CHAPTER ONE
INTRODUCTION
1.1 Background to the study
According to Cooper (1971), currency devaluation is one of the most traumatic economic policy measures that a government may undertake and as a result, most governments are reluctant to devalue their currencies. However, a country can be forced into devaluation by an ominous trade deficit. Thailand, China, Mexico, Czech Republic – all devalued strongly, willingly or unwillingly, after their trade deficits exceeded 8% of the GDP. Devaluation of currency is decided by the government issuing the currency, and is the result of governmental activities. One reason a country may devalue its currency is to combat trade imbalances. Devaluation causes a country’s exports to become less expensive, making them more competitive on the global market. This in turn means that imports are more expensive, making domestic consumers less likely to purchase them. By making the domestic currency relatively cheaper (i.e devaluation), local production and exportation of commodities is thereby encouraged.
This helps to enhance the level of output growth of the economy (Aguiar, 2005) cited in (Momodu and Akani 2016:152)
Currency devaluation is a deliberate downward adjustment of the value of a country’s currency relative to another currency or standard currency (usually dollars). It is one ofthe tools of monetary policy to stabilize the economy most especially the less developed ones operating fixed exchange rate or semi-fixed exchange rate. Devaluation increases international competitiveness of domestic industries which leads to diversion of consumption of foreign goods to domestic goods (Yilkal, 2014) cited in (Osundina 2016: 1944). It is used to encourage exportation, discourage importation and to correct unfavourable balance of payment by making home goods cheaper to foreign countries and foreign goods expensive in the home country.
Devaluation is a deliberate downward adjustment to the value of a country’s currency, currencies or standard. In other words, devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged (Yioyio, 2015).
According to Cooper (1971), currency devaluation is one of the most traumatic economic policy measures that the government may undertake and as a result, most governments are reluctant to devalue their currencies. However, a country can be forced into devaluation by an ominous trade deficit. Thailand, China, Mexico, Czech republic- all devalued strongly, willingly or unwillingly after their trade deficit exceeded 8% of the real gross domestic product (RGDP).
One reason a country may devalue its currency is to combat trade imbalances and it is decided by the government issuing the currency and is the result of governmental activities. Devaluation causes a country’s exports to become less expensive making them more competitive on the global market. This in turns means that imports are more expensive, making domestic consumers less likely to purchase them. By making domestic currency relatively cheaper (i.e. devaluation), local production and exportation of commodities are encouraged. This helps to enhance the level of output growth of the economy (Yioyio, 2015).
According to Yaqub (2010), governments of different countries devalue their currencies only when they have no other way to correct the economic problem. While devaluation can be seen as an attractive option, it can have negative consequences because by making imports more expensive it protects domestic industries which may then become less efficient without the pressure of foreign competition. Also Higher exports relative to imports can also increase aggregate demand which can lead to inflation.
Aguiar (2005) states that a nation experiencing the balance of payment deficit has to adopt both short and long term measures to correct the disequilibrium, and one of the measures is to devalue the nation’s currency relative to another currency, group of currencies or standard.
The effect of currency devaluation on the economy has long been recognized in literature. While the traditionalist argued that devaluation would promote trade balance, alleviate balance of payments difficulties and accordingly expand output and employment, provided the Marshal-Lernar conditions are met. The Marshal- Lernar conditions states that – devaluation would lead to expansion in output if the sum of price elasticity of demand for export and the price elasticity of demands for imports is greater than unity. The mechanism behind these positive effects, according to Imimole and Enoma (2011) is that devaluation switches demand from imports to domestic produced goods by increasing the relative prices of imports and making export industries more competitive in international market, thus stimulating domestic production of tradable goods and inducing domestic industries to use more domestic inputs. The monetarists on the other hand, argued that devaluation has no effect on real variables in the long-run.
The monetarist view is that exchange rate devaluation affects real magnitudes mainly through real balance effect in the short-run but leaves all real variables unchanged in the long-run. This approach is based on the assumption that the purchasing power parity (PPP) holds. It predicts that in the short- run, an increase in the exchange rate leads to increase in output and improves the balance of payments but in the long-run, the monetary consequence of the devaluation ensure that the increase in output and improvement in the balance of payment is neutralized by the rise in prices. These arguments are continuous and therefore require further investigations.
Nigeria’s GDP was recently rebased with the result placing the country as Africa’s largest economy with an annual GDP of $510 billion. Nigeria’s population and the size of the market has remained an attraction for FDI inflow with the current population estimated projected at 183million people in 2015 (growing at a projected rate of 2.82%). The country is currently ranked the 7th most populous country in the world and has enjoyed a positive GDP growth rate in the last 10 years and a relatively stable exchange rate regime. Between the first quarter of 2013 and the last quarter of 2014, Nigeria posted an average GDP growth rate OF 5.8%, a single digit inflation of 8.2% in the last quarter of 2014 and a relatively stable exchange rate regime (CBN, 2015).
