigeria. More so, since export contributes positively though insignificantly to the trade balance of Nigeria, while import contributes to trade balance negatively and significantly, government is advised to put more efforts in its export promotion strategy as that would results to significant improvement in the trade balance of the country in the long run, and hence, discourage excessive volume of importation observed in the economy. Keywords: Trade balance; exchange rate; devaluation; cointegration; vector error correction model. 1. INTRODUCTION There is no doubt that exchange rate devaluation affects trade balance of any economy, though it varies among countries of the world as a result of differences in the level of economic development [1]. The Marshall-Lerner condition is one of the major postulations, which argued that real devaluation of domestic currency results to improvement in trade balance of a country in the long run and however, deteriorates in the short run, if the sum values of imports and exports demand elasticity exceed unity [2]. Hence, change in national currency affects trade balance of a country in two major ways, which include the price effect and the quantity effect. Whereas the price effect makes imports more expensive, the quantity effect, results to cheaper exports for the purchasing countries in the short run. This is because the volume of imports and exports do not adjust automatically in the short run. Thus, trade balance tend to deteriorate in the short run following exchange rate devaluation; however, in the long run, when the adjustment process of exports and imports to the devaluation dominates, the devaluation effects lead to improvement in trade balance of the country thereby assuming the Marshall-Lerner condition. Prior to the adoption of the Nigeria naira in 1973, the currency in circulation was Nigeria pound. By 1971, during the period when the America devalued its dollar, Nigeria declined from devaluing its pound during the devaluation process, and this led to the Nigerian pound appreciation against US dollar in which $3.80 was exchanged for a Nigerian pound [3]. In 1973, naira replaced the Nigerian pound and hence, resulted to the devaluation of naira and was exchanged at the same rate with the US dollar at the ratio of $1.52 to a naira. In 1986, following the adoption of structuring adjustment programme (SAP), which came into existence as a result of the collapse of oil prices in the world market in the early 1980s, in addition to the unimaginable external trade imbalances and trade arrears witnessed by the country. The Nigerian external sector was characterized by decline in foreign exchange earnings, overvaluation of the naira exchange rate, accumulation of trade arrears and debt overhang [3]. In view of this, structural adjustment programme (SAP) characterized by exchange rate policy was adopted in order to address the structural imbalances and attain economic structural transformation [4]. Furthermore, in 1994, exchange rate was fixed at 22 to a US dollar which means a shift from exchange rate floating regime of 1986 to fixed exchange rate regime. [5] revealed that foreign exchange market in 1995 was liberalized, which led to the establishment of autonomous foreign exchange market (AFEM), and government dedicated trading in the foreign exchange to the market as well as purchase foreign exchange through the Central Bank of Nigeria (CBN). Another foreign exchange policies introduced during this period include Inter-Bank Foreign Exchange Market (IFEM) in 1999, as well as Dutch Auction System (DAS) to replace the IFEM. 2. TREND OF EXCHANGE RATE DEVALUATION AND TRADE BALANCE IN NIGERIA The main goal of exchange rate policy involves the determination of the appropriate rate of exchange for a nation s currency in order to achieve its stability. To achieve this, various options and techniques are employed to attain efficiency in the foreign exchange market. In Nigeria, exchange rate policies have overtime transited from fixed exchange regime between 1970s and 1980s to floating exchange regime since 1986 when the IMF-World Bank structural adjustment programme (SAP) was adopted in the country [6]. Floating exchange rate regime in Nigeria has ever since its commencement during 2

3 the SAP era suffered government commitment to defend any noticeable parity. As a result, naira exchange rate has continuously depreciated in real value against US dollar and other major foreign currencies of the world alongside the trade balance fluctuations. For instance, in 1981, the naira exchange rate stood at 0.61 to a US dollar, and depreciated to to a dollar in By 1991, 1996, 2001, 2006, 2011 and 2015, the naira exchange rates depreciated to , , , , and respectively to a dollar. However, the corresponding trade balance in 1981 was and increased to 2.9 in In 1991, 1996, 2001, 2006 and 2011, the trade balance of Nigeria were 32.0, 746.9, 509.8, 4,216.2 and 4,240.8 respectively, which represented an increase; and by 2015, the trade balance decreased to 2,230.9 [7]. The trend analysis of the exchange rate depreciation and trade balance shown above revealed the inconsistent rise in the trade balance of Nigeria, as exchange rate depreciated/devalued. Theoretically, [8] and [9] condition argued that exchange rate depreciation/devaluation improves trade balance of a country. Hence, the nominal value of the total demand elasticities for imports and exports must be greater than unity (εx + εm > 1). The nominal depreciation/devaluation of exchange rate leads to long run improvement in trade balance of any economy. From the facts in Table 1, it is observed that while exchange rate depreciated consistently, trade balance exhibited growth to some extent after