EFFECT OF DEVALUATION OF NAIRA ON PRICE LEVEL IN NIGERIA BY ?MR. IKECHI, PRINCE OBINNA MBA (Marketing), MCIM, MNIMN, Lecturer, Marketing Department; Rivers State College Of Education, St. John’s Campus, Port Harcourt, Nigeria. Email: [email protected] com. Tel: +234(0)8033429869; ?HON. TAMUNO, MAUREEN PIRIBONEMI KBVM MBA (Marketing), FCIM, AMNIM. Member, Rep. : Ogu/Bolo Constituency & Chairman, House Committee on Education Rivers State House of Assembly, Port Harcourt, Nigeria E Mail: [email protected] com; Tel: +234(0)8055096230 ?MR. IGONI, MORDECAI JAPHETH M. ED (Business Education), Lecturer, Business Admin. Department; Rivers State College Of Education, St. John’s Campus, Port Harcourt, Nigeria. Email:[email protected] com; Tel: +234(0)8055669179 ABSTRACT Almost all the countries of the world have devalued their currencies at one time or the other with a view to achieving certain economic objectives. This paper intends to demonstrate the existence of contractionary devaluation in Nigeria by drawing from previous studies.
In this study however, we intend to evaluate the effect of devaluation on the general price level in Nigeria; determine the possible way out of the dilemma of price increase in Nigeria in the face of devaluation and evaluate the antecedents of entrepreneurs in the event of devaluation in Nigeria. This study is basically empirical in nature; therefore, the research design used is the desk research. Devaluation pushes up import duties, since duties are computed based on the prevailing exchange rate. This puts pressure on both imported finished goods and production costs.
Purchasing power of citizens would reduce with increases in price level and this would worsen the pervasiveness of poverty. Speculative activities in the economy will increase as a result of instability. In the aftermath of the misfortunes of the Naira, manufacturers and importers adjusted the prices of their products upwards causing major distortions to the purchasing ability of the average Nigerian. Continuous devaluation such as we have experienced, has necessitated substantial sacrifice, but provided limited benefits. INTRODUCTION
Devaluation means officially lowering the value of currency in terms of foreign currencies. There is a difference between devaluation and exchange depreciation. Devaluation is the result of official government action. Depreciation or decline in the rate of exchange of one currency in terms of another is due to market forces. Substantially devaluation and depreciation both refer to the reduction of international Currency in terms of foreign currencies. There could be many motives of the devaluation. It stimulates exports of commodities.
It restricts import demand for goods and services. It helps in creating a favorable balance of payments. Almost all the countries of the world have devalued their currencies at one time or the other with a view to achieving certain economic objectives. During the great depression of 1930 devaluation was carried by most countries of the world for the objecting of correcting over-valuation of currencies. Continuous devaluation such as we have experienced, has necessitated substantial sacrifice, but provided limited benefits. OBJECTIVE OF THE STUDY The aim of this study is to: )Evaluate the effect of devaluation on the general price level in Nigeria. ii)Determine the possible way out of the dilemma of price increase in Nigeria in the face of devaluation iii)Evaluate the antecedents of entrepreneurs in the event of devaluation in Nigeria. STATEMENT OF PROBLEM The naira is the Nigerian form of currency. Fifty percent of every naira finds itself abroad. Since 1986 there has been a devaluation of the Nigerian naira. Since the devaluation of the naira there has been an inflow of second-hand goods from abroad such as clothing, foot wear, and vehicles.
Because of the depressed economy and decreased purchasing power of the naira, Nigerians can only afford to buy these second-hand products. So, even when Nigerians participate directly in economic investment as a consumer they are not able to buy Nigerian products and therefore are not directly aiding the Nigerian economy. Production in Nigeria has also increased in cost. This leads to the downfall of industries. The devaluation of currency is a major plank of World Bank and IMF policies for the development of the economies of Third World countries.
Nigeria’s compliance with this demand was allegedly tied to further rescheduling of Nigeria’s external debt and fresh aids. Purchasing power of citizens would reduce with increases in price level and this would worsen the pervasiveness of poverty. Speculative activities in the economy will increase as a result of instability. REVIEW OF RELEVANT LITERATURE There is a vast body of empirical literature on the impacts of devaluation on output and prices. In many of the existing studies, it has been recognized that the possible effects of devaluation on output could be contractionary.
