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

Abstract

The study empirically investigated the impact of exchange rate devaluation on trade balance of Nigeria for the period 1980-2015. 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 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.