The Nigerian government is thus in dilemma of the effect of further devaluation of naira as the former CBN governor, Sanusi Lamido and some other renowned Nigerian economists are clamoring for it while others like Tella, Teriba and Utomi see this as no solution to the economic problem facing the country. Also in 2015, the Central Bank of Nigeria Governor, Godwin Emefelie announced the devaluation of the naira against the dollar with the aim of strengthening the currency (naira) in the course of the dwindling oil price ( Osundiana & Osundiana, 2016).
According to Akpan and Atan (2012), the government of the day relies on foreign exchange reserve generated from crude oil to manage excessive volatility in exchange rate that exerts severe strain on the foreign exchange earnings. It is evident that the demand for foreign exchange has continuously been on the rise in the past few years as a result of factors like dependence on imported finished products, reversal of capital flow by investors and high speculative demand which has caused uncertainty in the foreign exchange market which also is caused by increased demand for foreign exchange in the face of unstable supply. Also the increasingly adverse balance of payment position and the inflationary pressures which the economy finds itself in which also affected the Real Gross Domestic Product (RGDP) of the economy has left the researcher in search for solution and how this myriad of economic challenges can be successfully tackled.
1.2 Statement of the problem.
The Nigerian government adopted the Nigerian pound since 1959 until 1973 where it was changed to Naira. In 1971 the Nigerian authorities chose not to devalue its Nigerian pound during the devaluation process of the American dollar and this resulted in the appreciation of the Nigerian pound dollar exchange rate $2.80 -$3.80 to the naira pound. In 1973 the naira replaced the Nigerian pound and then Nigeria devalued at the same rate with the US which caused the exchange rate to be $1.5 (Ogundipe et al 2013:234). According to (Osundina 2016:1947), currency devaluation is not a bad idea to solve the balance of payment’s economic problem in Nigeria given the fact that some other developing countries have used it as a tool. He further explained that devaluation of currency tends to favor the exporters but will cause output to fall since lower real wages will fall due to contraction of demand. It is these contradictions that spurred the interest in undertaking this study. Some theorists believe currency devaluation is good for the economy while some believe it shouldn’t be embarked on. This was also affirmed by Eromosele 2016: 26) in an argument for and against the Naira devaluation and the solutions proffered by the former minister of finance in the This day newspaper where he said the Naira is already undervalued and shouldn’t be devalued.
It is against this background that the study aims to examine the trend of currency devaluation in Nigeria and also understand the role of currency devaluation in developing countries with particular focus on Nigeria.
1.3 Objectives of the study.
The main objective of this study is to examine the role of currency devaluation in developing countries with particular focus on Nigeria. In order to achieve this objective, the following are the specific objectives:
1.) To understand currency devaluation and real gross domestic product in Nigeria
2.) To examine the Genesis and trends of currency devaluation and external debt in Nigeria.
3.) To investigate the role of currency devaluation in private domestic investment Nigeria
1.4 Research Questions.
1.) What is the role of currency devaluation in real gross domestic product in Nigeria?
2.) What is the relationship between currency devaluation and external debt in Nigeria?
3.) How has currency devaluation affected private domestic investment Nigeria?
1.5 Test of hypotheses
1.Ho: There is no significant relationship between Currency devaluation and real gross domestic product in Nigeria.
H1: There is a significant relationship between Currency devaluation and real gross domestic product in Nigeria.
2.Ho: There is no significant relationship between Currency devaluation and external debt in Nigeria.
HI: There is a significant relationship between Currency devaluation and external debt in Nigeria.
3.Ho: There is no significant relationship between Currency devaluation and private domestic investment Nigeria.
HI: There is a significant relationship between Currency devaluation and private domestic investment Nigeria.
1.6 Significance of the study.
This study is very significant as it contributes to the literature and would also assist policy makers and economists in decision making as regards devaluing currency.
The study when carried out will also be of great benefit to student researchers who have interest in researching more into currency devaluation and various ways it can affect the economy. It will act like a guide to student researchers who may find the recommendations and findings of the study useful.
1.7 Scope of the study.
This study will cover currency devaluation in developing countries and how this has affected their economies. A case study of Nigeria will be looked at, and a study of currency devaluation since inception will be taken. In addition to this, a profile of Nigeria’s exchange rate development will be taken.
1.8 Limitations of the study.
During the course of this research, a number of constraints were experienced. The problem of gathering information. Also, time constraint in carrying out the study is a limitation.
1.9 Definition of terms
1.) Currency Devaluation: this is a macro-economic fiscal policy that bothers on deliberate reduction in the value of home currency with the aim of maximizing gain in tradable items.
2.) Exchange Rate: This is the price one country’s currency expressed in another country’s currency