• The Complete Research Material is averagely 52 pages long and it is in Ms Word Format, it has 1-5 Chapters.
  • Major Attributes are Abstract, All Chapters, Figures, Appendix, References.
  • Study Level: BTech, BSc, BEng, BA, HND, ND or NCE.
  • Full Access Fee: ₦6,000

Get the complete project » Instant Download Active



1.1         Background of the study

Many developing countries have deficit Balance of Payments (BOP) account and face many troubles in monetary actions which raise many questions for monetary authorities. Like many other developing Countries, Nigeria also aims to stabilize the BOP account which strengthens the macroeconomic environment. One of the major purposes of International Monetary Fund [IMF 2000] is to stabilize the balance of payment position of developing countries.

Over the last-three decades, there has been an increasing trend in the fluctuations of the Nigeria BOP. BOP crisis distorts the workings of the entire system (economy) because it creates disequilibrium between the supply and demand for money. BOP disequilibrium is a reflection of disequilibrium in the money market (IMF, 2000). Monetary disequilibrium produces adverse effect on the aggregate expenditure for goods and services (absorption) in the sense that, if the public has an excess supply of money it gets rid of it by passing its excess cash balance to foreign countries in exchange for goods and services. If the public desires to keep more money than it has in stock, it achieves it by reducing absorption.

Disequilibrium in balance of payment occurs when, over a particular period of time, a country is recording persistent deficits or surpluses in its balance of payments. As a consequence, it has to be recognized that the exchange rate is either overvalued or undervalued on the foreign exchange market. In such situations, particularly in the case of a deficit, corrective action is required in order to prevent the economy draining its foreign currency reserves or ending hopelessly in debt. With this in mind, disequilibrium in the balance of payments can arise where: The imports of goods and services exceed exports and the financial account is in deficit; exports of goods and services may just exceed imports but there is a persistent surplus on the financial account; exceptionally, there is a large surplus on the current account, generating an overall balance of payments surplus. Japan is a pertinent example of such an economy.

At 1964, fifty years after amalgamation of Nigeria in 1914, Nigeria was at the height of her promise; among other promising trends, it was the world’s largest producer of groundnuts, palm oil and petroleum was making its debut in the national accounts. In the early 1980s, the oil


market weakened, substantial external and fiscal imbalances emerged. These were financed by public sector borrowing, depleting international reserves and large accumulation on payment arrears on external trade credits and as such created problems in the Nigerian Balance of payments. In 1984, austerity measures were introduced to redress the nagging deficits in the country’s balance of payments, these included; slashing of budgetary expenditures, administrative control for import licenses, increase and upward review of tariffs. In 1986, the Structural Adjustment Programme (SAP) was introduced, which amongst other things, combined exchange rates and trade policy reforms to promote economic efficiency and long term growth in the stabilization polices designed to restore balance of payments equilibrium and price stability.

The cardinal aim of every government in Nigeria from the regime of Tafawa Balewa up till date had been to get the balance of payments position right. This cardinal aim has inspired every major turn of policy; setting of bank rates, changes in taxes, regulation of incomes, the restructuring of industry, introduction of export rebates, control of money supply, level of local government expenditure, etc. The Current Account Deficit (CAD) in the balance of payments has been a problem for Nigeria because it adds to the already large indebtedness of Nigeria to the rest of the world. International credit is like an important drug to Nigeria. This is accepted by Nigerians even though the harm it does is known. If the credit supply that funds our current account deficits and add to our national debts dries up, we would go cold turkey. The Balance of Payments disequilibrium has reached an unviable proportion and has become a binding constraint in the realization of the government objectives. It has been undermined by a relatively poor non-oil export performance, high import bill, stagnated agriculture, high taste for foreign goods and services, continuous fall in the country’s foreign exchange, inflationary pressure, inefficient manufacturing sector and mishandling of the oil boom.

In an attempt to identify the long-term causes of BOP fluctuation in Nigeria, the vulnerability of the economy to external shocks, external debt burden and debt servicing issues, inflationary effects, trade openness, capital liberalization and exchange rate movement etc, have remained the focal issues. BOP adjustment through exchange rate changes relies upon the effect of the relative prices of domestic and foreign goods on the flows with the rest of the world (Thrillwall, 2004). This relative prices is defined by the ratio of export and import prices in domestic currency from the point of view of the country as a whole, it represents the amount of imports that can be


obtained in exchange for a unit of export. The terms of trade may vary both because of changes in the prices expressed in the respective national currencies and because of exchange rate changes. Thrill wall (2004) noted that depreciation in the exchange rate at unchanged domestic and foreign prices in the respective currencies makes domestic goods cheaper in the foreign markets and foreign goods more expensive in the domestic market. This has been the case in the Nigeria exchange rate, therefore it is expected that the demand for goods and services from Nigeria will increase both domestically and internationally hence, a balance of payment surplus but why Nigeria still experiences a BOP deficit is an issue of concern. It’s not only an issue of deficit that is the problem but the rate at which this deficit is increasing every year with all the exportable natural endowment in the country. Hence, this work also wants to investigate whether there is a correlation between the different types of exchange rate system such as floating and fixed exchange rate systems and BOP stability. Exchange rate arrangements in Nigeria have undergone significant changes over the past four decades. It shifted from a fixed regime in the 1960s to a pegged arrangement between the 1970s and the mid-1980s, and finally, to the various types of the floating regime since 1986, following the adoption of the Structural Adjustment Programme (SAP). A regime of managed float, without any strong commitment to defending any particular parity, has been the predominant characteristic of the floating regime in Nigeria since 1986 even till date. I must quickly add that these changes are not peculiar to the Naira as the US dollar was fixed in gold terms until 1971 when it was de-linked and has since been floated.

