Domestic and External Sector Correlates of Balance of Payments: Evidence from Nigeria

 

ABSTRACT

This thesis investigated the Domestic and External Sector Correlates of Balance of Payments in Nigeria. The study which covered a period of thirty five (35) years from 1980 to 2015 proposed six (6) research objectives and Hypotheses. In order to achieve the objectives of the study, Pearson Correlation and multiple regression analyses were employed to test the proposed hypotheses. The findings of the study indicate that Balance of Payment is negatively correlated with Exchange Rate, Foreign Direct Investment, Foreign Portfolio Investment, Government Expenditure, Private consumption Expenditure and All Share Index of the Nigerian Stock Exchange. On the other hand, only two out of six independent variables indicated a negative relationship with balance of payment. Thus, a naira increase in government expenditure or private consumption is expected to lead to a commensurate decrease in balance of payment and vice versa. A positive relationship is indicated to exist between balance of payment and exchange rate, foreign direct investment, foreign portfolio investment and the all share index. This implies that a unit increase in any of the above named variables will lead to an increase in balance of payment and vice versa. Finally, none of the independent variables in the hypotheses formulated for the study were found to be statistically significant, hence the decision to accept all six null hypotheses. Based on the above findings, it was concluded that even though all external correlates of balance of payment specified for the study have a positive relationship with balance of payment, none can be relied on to provide the needed stimulation to improve Nigeria’s balance of payment position. The domestic correlates (Government expenditure, Private consumption and All share index) do not significantly contribute to the objective of improving Nigeria’s balance of payment position. Given the conclusions above, we recommend that regulatory authorities should put appropriate policies in place that will help in enhancing/improving Nigeria’s balance of payment position. Foreign investors through the vehicle of foreign direct investment and foreign portfolio investment should be encouraged to bring in additional foreign investment into the country. Fluctuations in the exchange rate should be stabilized through control of the out-flow, this will help improve balance of payment position of the country. Finally, government expenditure especially in the area of recurrent expenditure should be curtailed in order to reduce drain on government earnings. Instead attention should be given to capital expenditure that is expected to lead to increase in economic activities in the country.

111 Pages 

Project Reference Code: C048

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CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF THE STUDY

           The external domestic sector of the Nigerian economy has undergone profound changes in recent years. Principal among these are the rapid depreciation of the naira, the accumulation of payments arrears, the external debt problem which has resulted in debt restructuring, etc. These changes, along with other aspects of international economic transaction are captured in the balance of payments (BOP), Statistics (CBN, 1998).

The balance of payments account is a periodic report that summarizes the flow of economic transactions with foreigners. It provides information on the nation’s exports, earnings of domestic assets owned by foreigners, international capital movements (Quantney et al, 1990).

          Prior to the introduction of the Structural Adjustment Programme (SAP) in 1986, Nigeria’s Balance of Payment (BOP) had started to show signs of disequilibrium having been managed over the years within a policy framework of direct control. The controls were in areas of credit, interest rate, exchange rate, and trade. Following the sudden collapse of international oil prices in 1980’s and the consequent fall in foreign exchange receipts, controls were tightened. However, the controls proved counter-productive as it became clear that the economy could not be managed with a policy framework that placed heavy reliance on direct controls (Olisadebe, 1993).

          The period beginning from the later end of 1999 marked a turning point from a hitherto culture of fiscal indiscipline characterized by frivolous spending to a new dawn of prudent consumption and saving. This is evidence from an unprecedented accumulation in the level of reserve from USD 4.98 billion in May 1999 to USD 59.37 billion as at March 28, 2007 (CBN, 2007). These robust domestic economic performances according to Magnus (2007) were occasioned by macroeconomic fundamentals like internal reforms, complemented by favourable external conditions like the persistent and unprecedented rise in crude oil prices joined with drastic decline on external obligations like debt service.