To this extent, several channels through which devaluation could be contractionary have been identified. First, Diaz-Alejandro (1965) examined the impacts of devaluation on some macroeconomic variables in Argentina for the period 1955–61. He observed that devaluation was contractionary for Argentina because it induces a shift in income distribution towards savers, which in turn depresses consumption and real absorption. He equally observed that current account improved because of the fall in absorption relative to output.
Cooper (1971) also reviewed twenty-four devaluation experiences involving nineteen different developing countries during the period 1959–66. The study showed that devaluation improved the trade balance of the devaluing country but that the economic activity often decreased in addition to an increase in inflation in the short term. In a similar vein, Gylfson and Schmid (1983) also constructed a log-linear macro model of an open economy for a sample of ten countries using different estimates of the key parameters of the model.
Their results showed that devaluation was expansionary in eight out of ten countries investigated. Devaluation was found to be contractionary in two countries (the United Kingdom and Brazil). The main feature of the studies reviewed above is that they were based on simulation analyses. The few studies on contractionary devaluation based on regression analysis include those of Edwards (1989), Agenor (1991), and Morley (1992).
In a pool-time series/cross-country sample, Edwards (1989) regressed the real GDP on measures of the nominal and real exchange rates, government spending, the terms of trade, and measures of money growth. He observed that devaluation tended to reduce the output in the short term even where other factors remained constant. His results for the long-term effect of a real devaluation were more mixed; but as a whole it was suggested that the initial contractionary effect was not reversed subsequently.
In the same way, Agenor (1991) using a sample of twenty-three developing countries, Regressed output growth on contemporaneous and lagged levels of the real exchange rate and on deviations of actual changes from expected ones in the real exchange rate, government spending, the money supply, and foreign income. The results showed that surprises in real exchange rate depreciation actually boosted output growth, but that depreciations of the level of the real exchange rate exerted a contractionary effect. OUTPUT, INFLATION, AND EXCHANGE RATE
Morley (1992) analyzed the effect of real exchange rates on output for twenty-eight devaluation experiences in developing countries using a regression framework. After the introduction of controls for factors that could simultaneously induce devaluation and reduce output including terms of trade, import growth, the money supply, and the fiscal balance, he observed that depreciation of the level of the real exchange rate reduced the output. Kamin and Klau (1998) using an error correction technique estimated a regression equation linking the output to the real exchange rate for a group of twenty-seven countries.
They did not find that devaluations were contractionary in the long term. Additionally, through the control of the sources of spurious correlation, reverse causality appeared to alternate the measured contractionary effect of devaluation in the short term although the effect persisted even after the introduction of controls. Apart from the findings from simulation and regression analyses, results from VAR models, though not focused mainly on the effects of the exchange rate on the output per se, are equally informative.
Ndung’u (1993) estimated a six-variable VAR—money supply, domestic price level, exchange rate index, foreign price index, real output, and the rate of interest—in an attempt to explain the inflation movement in Kenya. He observed that the rate of inflation and exchange rate explained each other. A similar conclusion was also reached in the extended version of this study (Ndung’u 1997). Rodriguez and Diaz (1995) estimated a six-variable VAR—output growth, real wage growth, exchange rate depreciation, inflation, monetary growth, and the Solow residuals—in an attempt to decompose the movements of Peruvian output.
They observed that output growth could mainly be explained by “own” shocks but was negatively affected by increases in exchange rate depreciation as well. Rogers and Wang (1995) obtained similar results for Mexico. In a five-variable VAR model—output, government spending, inflation, the real exchange rate, and money growth—most variations in the Mexican output resulted from “own” shocks. They however noted that exchange rate depreciations led to a decline in output.
Adopting the same methodology, though with slightly different variables, Copelman and Wermer (1996) reported that positive shocks to the rate of exchange rate depreciation significantly reduced a credit availability with a negative impact on the output. Surprisingly, they found that shocks to the level of the real exchange rate had no effects on the output, indicating that the contractionary effects of devaluation are more associated with the rate of change of the nominal exchange rate than with the level of the change of the real exchange rate.
