Devaluation and Trade Balance in Nigeria: A Test of Marshall-Lerner Condition

Abstract

This paper concentrates on devaluation and trade balance in Nigeria, specifically testing whether or not the Marshall-Lerner condition holds for Nigeria. The research empirically investigates the impact of devaluation of exchange rate on Nigerian trade balance. The Johansen cointegration and the error correction methodologies were employed to investigate the longrun and shortrun effects of the devaluation/depreciation of exchange rate on the balance of trade. The results indicate that all the variables are integrated of the order 1(1). An estimation of the cointegrating equation showed that there is a longrun negative relationship between the trade balance and real exchange rate in Nigeria. This means that an increase in the REXR (appreciation in the local currency) results in a deterioration in the trade balance, when all things are held constant. Likewise, a decrease in the REXR (depreciation in the local currency) results longrun improvement in the trade balance, when everything else is held constant. This provides evidence that the Marshal Lerner condition holds. Hence, factors leading to exchange rate depreciation of the naira needs to be monitored closely. High interest rate differentials in favour of Nigeria will induce large capital inflows, which is good for investments