which it became negative that obviously negates the theoretical postulations of Marshall-Lerner condition. For example, exchange rate was per US dollar in 1985/86, while trade balance was 2.9 billion. By 1995/96 and 2005/06, exchange rate depreciated to and , whereas the corresponding trade balance were billion and 4,216.2 billion respectively. In 2014/015, the exchange rate further depreciated to with trade balance recording a negative value of 2,230.9 billion, which is an indication that exports have decreased against imports in Nigeria [7]. Thus, a critical observation further revealed that the favourable trade balance recorded between the interval of 1985/86 and 2005/06 were driven by oil exports with non-oil exports recording negative trade balance almost all through. The negative trade balance recorded in 2014/015 was attributed to a fall in the oil price in the world market at the last quarter of In view of the above, one may ask; to what extent does exchange rate devaluation affects trade balance of Nigeria? It is against this background that the study empirically investigates the impact of exchange rate devaluation on trade balance of Nigeria from 1980 to Table 1. Trend of exchange rate depreciation and trade balance in Nigeria Year Exchange rate depreciation Trade balance 1985/ / / , / ,230.9 Source: CBN statistical bulletin, vol. 25, / / / /015 Exchange rate depreciation Trade balance Graph 1. Trend of exchange rate depreciation and trade balance in Nigeria Source: Researcher s own compilation 3

4 2.1 Trend Analysis of Exports in Nigeria [10] defined export as surplus goods and services of a country that are sold to other countries of the world. It involves the total goods and services a country were able to sale to other countries of the world in a given period of time. [11] viewed Nigerian export sector as one dominated by oil export, whereas raw materials and consumer goods dominate the import sector of the economy. The need for external trade emerged in Nigeria given the inability of the country to supply the needed input materials for its economic development. According to Economy Watch Content March 29, 2010, Nigerian foreign trade relations circulate around oil and natural gas sectors. The oil and natural gas are the most dominants export products for Nigeria s foreign trade. In 2007, the country approximately exported 2.34 million barrels of oil per day. In the world ranking according to total oil exports, the country ranked 8 th in the whole world. By 2009, the total oil exports of the country were approximately 36.2 billion barrel per day. However, prior to the oil production in commercial quantity in 1970s, the export sector of the country was dominated by agricultural production. But when oil became intensively the major foreign export earnings of the economy, the agriculture sector faltered though it is still the major employer of labour, employing about 70% of the total work force in the country. According to 2009 figures, the total value of export volumes of Nigeria stood at US$45.43 billion, with the major items of export being oil products, timber and cocoa. Similarly, the Central Bank of Nigeria (CBN), 2015, statistical bulletin revealed that the percentage growth rate of Nigeria s exports stood at -23.9% in 1986, and increased to 37.7% in By 2006 and 2015, the percentage growth rates of the exports fell to 1.08% and -31.8%. The largest trade partners include United Kingdom and United States of America for Nigeria s exports. 2.2 Trend Analysis of Imports in Nigeria Imports are goods and services purchased by residents or government of a country, but are made in other countries of the world. Goods and services that can be imported into a country include consumers goods, services and capital goods used for the production of consumers goods. In Nigeria, the major goods and services imported into the country include machinery, consumers goods, heavy equipments and food products. A greater percentage of the imports arrive from the European Union, specifically from the UK, Netherlands, China, France, Germany, United States and South Korea. Meanwhile, Nigeria s import trade was able to balance export revenue due to high price of oil in the world market. For instance, the value of imports in Nigeria stood at 198.7% in 1986, and was % in By 2006 and 2015, the values were 10.99% and 5.1% respectively [7]. Thus, a critical observation showed that non-oil imports were the main driver of imports in the country. Table 2. Trend of exports trade and imports trade in Nigeria Year Exports trade growth rate Imports trade growth rate % 198.7% % -79.7% % 10.99% % 5.1% Source: CBN statistical bulletin, vol. 25, % % % % 50.00% 0.00% % % Exports trade Imports trade Graph 2. Trend of exports trade and imports trade in Nigeria Source: Researcher s own compilation 4

5 The trend analysis of the exports trade and imports trade showed that at the interval of 10 years, exports trade has negative relationship with imports trade except in 2006 where otherwise is revealed. For instance, when the exports trade growth rate was -23.9%, imports trade stood at 198.7% in In 1996, 2006 and 2015, the exports trade growth rates were 37.7%, 1.08% and -31.8% respectively, while the corresponding imports trade growth rates were 198.7%, -79.7%, 10.99% and 5.1% respectively. From the Table 3, the table shows that oil exports trade dominate the Nigeria s trade balance as against the non-oil exports trade. For example, while the oil exports trade records positive trade balance in almost all the periods, the non-oil exports trade showed negative trade balance throughout the periods. 3. REVIEW OF RELATED LITERATURE There are several related and relevant literatures existing in this field of study, which explain the theoretical relationship between exchange rate devaluation and trade balance in the economic development literature. The essence of this is to emphatically explore the causal relationship between exchange rate devaluation policy of a Table 3. Nigeria s trade balance from 1981 to 2015 Year Trade balance (with oil, b) Trade balance (without oil, b) Total trade balance ( b) , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,230.9 Source: CBN statistical bulletin,