          The recent growth of external reserve is not a phenomenon that has been unique to Nigeria. Most of the South East Asian as well as Latin American economies have also been indulging in this kind of behaviour. For instance, Adam and Leonce (2007) noted that global official foreign exchange reserves rose from USD 1.2 trillion in January 1995 to USD 5.04 trillion in December 2006 and the share of developing countries in world reserves increased from 50 to 72% over the same period. These development according to Magnus (2007) consequently underscored the critical role of foreign exchange reserve in the balance sheet of Central Bank and monetary policy operation, generating renewed and ranging controversies among schools and analysts in the process.

          Domestic public debt is not a new phenomenon for developing countries. Guidotti and Kumor (1991) study the case of 15 emerging market countries and show that their domestic public debt-to-GDP ratio went from 10 per cent in 1981 to 16 per cent in 1988. They also point out that while the ratio of domestic debt to total public debt remained more or less constant over the period (at about 30 percent), there were important differences in the process that led to the accumulation of domestic and external debt. The increase in domestic debt was mainly due to new borrowing and that of external debt was due to accumulation of arrears. This suggests that if emerging market countries had not been shut down from the international capital market, they would have probably accumulated more external and less domestic debt. This view is consistent with the one put forward by Borensztein, Cowan, Eichengreen and Panizza (2007), who find that crisis play a key role for the development of the domestic bond market.

          The determination of the level of domestic and external sector correlates of balance of payment that is appropriate to achieve the goals of macroeconomic policy forms the fulcrum of domestic and external sector correlation. In particular, it is of paramount importance to the achievement of a favourable balance of payment position. This is in view of the serious balance of payments problems that might result from improper articulation and implementation of domestic and external sector correlation. Thus, in order that a country like Nigeria may optimize the advantages of international trade, it becomes imperative for the country to institute appropriate domestic and external sector correlation.

1.2     STATEMENT OF THE PROBLEM

          The external sector of the Nigeria economy has undergone profound changes in recent years. The most significant among these changes are the rapid depreciation of the naira exchange rate and the accumulation of payment arrears. At the period corresponding to Nigeria’s independence, the Nigeria economy witnessed tremendous growth in all macroeconomic aggregate. The economy at that time was largely agrarian, with agriculture contributing over 60 percent to the Gross Domestic Product and constituting over 80 percent of total export earnings. The situation however changed with the emergency of the oil boom of the 1970s.

          The oil boom of the 1970s brought with it fundamental changes in the Nigeria economy and was orchestrated by the sharp rise in world oil prices as a result of the Arab-Israeli war in 1973 and the oil shock of 1979 (Gbosi, 1997). These developments led to unprecedented transfer of wealth to Nigerian specifically in the wake of the oil boom, export revenues increased substantially, as also did foreign exchange reserves, import bills and national income. Government expenditure rose to mop up the phenomenal inflow of wealth and foreign exchange, real wages increased and the real exchange rate appreciated. As a result, the economy depended heavily on crude petroleum export as the main source of foreign exchange earnings and government revenue. By 1980, the oil sector which accounted for 22 percent of the GDP provided 80 percent of Government revenue and over 96 percent of export earnings. Also, the structure of sector correlation incentives and controls encouraged import orientated production and consumption patterns with little incentives for non-oil exports. Again, the competitiveness of the agricultural sector in the world market was eroded by over-valued naira exchange rate, inadequate pricing policies, rural-urban migration and neglect arising from the oil syndrome. Thus, its share of 40 percent of GDP in the early 1970s fell to 20 percent in 1980s. In fact, low productivity in the agricultural sector, became so acute that Nigeria became heavily dependent on imported food and agro-allied industrial inputs. Moreover, the public sector became the prime mover of the economy through huge investments in economic and social activities.

