ABSTRACT

The relationship between balance of payment and exchange rate have been modeled by various researchers using single equation models in which, either balance of payment or exchange rate was each considered as dependent variable. In other words, the cause-and-effect relationship between balance of payment and exchange rate was assumed to be one-way or unidirectional. However, in many practical situations, such unidirectional or one-way cause-and-effect relationship is not meaningful. This is because economic theory has suggested that balance of payment could be determined by exchange rate and exchange rate is, in turn determined by balance of payment, thereby requiring the use of a simultaneous equation model. This thesis discussed the Balance of Payment and Exchange rates in Nigeria so as to account for the two-way cause-and-effect relationship between balance of payment and exchange rate in Nigeria. The relevance of this lies in the fact that it could help to monitor the Balance of Payments and Exchange rates and throw early warning signal about any economic crisis. Monthly data on Nigeria exchange rate, interest rate, inflation and balance of payment for the period January 2000 to December, 2016 were derived from the 2018 CBN Statistical Bulletin. The data were analyzed using indirect least squares estimation method of the simultaneous equation model. Results of the analyses showed that (i) the data satisfied the exogeineity and simultaneity assumptions of the specified model (ii) relationships existed between exchange rate and BOP. As shown in the result there was balance of payment deficit due to the negative impact of exchange rate on it. To forestall this problem, we recommended that there should be a reduction in government spending; higher interest rates and higher taxes as these could all have the effect of dampening consumer demand reducing the demand for imports. Furthermore, the government should make policies to raise productivity measures to bring about more innovation and incentives to increase investment in industries with export potential so as to boost exports performance and compete more effectively with imports. Moreover, the government may invest in education and health to boost human capital and increase competitiveness in fast-growing and high value industries such as bio-technology, engineering, finance and medicine. Meanwhile, we recommended that Nigeria should begin to produce agro-products such as live-stock production, rice, pulses, millets, and so on, that will have better quality than those imported from other countries and ensure that these locally manufactured goods are relatively cheaper than those imported.  Once this is achieved, the balance of payment deficit will gradually disappear. We also recommended currency devaluation because making Nigeria’s currency less valuable will reduce its consumption, shifting some demand to local manufacturers, whose price will not increase as a result of currency devaluation. For instance, suppose one Naira equals one U.S. dollar, and therefore a product cost N10 in Nigeria also cost $10 in the U.S., then Nigerians will prefer to buy from local manufacturers.