6 country and its trade balance. In this sense, this study decomposed the literatures into theoretical and empirical review sub-sections. 3.1 Theoretical Review Several theories exist in the economic literature, which explain the impact of devaluation/depreciation on trade balance of any economy. These theories as considered in this research study include the elasticity approach and monetary approach The elasticity approach The major proponent of the elasticity approach was [12] and popularized by [13] and [14]. Following the expositions of Bickerdike- Robinson-Metzler (BRM) and Marshall-Lerner (ML) conditions, elasticity approach provides explanation on the relationship between exchange rate devaluation and trade balance of any country. The approach argued that exchange rates are the major determinants of trade balance of a country. Hence, it links foreign exchange demand to the demand for foreign goods and services. According to [3], transactions undertaken during a period of currency devaluation negatively affects trade balance in the short run but improves trade balance in the long run as exports and imports volumes adjust, giving rise to exports and imports elasticities to increase with the quantities adjusting. In view of this, the export s price of the devaluing country is reduced and the price of imported goods increasing thereby reducing the demand for imports of the country in the long run, which in turn, results to improve in the trade balance. The theory emphatically argued that the effect of devaluation depended on the elasticity of demand for exports and imports of a country. Thus, the main position of the elasticity approach is the substitution effects in consumption and production induced by relative price changes resulting from exchange rate devaluation [4]. This approach otherwise referred to as the BRM model has generally been accepted in the economic literature as the most providing sufficient condition to improved trade balance under exchange rate devaluation. The BRM and ML conditions postulated that devaluation improves trade balance (Marshall, 1923; Lerner, 1944). The condition opines that for devaluation to affect trade balance positively, as well as stabilize exchange market, the nominal values of the sum of the demand elasticities for exports and imports should be greater than unity; devaluation leads to countries improve in its balance of payments. In this sense, ML condition [8,9] further postulated that when a country devalued its domestic currency, the country s import prices rises while its foreign prices of exports falls leading trade balance to improve by increasing exports and decreasing imports. However, the extent to which it succeeds is mainly depended on the price elasticities of a country s domestic demand for imports and foreign demand for exports. The Marshall-Lerner condition states that when the sum of price elasticities of demand for exports and imports in nominal terms exceeds unity, devaluation improves the balance of payments of the country; i.e., nx + nm >1 (1) Where; nx = demand elasticity for exports; nm = demand elasticity for imports. Thus, if the sum of price elasticities of demand for exports and imports in absolute terms is less than unity, i.e nx + bm< 1 (2) It means that devaluation worsen the balance of payment. However, if the sum of these elasticity in absolute terms is equal to unity; i.e. nx + nm = 1 (3) It implies that devaluation does not have an effect on the balance of payment situation; hence, it will remain unchanged. The distinction between short run and long run elasticities is important and results to what is known as the J- curve effect. A real devaluation/depreciation improves trade balance in the long run and worsens it in the short run when the ML condition is satisfied Monetary approach The monetary theory of exchange rate viewed money as an important factor in an economy. Thus, the monetary theory focused on money supply as the main determinant of exchange rates. The main trust of the monetary theory is that exchange rate fluctuations are explained in terms of variations in the relative supplies of national currencies [15]. In view of this, the theory advocated that the money supply could be applied to forecast exchange rates movements; hence, there is causal relationship existing 6

7 between exchange rates and changes in money supply. [16] stated that given the monetarists model, increase or decrease in economic factors affects exchange rate by impacting on both demand for and supply of money balances. Thus, it was argued in the theory that both the supply and the demand for money have strong forces in the determination of external position of a country. While rise in the country s money demand results to surpluses in the balance of payments, a rise in money supply leads to deficits in the balance of payments. The main concern of the monetary approach is on the deficit of monetary account that consists of the items, which affect the domestic monetary base. The approach stresses more on the monetary aspects of the balance of payments by considering the role of financial assets beyond merchandise trade. On the aspect of exchange rate, the monetary approach viewed that a country s exchange