The Impact of Exchange Rate Variations on Trade Balance: Evidence from Nigeria, 1970-2005

Abstract

This study examines the empirical relationship between the real exchange rate and aggregate trade balance of Nigeria. Conventional wisdom states that a nominal devaluation of exchange rate improves the trade balance. This conjecture is founded on the Bickerdike-Robinson-Metzler (BRM) and Marshall- Lerner (ML) conditions. Empirically, the evidence for Nigeria has been inconsistent in either rejecting or supporting BRM or ML conditions. This study tests the ML conditions to see if it is satisfied for Nigeria. It uses the a regression model formulation which include income and real exchange rate, so that absorption approach to balance of payments is also investigated. The econometric procedures used to assess the impact of exchange rate variations on the aggregate trade balance are: Unit root tests (ADF and PP), Johansen an Juselius approach to estimation of multivariate cointegration system and ordinary least square (OLS). The results suggest no co integration for the trade balance model. The results further show that depreciation/devaluation improves trade balance and that Marshall-Learn (ML) condition holds for Nigeria. This is an indication that in Nigeria, exchange rate management may be regarded as a relevant tool for balance of trade adjustment.

Keywords: Nigeria, Exchange Rate, ML Condition, Trade Balance and OLS.