They equally observed that “own” shocks to real credit did not affect the output, implying that depreciation depressed the output through mechanisms other than the reduction of credit availability. Besides, Kamin and Rogers (1997) and Santaella and Vela (1996) also noted that the depreciation shocks to some measures of exchange rate (real or nominal level or rates of change) led to a decline of the output in Mexico. Hoffmaister and Vegh (1996) reached similar conclusions in a VAR model for Uruguay but unlike Copelman and Wermer, a negative shock to money strongly depressed the output.
Montiel (1989) utilized a five-variable VAR model—money, exchange rate, wages, prices, and income—to examine the sources of acceleration of inflation in Argentina, Brazil, and Israel. He concluded that among other key factors, exchange rate movements explained inflation in the three countries. Dornbusch, Sturzenbegger, and Wolf (1990) utilizing a three-variable VAR model (inflation, the real exchange rate, and a proxy for fiscal deficits) for several high inflation countries, found that the real exchange rate was an important source of inflation in Argentina, Brazil, Peru, and Mexico, but not in Bolivia.
Kamas (1995) study on Colombia extended the works of Montiel (1989) and Dornbusch, Sturzenbegger, and Wolf (1990) by separating the base money into domestic credit and reserves, with a view to identifying the domestic monetary impulses as well as analyzing their effects on the balance of payments. He observed that exchange rates did not play an important role in explaining the variation in inflation in Colombia and that inflation appeared to be primarily inertial with respect to the exchange rate but largely determined by demand shocks.
Khan (1989) applying two different econometric approaches—and a theoretical vector auto regression and a structural production function—concluded that the net effect of a decline in the value of the dollar is a temporary increase in inflation and real output, followed by a permanent reduction in output and level of real wages. In several other studies the relationship between exchange rates and inflation has also been investigated.
It was explicitly concluded that exchange rate devaluation is a major factor for the upsurge of inflation (Kamin 1996; Odedokun 1996; London 1989; Canetti and Greene 1991; Calvo, Reinhart, and Vegh 1994; Elbadawi 1990). Kamin (1996) showed that the level of the real exchange rate was a primary determinant of the rate of inflation in Mexico during the 1980s and 1990s while Calvo, Reinhart, and Vegh (1994) identified correlations between the temporary components of inflation and the real exchange rate in Brazil, Chile, and Colombia.
Elbadawi (1990) also noted that precipitous depreciation of the parallel exchange rate exerted a significant effect on inflation in Uganda. Odedokun (1996), Canetti and Greene (1991), Egwaikhide, Chete, and Falokun (1994), and London (1989) reached similar conclusions for some selected African countries. In conclusion, most of the econometric analyses indicated that devaluations (either increases in the level of the real exchange rate or in the rate of depreciation) were associated with a reduction in output and increase in inflation.
The few VAR studies reviewed above equally supported the existence of a contractionary devaluation in the sampled countries. However, we observed that most cases of contractionary devaluations had been focused on Latin America and other developed nations. Only few studies had been conducted on the issue in sub-Saharan Africa, particularly Nigeria. More importantly, there are few data on contractionary devaluation in Nigeria based on regression and simulation analyses.
Our study intends to demonstrate the existence of contractionary devaluation in Nigeria by applying the restricted vector autoregressive model, drawing from previous studies conducted in the other countries reviewed above. This approach may enable to identify other shocks that might exert important influences on output and inflation in Nigeria. To achieve this objective, a six variable VAR was estimated (official exchange rate, parallel exchange rate, prices, income, money supply, and interest rate). ISSUES FOR DISCUSSION
Before the advent of the Babangida regime, Nigeria operated a fixed exchange rate but with the introduction of the Structural Adjustment Program (SAP) in 1986, the Babangida regime introduced (as advised by the IMF) devaluation of the Naira as a major instrument to be used in resolving the country’s economic problems. It was the beginning of several tales of woes for the Naira. Although, the Naira was devalued after its introduction as national currency in 1970, it was 71 Kobo to $1. 00. In 1971, the official exchange rate appreciated to a peak of 55 Kobo/$1. 00 in 1980 before losing value to 89 Kobo/$1. 0 in 1985. The official exchange rate crossed one Naira to a dollar mark for the first time in March 1986, when it exchanged N1. 00 for $1. 00. But the CBN devalued the Naira (from N1. 3 to /$1. 00, to N4. 64 to $1. 00) by over 250 per cent in September 1986. Then federal government explained that it was meant to encourage rapid expansion in the revenue derivable from non-oil exports and to achieve the other objectives of Structural Adjustment Program (SAP). The policy of fixed exchange rate was however discarded and a policy of guided deregulation of the Forex market adopted in 1995.