rate dynamics is a monetary phenomenon; hence, any observed balance of payments disequilibrium can be eliminated by manipulating monetary variables such as domestic credit, absence of sterilization by the monetary authorities, under controlled exchange rate and money demand stability function [17]. More so, money supply is treated as endogenous variable through the assumption of a feedback from the balance of payments by increase or decrease in international reserves to changes in the money, monetary liabilities of the central bank. 3.2 Empirical Review [1] examined the link between the real exchange rate and trade balance in Malaysia for the period of Cointegration test, Vector Error Correction Model (VECM), Engle Granger test and impulse response analyses were employed in the analysis. The study found that real exchange rate is a critical variable to trade balance; hence, a devaluation of exchange rate improves trade balance in the long run, which satisfied the Marshall-Lerner condition in Malaysia. J-curve effect evidence was not found in Malaysia case. [18] examined the effects of currency depreciation trade balance in selected export sector in Asian countries. The study theoretically observed that exchange rate devaluation brings positive impact on trade balance, which can only be feasible when the sum of the elasticities of demand for exports and imports exceeds unity. The study indicates no evidence of effect of exchange rate devaluation to improve trade balance in 14 Asian economies used in the investigation. However, in the second approach, which narrowed down the number of countries to 8 countries that are relatively bigger, industrialized and stable; the study found that devaluation improved their trade balances. [19] examined the impact of exchange rate of China on the US trade, employment, as well as its currency. The study tried to answer such questions as to what mechanism adopted by China to determine exchange rate? The interest of China in adopting fixed exchange rate strategy; the steps undertaken by China in affecting the U.S. trade; the steps taken by US to abandon China s policy. Hence, the study concludes that US economy was affected badly; China snatched the jobs of US, exports of China rushes towards US economy while imports from US towards China did not come with that pace. This happens because of exchange rate and trade mechanism adopted by China. [20] investigated the impact of exchange rate devaluation on trade balance of Pakistan from 1980 to 2014 by testing for the validity of J-curve in the economy of Pakistan. The main goal of the study was to examine the long run relationship among the devaluation of domestic currency, balance of trade and external debt. The study employed autoregressive distributed lag model (ARDL) and error correction model (ECM) in the investigation. The variables used in the study include trade balances, real effective exchange rate and external debt. The study found absence of J-curve in case Pakistan. [21] examined the effects of nominal effective exchange rate changes on trade balance in Malawi by employing multivariate cointegration test. The results indicate that exchange rate devaluation has insignificant impact on trade balance in the long run. However, trade balance was showed by the result to have greater impact on domestic income changes in Malawi. [22] examined the impact of real effective exchange rate on South Africa s trade balance and to determine whether the J-curve effect and the Marshal-Lerner conditions are satisfied in the South African economy by using the bounds test and cointegration test. The results indicate evidence of long run relationship among trade balance, real effective exchange rate, domestic GDP, money supply, terms of trade and foreign reserves. The results also showed that a depreciation of the ZAR improves the trade balance in the long run, thereby supporting the Marshal-Lerner condition. In the short run, a ZAR 7

8 depreciation results to a deterioration of the trade balance, which confirmed the J-curve effect for the RSA economy. [23] investigated the Marshall-Lerner condition in Kenya s bilateral trade by employing extended trade balance model developed recently through the applications of the Im-Pesaran-Shin (IPS) unit root test and the Pedroni cointegration test after which mean group estimation technique was applied in the analysis. The results revealed that the Marshall-Lerner condition was only fulfilled for trade between Kenya and China, UAE, India and South Africa. Similarly, [24] examined the short run and long run impact of the changes in exchange rates on the trade balance of Zambia through the applications of cointergration test and the vector error correction model (VECM) from 2000 to 2010, and the results indicated that exchange rates do not impact on the trade balance of Zambia in the short run but they have impact on the trade balance in the long run. [25] investigated exchange rate and trade balance in Ghana from 1980 to 2013 by testing the validity of the Marshall-Lerner condition. Cointegration and vector error correction model (VECM) were used in the analysis. The empirical results revealed that real effective exchange rate has negative relationship with trade balance in the long run. In the short run, the results showed that exchange rate has positive relationship with trade balance. The study therefore, concludes that exchange rate depreciation does not improves Ghana s trade balance in the long run, as the Marshall Lerner condition was not satisfied since the coefficient is less than unity; however, the evidence from the result indicates that depreciation can be used to improve on the trade balance. [26] examined the effects of exchange rate change