Nigeria: Should the Government Float or Devalue the Naira?

Abstract

AbstractThe recent rapid fall in oil prices and its impacts on foreign exchange earnings and reserves in Nigeria has resulted in a number of internal and external imbalances putting serious threat to the stability of the economy. This study therefore examines whether devaluation or floating exchange rate regime is an option to consider given the recent challenges in the nation's policy space. A behavioural equilibrium exchange rate approach is used to determine the extent of exchange rate misalignment complemented with a structural vector autoregressive (SVAR) model to examine the impact of currency devaluation on trade balance, domestic output and inflation. The result reveals the existence of an overvalued currency misalignment in recent times; while there is weak evidence to support that devaluation will improve the trade balance. Hence, floating the currency will be an adequate policy option given the current reality. This is expected to boost investors’ confidence, creates needed automatic adjustment mechanism and makes the tradable goods sector more competitive, resulting in more favourable external balances. However, this requires a concerted effort at boosting the nation's supply capacity through implementation of structural reforms in both oil and the non‐energy sector to diversify Nigeria's production and export base.