          However, the oil boom came to an abrupt end with the collapse of world oil prices in 1982 and a rise on real interest rates on world-wide basis and with it at economic crisis emerged in Nigeria. The fall in oil prices was reflected in domestic and external sector receipts and Government revenue. Thus, foreign exchange receipts and revenues from oil dropped proportionally to dismal levels. Consequently, the external reserves fell sharply and foreign debts mounted in the face of rising imports, government deficits widened and efforts at containing the adverse developments created some other serious problems such as economic depression, rising inflation, unemployment and persistent balance of payments (BOP) deficits. Specifically, the external sector of the economy became characterized by rapidly depleting external reserves, expansive and persistent balance of payments deficits, and the emergence of the external debts crisis.

          In addition to the above problems that were necessitated by the slump in oil prices during this period, was the fact that foreign direct investment (FDI) and foreign portfolio investment (FPI) into Nigeria all but dried up due to the perceived high risk inherent in the Nigeria economy.

          From the foregoing, it can be seen that domestic and external factors such as foreign exchange rate, foreign direct investment, foreign portfolio investment, government expenditure, private consumption and the all share price index are among the first line indicators of balance of payment problems which by extension is a economic growth problem.

          Thus, finding a solution to problems involving these domestic and external correlates represent the principal panacea to balance of payments problems.

          Generally, domestic and external sector correlation involves choosing a foreign exchange rate management system and determining the particular rate at which foreign transactions will take place Cobadan, (1996). It can be used to achieve macroeconomic efficiency through the achievement of balance of payments viability and thus domestic and external sector stability, which ultimately results in economic growth and development.

          Much emphasis has been laid by previous authors on the different aspects of the domestic and external correlates of Balance of Payment without seeming to realize the importance of having appreciation of the comprehensive effects of these correlates on the balance of payment. For example, Agene (1991), Ogiogo (1996), Olisadebe Anietie et al. (2004), Enrique and Nagayasu (2004), Annsofie (2005),Speller (2006), Yu (2006), Balogun (2007), Antonia et al. (2008), Dubas (2009), etc. laid much emphasis on the the relationship between balance of payment and exchange rate while Landua (1986), Ram (1986),  Lin (1994), Deverajan et al (1993), Nitoy et al. (2003), Josaphat et al. (2000). Junko and Vitali (IMF, 2008) investigate the impact of foreign investment on BOP.

          All the aforementioned previous empirical studies have covered the correlates of Balance of Payment (BOP) in one form or the other but failed to provide a comprehensive or holistic coverage of the study matter. The present study intends to fill this gap in literature and analyses by providing a comprehensive study that takes into consideration       all the above mentioned correlates of balance of payment both domestic and external.

 

1.3     PURPOSE OF THE STUDY

1.4     RESEARCH QUESTIONS

1.5     RESEARCH HYPOTHESIS

          To address these problems above and to have a focus, the following null hypothesis has formulated:

Ho₁:  There is no significant relationship between all share price index and      balance of           payment.

Ho₂:  There is no significant relationship between government        expenditure and   balance of payment.

Ho₃:  There is no significant relationship between private consumption   and balance of payment.

Ho₄:  There is no significant relationship between exchange rate and        balance       of payment.

Ho₅:  There is no significant relationship between foreign portfolio          investment and balance of payment.

Ho₆:  There is no significant relationship between foreign direct      investment and balance of payment.

1.6     SIGNIFICANCE OF THE STUDY

1.7     SCOPE AND LIMITATION OF STUDY

1.8     DEFINITION OF TERMS

REFERENCES

 

CHAPTER TWO

LITERATURE REVIEW

2.0                   INTRODUCTION

In this chapter, a concerted effect will be made to review the relevant theories and empirical literature relating to domestic and external sector correlates and the balance of payment as propounded by various researchers. Attention will also be focused of trends, management and current issues in the area of the subject matter. This is to enable us build a proper foundation of knowledge on the subject matter so as to contribute to the advancement of knowledge, with a view to achieving the purpose and objectives of this study.

Several researches have been carried out over the years on foreign portfolio investment policy and management, as well as the balance of international payment. It is our intention to examine these academic exercises and establish the relationship between domestic and external sector correlates and balance of payments performance in Nigeria, with a view to adequately addressing the pertinent issue of Nigeria’s domestic and external sector correlates of balance of payment viability/ efficiency.