on trade balance of Slovakia by testing for the J-curve effect from 1997 to 2013 through the applications of cointegration approach, vector error correction model (VECM) and impulse responses function. The results showed evidence of long run relationship among trade balance, real effective exchange rate, gross domestic product and world gross domestic product. The J-curve in Slovakia was not revealed within the period. Hence, J- curve exhibits inverse pattern, which implies that depreciation results to improvement in trade balance and then this effect gradually wanes out. Furthermore, [27] investigated the effect of real exchange rate, domestic and foreign income on bilateral trade balance for Vietnam and her sixteen trading partners from 1999 to Panel cointegration approach, DOLS and FMOLS estimations were utilized to examine the long run relationship between the real exchange rate and bilateral trade. The results showed evidence of cointegration among trade balance, domestic income, real exchange rate and foreign income in Vietnam. Similarly, the results from both panel FMOLS and DOLS estimation results revealed that real exchange rate and domestic income have negative influence on trade balance, while foreign income has positive effect on trade balance. [28] studied the impact of devaluation on trade balance in Zimbabwe using a quarterly data from 1990 to Johansen- Juselius Cointegration approach, Vector Error Correction Model (VECM) technique and impulse response analysis were used in the investigation. The empirical result indicates that devaluation of exchange rate improves trade balance in the long run and cointegration exists between real effective exchange rate and trade balance in the long run. Thus, it shows that devaluation improves trade balance in the long run, which is consistent with the Marshall-Lerner condition and no J-curve effect evidence is found in Zimbabwe. [29] estimated the effect of real effective exchange rate volatility on trade balance of Iran from 1993 to 2011 through the applications of GARCH (1, 1) technique and balance panel data model. The results showed that the real effective exchange rate does not have significant effect on trade balance of Iran. Hence, in the country, real effective exchange rate volatility cannot solely be used in managing the trade balance of Iran with its main trading partners. More so, the results found that trade balance is affected by import, rather than export. More so, [11] investigated the effect of naira exchange rate devaluation on trade balance of Nigeria from 1986 to 2008 by focusing on elasticity approach of the Marshall-Lerner condition to the balance of payment adjustment mechanism. Ordinary least square (OLS) technique was applied to examine the import and export demand relationships. The findings of the study revealed that devaluation did not improve trade balance in the economy, since the sum of demand elasticities for imports and exports is less than unity; hence, the Marshall-Lerner condition is not satisfied. Furthermore, it argued that devaluation can only be beneficial when a country is originally an export based economy, rather than focusing on export of raw materials like Nigeria. [4] investigated the link between real exchange rate devaluation and aggregate trade 8

9 balance of Nigeria with the objective that a nominal devaluation of exchange rate improves the trade balance of a country by testing to determine whether the ML conditions is met in Nigeria. Johansen and Juselius approach to estimation of multivariate cointegration method, as well as ordinary least square (OLS) technique were utilized in the study. The empirical results indicated that depreciation/devaluation improves trade balance, with Marshall-Learn (ML) condition holding in Nigeria. [2] employed the J-curve effect focused on time series data through the application of the vector error correction model (VECM) to investigate the trade flows and exchange rate shocks in Nigeria. The empirical results showed cyclical feedback between real exchange rate depreciation of naira and trade balance. The finding however, indicates no evidence in support of the short run decline of the trade balance as postulated in J- curve hypothesis. In contrast to that, the empirical finding favoured cyclical trade effect of exchange rate shocks. This means that real exchange rate shock initially improves then worsened which in turn; improve the aggregate trade balance of the country. [3] empirically investigated the impact of exchange rate devaluation on trade balance of Nigeria from 1970 to 2010 through the applications of cointegration and variance decomposition analyses. The primary of objective of the study was to determine whether devaluation of domestic currency improves trade balance of Nigeria in line with the postulation of the economic literature. The variables employed in the investigation include trade balance, domestic income, foreign and domestic money supply, nominal exchange rate and domestic interest rate. The findings of the study indicate that exchange rate has inelastic and significant influence on trade balance in the long run; and in the short run, there is no causality running from exchange rate to trade balance, and that money supply volatility led to variance in trade balance than exchange rate volatility. Hence, exchange rate was revealed to worsen the trade balance of Nigeria in the long run. [15] studied the impact of exchange rate on Nigeria s balance of payment from 1971 to 2012 using autoregressive distributed lag (ARDL) cointegration method to examine the long term and short term dynamic relationship between the variables under study. Accordingly, Marshall- Lerner (ML) condition was tested to find out