The Autonomous Foreign Exchange Market (AFEM) was introduced in 1995 but it had to give way to AFEM towards the end of September 1999. In the aftermath of the misfortunes of the Naira, manufacturers and importers adjusted the prices of their products upwards causing major distortions to the purchasing ability of the average Nigerian. A report has it that the prices of drugs and foodstuffs, went up by between 15 and 35 per cent. Popular fast food joint, Mr. Biggs, a subsidiary of UAC of Nigeria Plc (UACN), marked up the prices of its edibles by over 16 per cent.
Everyday one goes to the market, what was bought for N5. 00 yesterday is now N10. 00. Everywhere you go, the minimum price increase is now in the range of 40-50 per cent. And if you want to run your company in a way that it would not crumble, you must do what is called replacement costing. For instance, if I bought the foreign exchange for 5 Naira, I am now going to buy it for N50. I must make sure that the goods I am about to sell will be able to give me the money to replace it. Otherwise I don’t need to sell the goods this is the scenario in Nigeria.
Some manufacturers tried to disabused claims that such increases could be passed on to the end users for an indefinite period. Some people may argue that this can be passed on to consumers in the form of high prices but there is a limit to which such can be passed on to consumers. Besides, many manufacturing concern have also adjusted their costs of production up to the extent that they may not be able to cut cost again. It is killing to manufacturers. Already, many manufacturers are crying under the initial rate and now the rate has increased again. CONCLUSIONS
Developing countries should be cautious when it comes to the devaluation of their currencies, as devaluation indirectly destroys part of the wealth of their citizens. They should fully analyse the macro-economic impacts, first looking at other options, they must ask themselves, what they consider more damaging, as the merit of having an equilibrium exchange rate in the current world economic dispensation may be relatively small compared with the social cost to society and the loss of all the goods and services of all the people becoming unemployed in a Nation, resulting from imported inflation.
In the case of the Naira, because of the volatility and unpredictability of the value of the currency most people with fixed money incomes, retired people, white-collar workers, and public employees are suffering a dramatic decline in their living standard, consuming less, as they get poorer by the day with their Naira at hand. As the exchange rate of a nation’s currency does affect production and employment level, and living standard of its people, devaluation is a national issue that affects everyone and must therefore be analysed in depth and discussed broadly before changes are made.
Devaluation would push up import duties, since duties are computed based on the prevailing exchange rate. This will put pressure on both imported finished goods and production costs. The Naira is the blood that runs in the vein of the Nigerian economy. Since the body can only be as healthy as the purity of the blood that runs in the vein, a devalued Naira that defies economic law can never maintain a healthy economy. REFERENCES Agenor, P. (1991). “Output, Devaluation and the Real Exchange Rate in Developing Countries. ” Weltwintschaftliches Archive 127, no. : 18–41. Calvo, G. A. ; Reinhart, C. M; and Vegh, C. A. (1994). Targeting the Real Exchange Rate: Theory and Evidence. IMF Working Paper WP/94/22. Washington, D. C. : International Monetary Fund. Canetti, E and Greene, J. (1991). Monetary Growth and Exchange Rate Depreciation as Causes of Inflation in African Countries: An Empirical Analysis. IMF Working Paper WP/91/67. Washington, D. C. : International Monetary Fund. Central Bank of Nigeria and Nigerian Institute of Social and Economic Research (CBNNISER). Cooper, R. (1971).
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