To this end the impact of all share price index of Nigeria’s domestic and external sector correlates of balance of payment will be critically examined. Also, the impact of government expenditure to balance of payment and the effects of private consumption on balance of payment will also be examined. Attempt will also be made to examine the exchange rate to balance of payments stabilization, as well as review the various effect of foreign portfolio investment to balance of payment, furthermore examine foreign direct investment to balance of payment and their effects on balance of payments performance. This will greatly enable us achieve the objectives of this study.

Thus, by the conclusion of this exercise, we would be in a better position to articulate remedial and amelioratory measures towards curbing the intractable problem of Nigeria’s domestic and external sector correlates of balance of payment instability. 

2.1     CONCEPTUAL FRAMEWORK OF BALANCE OF PAYMENT

The balance of payments is defined as a systematic record of economic and financial transactions for a given period of time, say one year, between residents of an economy and non residents - rest of the world. These transactions involves the provision and receipts of real resources – goods, services and income – and changes in claims on and liabilities to the rest of the world.

Specifically, the balance of payments records transaction in goods, services and income, changes in ownership and other changes in an economy’s holdings of monetary gold, Special Drawing Rights (SDRs) and claims on and liabilities to the rest of the world. It also records unrequited or unilateral transfers –the provision or receipts of an economic value without the acceptance or relinquishing of something of equal value. Generally, transactions involving payments to a country by non-resident are classified as credit entries. Those involving payments by country to non-residents are debt entries.

Basically, the balance of payments is divided into the current and capital account. The capital account is made up of portfolio and direct investment, either long or short term capital and capital transfers. While the current account records all current transactions, which are transactions that include either the export or import of goods and services. They include merchandise and services. The capital account also refers to charges in financial assets and liabilities, portfolio investment, external loan drawings and amortization and charges in short-term capital movements.

However, it should be noted that development in the other sectors – real, monetary and public – has implications for the balance of payments. As a result, current account deficit may not necessarily be an inappropriate policy to pursue especially in a country that is for example, importing to increase domestic investment. However, in a short-term, import bills may remain unpaid or external reserves could be drawn down. A long-term and more viable solution lies in ensuring balance of payments viability.

A viable balance of payments position may be defined as a current account position, which can be financed on a sustainable basis by net capital movements on terms that are compatible with reasonable development, growth prospects and debt servicing capacity as well as macro-economic stability. It can be seen that the balance of payments is linked with the other accounts in a general equilibrium framework. This implies that disequilibrium in one sector; say external sector is transmitted to the other sectors and vice versa. Thus, there is need to achieve both internal and external balance.

According to Marsha (1994), two types of policy measures are used in dealing with balance of payments problems. These are expenditure switching measures and expenditure reducing policies. Expenditure reducing policies refer to fiscal policy (conducted by changing government expenditure and /or taxes) and monetary policy which refers to changes in money supply, which in turn affect interest rate. Expenditure switching policies refers to devaluation (depreciation) and revaluation (appreciation) of the country’s currency.

The aim of expenditure reducing policies is to reduce domestic expenditure on consumption and increase expenditure on investment, thus, releasing goods and services for exports while leaving aggregate output unchanged. The aim of expenditure switching policies is to switch domestic demand from imported goods to home made goods. However, the extent to which expenditure switching policies is achieved depends on elasticity of supply and demand for tradable goods. If the depreciation of the nominal exchange rate is matched by increase in wages, absorption and inflation, the real exchange rate would not depreciate and so the balance of payments would not improve.

However, expenditure reducing policies have costs in terms of loss of output, investment and employment. The loss will be minimized if resources can be easily moved to the tradable goods sector. Alternatively bridging external loans may be contributed to sustain investment and output.