whether the condition is satisfied in Nigerian case. The study found that exchange rate devaluation improves balance of payment, which satisfied the Marshall-Lerner (ML) condition in Nigeria. Thus, the study recommended excessive importation policies should be discourage, as export promotion policies should be encouraged in the sector. More so, diversification of the economy and the promotion of entrepreneurial development were also recommended in Nigeria. [30] investigated the effect of exchange rate on the balance of trade of Nigeria from 1970 to The main objective of the study was to determine the effectiveness of currency devaluation policy as a tool for improving balance of trade of the country. Cointegration test and its error correction model (ECM) were used in the analysis. The results indicate long run relationship among the variables. The results also showed that devaluation of the domestic currency does not improve balance of trade in the country. [10] evaluated the implication of exchange rate variability on oil export trade performance in Nigeria using ordinary least square (OLS), correlation coefficients and graph. The empirical finding showed that exchange rate variability has positive and significant implications on oil export receipt and oil export price in Nigeria. [31] investigated the effect of exchange rate depreciation on trade balance of Nigeria from 1986 to 2014 by using cointegration approach, vector error correction model (VECM) and Granger causality technique. The empirical finding of the study revealed that exchange rate depreciation does not improve trade balance in the economy of Nigerian in the short run. Hence, the study recommended that more efforts should be made to diversify the sources of foreign exchange of Nigeria, rather over relying on oil export only in order to achieve favourable trade balance in the long run. More so, government was advised to discourage further depreciation of naira since such policy results to unfavourable trade balance in the economy. The result shows that a rise in foreign direct investment (FDI) will promote trade in the economy. [32] investigated the impact of exchange rate on macroeconomic aggregates in Nigeria from 1970 to 2009 through the applications of simultaneous equations and a vector autoregressive model. The results indicate no evidence of a strong direct relationship between changes in the exchange rate and GDP growth. Rather, Nigeria s economic growth has been directly affected by fiscal and monetary policies 9

10 and other economic variables such as the growth of exports (oil). These factors have tended to sustain a pattern of real exchange rate overvaluation, which has been unfavourable for growth. The conclusion was that improvements in exchange rate management are necessary but not adequate to revive the Nigerian economy. The study reviewed wide range of empirical studies on the impact of exchange rate devaluation/depreciation on trade balance across countries. In spite of the several empirical studies conducted on the subject matter, the study found that while there are several studies existing on the influence of exchange rate devaluation/depreciation and trade balance in other countries, which satisfied ML conditions; in developing countries, Nigeria in particular, such studies are scanty and most of which contradicted the ML condition on trade balance. For example, [11,2,31] etc. studied the influence of exchange rate devaluation on trade balance in Nigeria and found that devaluation does not improve trade balance in the economy. In contrast, [18,20] etc. in the developed countries conducted same studies on the subject matter and found that exchange rate devaluation improves trade balance. Meanwhile, it is observed that most cases of contradictory results are commonly associated with the studies in the developing countries, especially in Nigeria; hence, this is the gap the study tries to close. 4. METHODOLOGY In order to find the impact of exchange rate devaluation/depreciation on trade balance in Nigeria, the study employed stationarity test, cointegration test and vector error correction model (VECM) in the analysis. The stationarity test is employed to investigate the order of integration of the time series through the application of the Augmented Dickey-Fuller (ADF) test. The cointegration test is used to examine the long run relationship among the variables by using the Johansen co-integration approach, while the vector error correction model (VECM) is employed to investigate the short run dynamics and long run relationship among the variables of the study. The variables used in the study include trade balance, nominal exchange rate, export and import. Data for the study are sourced from the CBN statistical bulletin, vols. 20, 24, 25 of 2010, 2014 and 2015 respectively. 4.1 Model Specification This study follows the model developed by [12,13,14] known as the elasticity approach to trade balance. This model focused on the substitution effects in consumption and production generated by the relative price changes caused by exchange rate devaluation. A sufficient condition for balance of trade improvement and stability of the foreign exchange market is adequately provided by Bickerdike-Robinson-Metzler (BRM) condition. The condition relates the response of trade balance to exchange rate changes to domestic and foreign price elasticities of exports and imports [33]. Following [31] modelling of the BRM condition expressed as: DB DE = P xx s (1+ε)η* ( ε +η*) Where; B = balance of trade, E = exchange rate depreciation, η and ε represent the price elasticities of domestic demand for imports and exports. ɳ* and l represent foreign price elasticities. If B=O, then db/de will be greater than zero when (ε + η) (η + ε) (5) In view of the earlier empirical studies and theoretical explanations, the impact of exchange rate devaluation/depreciation including other determinants on trade balance (TB) in the economy is specified in functional form as: TB = f (NEXCR, XP, MP) (6) In linear form, it is expressed as; TB t = β 0 + β 1 NEXCRt + β 2 XP t + β 3 MP t + Ս t (7) Where; TB = Trade Balance; NEXCR = Nominal Exchange rate; XP = Export; MP = Import; β 0 = Constant term; Ս t is the error term and t is the current period 5. RESULTS AND DISCUSSION - (ε +η) (4) In this section, the study presents the estimation results and consequently the discussion of the results as estimated on the impact of real exchange rate depreciation/depreciation on trade balance of Nigeria. 10