Figure 1.1        A Managed exchange rate system using foreign reserve

Price of

Supply of N



Upper limit

P      Par value Lower limit


Demand of N


0                                                  q


Figure 1.1 shows the principles of a managed exchange rate system, whereby the currency has a par value of 0P, with an upper and lower limit. If there is an increase in the supply of naira, for example due to an increase in import of goods and services, then the supply curve shifts to S2. This will reduce the value of the naira in a free market to below its agreed lower limit. To maintain the currency at its lower limit, the demand for naira has to shift to the right, an action requiring the use of foreign exchange reserves by the government. If it wishes to return the naira to its par value, then even greater reserves are needed to bring it back to (0P).

The fixed exchange rate regime induced an overvaluation of the naira and was supported by exchange control regulations that engendered significant distortions in the economy. That gave vent to massive importation of finished goods with the adverse consequences for domestic production, balance of payments position and the nation’s external reserves level. Moreover, the period was bedeviled by sharp practices perpetrated by dealers and end-users of foreign exchange. These and many other problems informed the adoption of a more flexible exchange rate regime in the context of the SAP, adopted in 1986.

Soderstan (1989) contends that devaluation tends to make imports more expensive in domestic currency terms, which are not matched by corresponding rise in export prices. This implies that the terms of trade will deteriorate. Deterioration in terms of trade represents a loss of real national income and can lead to BOP crisis because more units of exports have to be given to obtain one unit or lesser unit of imports. Hence, the terms of trade effects caused by devaluation lowers income. A devaluation of currency causes an increase in the import prices and general price level. This initiates reduction in the real value of wealth held in monetary form such that the real value of cash balance is reduced leading to unfavourable BOP.

Chacholiades (1978) maintained that money illusion and expectation effects can induce BOP fluctuation because real income does not change due to proportionate increase of price and money income. The direction of the change depends on the type of money illusion. Money illusion inhibits real activities though these effects are significant only at the short run. Therefore, if people are unconscious of the working of money illusion, they will likely change their absorption. It is possible that economic agents in Nigeria regard the increase in price


induced by currency devaluation as likely to spark further price rises. This has consequently resulted to an increase in direct absorption which is capable of worsening the country’s balance of payments.

Nigeria external debt burden and external debt servicing over the last three decades has been blamed by several authors for the negative profile of the country’s BOP. Dell and Lawrence (1980) stressed that a potential and increasing significant source of demand deflection, which might be induced by currency depreciation in developing countries, arises from its effects on debt servicing. Clearly, the Nigerian external debt obligation is large and the interest payable keeps rising over the years. The implication of this circumstance is that debt service expenditure reduces wealth and the resource available to improve the country’s real activities and this is detrimental to BOP.

Inflationary effects caused by currency depreciation might be expected to have an expenditure reducing impact (Dombusch 1992). Reduction in real expenditure will occur only if the appropriate monetary policy is simultaneously pursued (Fakiyesi, 1996). But over the years, inflation policies and targets in Nigeria has failed to achieve its desired objective of correcting BOP disequilibrium due to miss-specification of macroeconomic policies and insufficient time lag. The monetary approach to the balance of payment sees the monetary implications of exchange rate depreciation as being absolutely crucial. But depreciation becomes unnecessary provided sufficient time (that is financing) is available for automatic correction to occur. According to this approach the mechanism by which depreciation affects the BOP is by raising the domestic price level and thereby increasing the demand for nominal money balances (Ikihdie, 1993).

These and many more could be the reasons behind the negative profile of the Nigerian Balance of Payments as should be revealed by this work. This is the gamut of this research work.


Every society desires growth which could be achieved in various ways among which balance of payments stability is one of the ways. This is so because fluctuation in exchange rate will distort not only international transactions but also domestic prices of goods and services. In reality, BOP stability is more or less a mirage. However, fluctuation in BOP which can either be a surplus or deficit comes with varying benefits and harm. For instance, a BOP surplus entails that sources of


funds (such as exported goods and services sold and bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign bonds purchased). There is a balance of payments deficit if the former are less than the latter.