2.2     THEORY OF BALANCE OF PAYMENT

2.3     COMPONENTS OF BALANCE OF PAYMENTS

2.3.1  The Current Account

2.3.2  The Capital Account

2.3.3  Official Financing Account

2.4     CAUSES OF BOP IMBALANCES

2.5     CAUSES OF BALANCE OF PAYMENTS DISEQUILIBRIUM

2.6     BALANCE OF PAYMENTS CRISIS

2.6.1  Balancing mechanisms

2.6.2  Rebalancing by changing the exchange rate

2.6.3  Rebalancing by adjusting internal prices and demand

 2.6.4 Rules based rebalancing mechanisms

2.7     POLICIES TO CORRECT BALANCE OF PAYMENTS DISEQUILIBRIUM

2.8     EXCHANGE RATE POLICY IN NIGERIA

2.9     THE RELATIONSHIP BETWEEN EXCHANGE RATES         AND           BALANCE OF PAYMENTS

2.10   RELATIONSHIP BETWEEN FOREIGN INVESTMENT AND          BALANCE OF PAYMENTS

2.11   THEORY OF GOVERNMENT EXPENDITURE

2.11.1                   PUBLIC EXPENDITURE POLICIES IN NIGERIA

2.12   PERFORMANCE AND TRENDS IN NIGERIA’S BALANCE            OF PAYMENTS      

2.13            A REVIEW OF RELEVANT EMPIRICAL LITERATURE

2.13.1                   Balance of Payment and Exchange Rate

2.13.2                   Balance of Payment and Foreign Investment

2.13.4                   Government Expenditure and the Economy

         REFERENCES

 

CHAPTER THREE

RESEARCH METHODOLOGY

3.1     INTRODUCTION
          In this chapter, a considerable amount of effort will be made to design all the methods and techniques to be used in collecting the research data. The data gathering techniques to be employed as well as the analytical tools to be adopted in this research will be dictated by the nature of this study and the problem under consideration. Thus, the data to be collected will be those that relate to the variables under consideration, that is, balance of payments, exchange rates, foreign direct investment, foreign portfolio investment, government expenditure, private consumption and all share index of the Nigeria stock exchange for the period of the study.

3.2     RESEARCH DESIGN

          In every research work, there are many designs open to the researcher to choose from in order to obtain necessary data aimed at the successful realization of the objectives of the study. However, some research designs are more appropriate and suitable in the collection and analysis of the research data, in order to achieve the objectives of studies like this one.

          To this end, we will adopt the quasi-experimental research design for this research. The experimental method attempt to account for the influence of a factor or multiple factors conditioning a given situation; it attempts to demonstrate the existence of a causal relationship between one or more independent variables and one or more dependent variables (lkeagwu, 1998).

          Our choice of this method is motivated by its inherent ability to critically highlight the caused relationship between exchange rates and balance of payments performance, analyze the influence of exchange rates on balance of payments performance, as well as test the hypothesized relationship. This design has the advantage of establishing relationships, as well as providing opportunity for studying change over time. Most importantly, it reduces bias thus ensuring reliability. These characteristics are critical to the
achievement of the purpose of this study.

3.3     DATA COLLECTION

3.4     DATA ANALYSES TECHNIQUES

3.5.1  MODEL SPECIFICATION

As we stated earlier, data collected for this study was estimated using a Multiple Regression Analysis of the Ordinary Least Squares Method. In its general form, the model is specified as:

y = a + b₁x₁ + b₂x₂ + ...... + b_nx_n + ie

where      y = the dependent or outcome variable

                         a = constant term

   x₁, x₂…x_n = set of independent variables or predictors

b₁, b₂, ….b_n  = coefficients of the predictor variables and

                ie = the error term.