11 5.1 Stationarity Test This test is conducted through the application of the Augmented Dickey-Fuller (ADF) unit root test. The test is employed in order to find the long term properties of the variables of the study. If the time series are found to be stationary, it implies that their variance, mean and covariance are constant overtime and that the result obtained from their analysis is reliable and can be used to predict future economic activities of the economy [34]. The estimation result of the stationarity test is shown below. The Table 4 represents the results of the stationarity test estimated from the Augmented Dickey-Fuller (ADF) unit root test at 5% critical value. The results showed that all the variables including TB, NEXCR, XP and MP are not stationary at level; however, after first differencing, all the variables became stationary at 5% critical value. This claim is supported by the respective p-values of the variables estimated in the test (see Table 4). Since the evidence of integration of the same order is reported among the variables after first differencing, it implies that the variables possessed long run properties, and that their variance, mean and covariance are constant overtime. Thus, the series can reliably be used for the investigation of the behaviours of the variables under study. 5.2 Cointegration Test Having achieved the integration of the variables at the same order one, cointegration test is further applied mainly to examine the long run equilibrium relationship among the variables employed in the study. Hence, the results of the estimation through the application of Johansen cointegration approach are revealed in Tables 5 and 6. Tables 5 and 6 represent the estimation results of the Johansen cointegration test. The results indicate 3 cointegrating equations, which is an Table 4. Augmented Dickey-Fuller (ADF) stationarity test At level At first difference Variables ADF 5% critical Prob. ADF 5% critical Prob. Remarks statistic value statistic value TB Stationary NEXCR Stationary XP Stationary MP Stationary Source: Researcher's compilation from E-view 8 Table 5. Unrestricted cointegration rank test (Trace) Hypothesized no. of CE(s) Eigenvalue Trace statistic 0.05 critical value Prob.** None * At most 1 * At most 2 * At most Trace test indicates 3 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level Source: Researcher's compilation from E-view 8 Table 6. Unrestricted cointegration rank test (maximum eigenvalue) Hypothesized no. of CE(s) Eigenvalue Trace statistic 0.05 critical value Prob.** None * At most 1 * At most 2 * At most Trace test indicates 3 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level Source: Researcher's compilation from E-view 8 11

12 indication that evidence of long run equilibrium relationship is established among the variables under investigation. The claim is supported by the trace statistic and the maximum eigenvalue statistic together with the respective p-values of the results as estimated in the test. In the results, both the trace statistic and the maximum eigenvalue statistic revealed evidence of long run equilibrium relationship among the variables by indicating 3 cointegrating equations at 5% critical value. This implies that all the variables including TB, NEXCR, XP and MP are in long run equilibrium relationship. This finding is in accordance with the findings of [1,15,2,31,30] etc, who investigated the long run relationship between exchange rate devaluation/depreciation and trade balance in the developing countries including Nigeria, Malaysia, Zambia, Ghana, Zimbabwe; and found long run relationship between exchange rate devaluation and trade balance; however, the results negate the findings of [4,32] who conducted similar investigations. Hence, vector error correction model (VECM) is required to determine the coefficient elasticities, as well as the impact of the parameters on trade balance. 5.3 Vector Error Correction Model (VECM) Since evidence of the existence of long run relationship has been established among the variables; VECM is therefore, become necessary to examine the short run dynamics and the long run relationship among the variables. Hence, the VECM results are presented in Table 7. Model: TB t = β 0 + β 1 NEXCR t + β 2 XP t + β 3 MP t + Ս t Table 7 represents the estimation results of the vector error correction model (VECM). The estimation results revealed that the a priori expectation is met; and as well satisfied the stability condition. The coefficient of the error correction term (ECT) value of possessed its desired signs. The ECT value is negative, fractional and statistically significant. The value of the ECT is , less than unity, with its associated p-value being , which implies that the a priori expectation is satisfied in the study. The ECT value also indicates that the speed of adjustment towards long run equilibrium relationship from short run disequilibrium corrected annually is 