In theory and practice, a prolonged misalignment of the exchange rate in the foreign exchange market will, in the medium term, tend to impact adversely on economic performance. Consequently, the authorities should always provide a timely intervention to ensure that the exchange rate is in equilibrium. The monetary authorities usually intervene through its monetary policy actions and operations in the money market to influence the exchange rate movement in the desired direction such that it ensures the competitiveness of the domestic economy. In Nigeria, maintaining a realistic exchange rate for the naira is very crucial, given the structure of the economy, and the need to minimize distortions in production and consumption, increase the inflow of non-oil export receipts and attract foreign direct investment. Moreover, the persisting problems of import dependency, capital flight, and lack of motivation for backward linkages in the production process need to be addressed, amongst others.

Under a fixed exchange rate system, the Central Bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country’s currency and other currencies. Then the net change per year in the Central Bank’s foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a fixed exchange rate system include managed float where some changes of exchange rate are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a pure float, the central bank does not intervene at all to protect or devalue its currency. Central bank’s foreign exchange reserves do not change.

Exchange rate appreciation arises due to BOP surplus which creates an increase in the demand of a country’s currency and a fall in the supply of their currency due to the fact that BOP surplus always go with increase in export and a fall in import. However, this effect will make the goods and services of the country to be expensive in international market and foreign goods to be cheaper relative to domestic ones because the currency is overvalued. If this is not put in check, unemployment will rise, leading to fall in output and GDP per head. On the other hand, if a country experiences a BOP deficit (BOP


negative), the reverse will be the case, leading to inflationary tendencies. The Current Account Deficit (CAD) in the balance of payments has been a problem for Nigeria because it adds to the already large indebtedness of Nigeria to the rest of the world. International credit is like a drug to us. We accept it indeed grave it even though we know the harm it does to us. If the credit supply that funds our current account deficits and add to our national debts dries up, we would go cold turkey. The balance of payments problem has reached an unviable proportion and has become a binding constraint in the realization of the government objectives. It have been undermined by a relatively poor non-oil export performance, high import bill, stagnated agriculture, high taste for foreign goods and services, continuous fall in the country’s foreign exchange, inflationary pressure, inefficient manufacturing sector and mishandling of the oil boom.


The above problem statement therefore leads us to the following specific questions of the study:

Ø  What are the macroeconomic determinants of Balance of payments in Nigeria?

Ø  Do the type of exchange rate system affect balance of payment disequilibrium in Nigeria?


The broad objective of this work is to examine the long run determinants of balance of payment disequilibrium, drawing evidence from Nigeria.

The specific objectives are:-

Ø     To investigate the macroeconomic determinants of on Balance of Payments in Nigeria.

Ø     To examine whether the type of exchange rate system has any impact on balance of payments disequilibrium in Nigeria.



In line with the preceding objectives, the hypotheses for the study are developed thus:

·       There exist no significant macroeconomic determinants on balance of payments in Nigeria.

·       The exchange rate systems do not have significant effect on balance of payments disequilibrium in Nigeria.


This research would contribute to the ongoing policy by identifying growth patterns of the Nigerian economy and to what extent will BOP stability achieve economic growth. Owing to the vision 2020(making Nigeria one of the largest (20) economies in the world in the year 2020), the identification of BOP fluctuation in Nigeria is necessary because this will help to model the economy and control the variable such that it does not trigger other un-wanted disturbances that will hinder the economic growth of the country. Take for instance if the BOP of the economy is in disequilibrium, say deficit to be precise the exchange rate will be undervalued on the foreign exchange market. In such situations, particularly in the case of a deficit, corrective action is required in order to prevent the economy draining its foreign currency reserves or ending hopelessly in debt. The main reason for Nigeria’s BOP deficits is the way in which Nigeria consumers have increased their demand for imported manufactured goods such as food stuffs, capital equipment, etc. This equally implies that there is a net outflow of currency than the inflow of foreign reserve. If this lingers, it can lead to inflationary pressure and unwanted distortions in the system. Therefore, in order to correct that, the country might increase domestic interest rate to act as an incentive for foreign direct investment in anticipation of a high returns. Other things being equal, the high interest rate will lead to foreign inflow of capital, hence a BOP current account deficit will be corrected by BOP capital account surplus.

However, the high interest rate will act as a disincentive for domestic investment, leading to unemployment and can equally bring about high prices of goods and services in the long run due to fallen investment which will in turn make the country’s goods and services to become less price competitive in the international market, hence, the demand for net exports (export-import)


has fallen. Although a vicious cycle may eventually arise but BOP fluctuation if not controlled very well may lead to policy conflict and conflict in macroeconomic objectives.

The significance for the balance of payments of many developing economies like Nigeria is that large sums of capital were borrowed from commercial banks in the 1970’s and early 1980s to fund development projects from which it was expected future income streams would be generated (CBN 2000). Many such projects have turned out to be very poor investments. In other cases the money has been spent on other things or has been used corruptly by recipients. The legacy is one of chronic balance of payments deficits. The problem for many developing countries like Nigeria is that a very substantial part of their export earnings has to be paid annually in order to service this debt.

1.7     &n

You either get what you want or your money back. T&C Apply

You can find more project topics easily, just search

Quick Project Topic Search