Thus, given our variable: (Balance of Payments (BOP), Exchange Rates (EXRATE), Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), Government Expenditure (GOVT), Private Consumption (PRIVATE) and All Share Index (ASI)), following the multiple regression model as specified above,

BOP = a + b₁EXRATE + b₂FDI + b₃FPI + b₄GOVTEX + b₅PRCONS + b₆ASI + ie

Where         BOP            = Balance of Payments            

                   EXRATE    = Exchange Rates                    

                   FDI             = Foreign Direct Investment

                   FPI              = Foreign Portfolio Investment

                   GOVT        = Government Expenditure

                   PRIVATE   = Private Consumption and

                   ASI             = All Share Index

 

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.0     INTRODUCTION

In this chapter, we carry out an analysis of the data collected from secondary sources from the central bank Nigeria statistical bulletin. For the purpose of clarity and easy understanding of the analysis, this chapter has been divided into three sections. The first section presents an introduction to the chapter, the second presents an analysis of the data characteristics. Finally, section three deals with the testing of hypothesis.

Tables and charts will be used for the presentation of the data and the report is structured around these exhibits.

4.2     DATA PRESENTATION

4.3     DATA ANALYSES AND INTERPRETATION OF RESULTS

4.4     HYPOTHESES TESTING

HYPOTHESIS ONE

HYPOTHESIS TWO

HYPOTHESIS THREE

HYPOTHESIS FOUR

HYPOTHESIS FIVE

HYPOTHESIS SIX

 

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION

5.1     SUMMARY AND DISCUSSION OF FINDINGS

This chapter shows the summary of findings, conclusions drawn and the recommendation made on the basis of the findings and conclusions of the study. This study undertook to investigate the Correlates of Balance of Payments in Nigeria.

Among the findings of the analyses carried are the following:

a)     Balance of Payment is negatively correlated with Exchange Rate, Foreign Direct Investment, Foreign Portfolio Investment, Government Expenditure, Private consumption Expenditure and All Share Index of the Nigerian Stock Exchange.

b)    On the other hand, only two out of six independent variables indicated a negative relationship with balance of payment. Thus, a naira increase in government expenditure or private consumption is expected to lead to a commensurate decrease in balance of payment and vice versa.

c)     A positive relationship is indicated to exist between balance of payment and exchange rate, foreign direct investment, foreign portfolio investment and the all share index. This implies that a unit increase in any of the above named variables will lead to an increase in balance of payment and vice versa.

d)    Finally, none of the independent variables in the hypotheses formulated for the study were found to be statistically significant, hence the decision to accept all six null hypotheses.

 5.2    CONCLUSIONS

5.3     RECOMMENDATIONS

 

BIBLIOGRAPHY

Abeysinghe, A. and T. L. Yeok (1998), "Exchange Rate Appreciation and Export Competitiveness: The Case of Singapore", Applied Economies, 30, pp. 51-55.

Anietie N. B, S. O. Ayodele, F. N. Obafemi and F. S. Ebong (2004), "Exchange Rate Policy and Inflation in Nigeria: A Causal Analysis", Cited at http://ssunicaledu.org/schedule.htm

Annsofie P.(2005), "Identifying the Determinants of Exchange Rate Movements: Evaluating the Real Interest Differential Model"

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Sanusi, J.O. (2004), Exchange Rate Mechanism, the Current Nigerian Experience. [Online]. Available: www.cenbank.org/OUT/SPEECHES/2004/Govadd-24Feb.pdf.  [Accessed 20June 2010]

Takaendesa, P. (2006), "The Behaviour and Fundamental Determinants of Real Exchange Rate in South Africa", A Masters Thesis Submitted to Rhodes University, South Africa

Umoru D. and M. I. Eboreime, (2013), The J-Curve Hypothesis and the Nigerian Oil Sector: The ARDL BOUNDS Testing Approach. European Scientific Journal London, United Kingdom ISSN: 1857 – 7881 (Print) e - ISSN 1857- 7431 Vol.9, No.4: 314-332 [February Issue]

Yu H. (2006), "Determinants of Exchange Rate Fluctuations for Venezuela: Application of an Extended Mundell-Fleming Model", Journal of Applied Econometrics and International Development, Vol. 6, No. 1. Cited at http://ssrn.com/abstract=1240592

 

 

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