89.9%. Similarly, the results showed that the coefficient values of nominal exchange rate (NEXCR), export (XP) and import (MP) are , , and ; the corresponding t- statistic values include (NEXCR), (XP) and (MP) with its p- values being , and for NEXCR, XP and MP respectively. The results imply that nominal exchange rate (NEXCR) and export (XP) have positive and insignificant effects on trade balance (TB), while import has negative and significant effect on trade balance (TB). Furthermore, it was also showed in the estimation results that the F-statistic value is , while its associated Prob(F-statistic) value is , which is an indication that the Table 7. Vector Error Correction Model (VECM) Coefficient Std. Error t-statistic Prob. CointEq C(TB) C(TB) C(NEXCR) C(NEXCR) C(XP) C(XP) C(MP) C(MP) C R-squared Mean dependent var Adjusted R-squared S.D. dependent var F-statistic Durbin-Watson stat Prob(F-statistic) Source: Researcher's compilation from E-view 8 12

13 joint influence of the explanatory variables on the dependent variable is statistically significant. More so, the value of the computed coefficient of multiple determination (R 2 ) is , which implies that 80.3% of changes in trade balance (TB) are explained by the explanatory variables including NEXCR, XP and MP whereas the remaining 19.7% of the changes are attributed to other factors not included in the investigation. Similarly, the result revealed the Durbin Watson (DW) statistic value is In this study, the tabulated value of the lower limit (dl) of Durbin Watson statistic is 1.271, and the upper limit value is Since the Durbin Watson statistic value computed of is greater than the upper limit value of 1.651, the study concludes that evidence of serial correlation does not exist in the model. To confirm this claim, the result of Breusch-Godfrey Serial Correlation LM Test indicated that Obs*Rsquared value of LM Test is , while the p-value is Since LM p-value of is greater than 5% chosen level of significance, the study concludes that evidence of serial correlation is not found in the model. The discovery is in line with the findings of [1,15,24,25,2,31] who carried out studies on the influence of exchange rate devaluation and trade balance in the developing countries including Nigeria, Malaysia, Zambia, Ghana, Zimbabwe, etc and found that exchange rate devaluation does not improve trade balance; however, the discovery negates the findings of [35,28,4,32] who also conducted the similar research and found that devaluation improves trade balance in the countries reviewed. Similarly, the findings are accordance with the discovery of [4,32,15], etc who conducted research on the influence of exchange rate devaluation on trade balance and found positive effects; and however, negates the findings of [11,3,30,31], etc who also conducted a similar research and found negative effect of exchange rate devaluation on trade balance. 5.4 Policy Implications of the Results The study investigated the impact of nominal exchange rate devaluation on the trade balance of Nigeria. The cointegration test showed evidence of long run equilibrium relationship between nominal exchange rate devaluation and trade balance in Nigeria. Similarly, the VECM results revealed that nominal exchange rate devaluation positively insignificantly impacted on trade balance of Nigeria in the long run, which does not satisfied the BRM-ML conditions, as well as the J-curve effect condition in the short run; since the nominal exchange rate insignificantly impacted on the trade balance in both long run and short run. Hence, it is estimated on average that, any economic policy that targeted 1% increase in nominal exchange rate devaluation, will lead to increase in trade balance of Nigeria. Furthermore, the results showed that export has positive and insignificant relationship with trade balance, while import has negative and significant effect on trade balance. This suggests that while export effect trade balance positively, import has negative effect on the trade balance of Nigeria. Therefore, any economic policy geared towards achieving improves or positive trade balance, should consider export promotion policy as appropriate measure, and discourage imports in order to raise exports level of the country and positively improve trade balance. Thus, it is estimated on average that, 1% increase in exports leads to increase in trade balance, while 1% increase in imports results to decrease in trade balance of Nigeria. 6. CONCLUSION AND RECOMMENDA- TIONS The main objective of the study is to investigate the impact of exchange rate devaluation on the trade balance of Nigeria from 1980 to Cointegration test and vector error correction model (VECM) were utilized in the analysis. The variables employed in the investigation include trade balance (TB) as the dependent variable, whereas nominal exchange rate (NEXCR), export (XP) and import (MP) were used as the independent variables. The results of the cointegration test through the application of Johansen cointegration revealed evidence of long run equilibrium relationship among the variables under study. The vector error correction model (VECM) estimation results indicated that nominal exchange (NEXCR) has positive and insignificant impact on trade balance in Nigeria. More so, the results further showed that export (XP) has positive and insignificant impact on trade balance, while import (MP) impacted negatively and significantly on trade balance of Nigeria. This implies that naira exchange rate devaluation leads to a decrease in import demand and increase in export demand of the country within the period reviewed. The coefficient elasticity of the nominal exchange rate is positive and insignificant at 5% level of 13