Oil price, trade openness, current account balances and the official exchange rate in Nigeria

• Author: Adedayo Emmanuel Longe,Patricia Iyore Ajayi,Shehu Muhammad,Olawunmi Omitogun
• DOI: http://doi.org/10.1111/opec.12164
• Date: 01 December 2019
• Published date: 01 December 2019

Oil price, trade openness, current account

balances and the official exchange rate in

Nigeria

Adedayo Emmanuel Longe*, Shehu Muhammad**, Patricia Iyore Ajayi***

and Olawunmi Omitogun****

*Centre for Petroleum, Energy Economics and Law, University of Ibadan, Ibadan, Oyo State, Nigeria. Email:

longeemmanuel28@gmail.com

**Department of Social Sciences, Federal Polytechnic, Bida, Nigeria. Email: ibshmad@yahoo.co.uk

***Department of Economics, University of Ibadan, Ibadan, Nigeria. Email: patajayi71@gmail.com

****Department of Economics Olabisi, Onabanjo University, Ago-Iwoye, Nigeria. Email:

omitogun.olawunmi@oouagoiwoye.edu.ng

Abstract

Since a larger percentage of government revenue are generated from crude oil trade, the

fluctuations in the price of oil have always been influencing the budget financing in Nigeria. Also,

investment decisions and trade cost are been influenced by the status of the oil price. The study

investigates the relationship between oil price, trade openness, current account balances and

official exchange rate in Nigeria using secondary data from 1980 through 2016. The non-linear

auto-regressive distributed lag (NARDL) was used to analyse the short-run and long-run link

between the variables. From the findings, it was established that in the short run and long run, trade

openness negatively impacts on the official exchange rate of naira to dollar in Nigeria. The

consumer price index positively and significantly influences exchange rate value in Nigeria in the

short run and long run. Positive changes in oil price impacted negatively on official exchange rate

in the short run, but in the long run had a positive impact. Negative changes in the price of oil have

a positive insignificant and negative significant impact on official exchange rate in the short run

and long run, respectively. The error correction result verified that the variables (trade openness,

current account, oil price and consumer price index) correct 91 per cent deviations of exchange rate

from short-run equilibrium back to equilibrium in the long run. The study concludes that trade

policy in Nigeria is not in favourable direction of official exchange rate in Nigeria. Also, positive

changes in oil price and current account balances are strong determinants of the Nigerian official

exchange rate of naira to dollar in the long run. Therefore, it is recommended that trade policies

should be reviewed in Nigeria towards enhancing other sectors that would add more value to naira.

JEL classification: C5, E3, F1.

©2019 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

446

1. Introduction

It is common in the literature focusing on the impact of oil price on macroeconomic

variables. Another innovative interesting part of oil price fluctuations is their on financial

decisions in recent years (Iavorschi, 2014 and Alley, 2018). Also, the price of oil has

been linked to current account balances for oil-dependent countries (Babatunde, 2015;

and Longe et al., 2018). Current account balance in most developed and emerging

economies is a catalyst growth experienced in the economies. In Nigeria, 85 per cent of

revenue and about 95 per cent of the country’s foreign exchange earnings are from the

oil sector. Given this status of the economy, it is expected that changes in oil price

should influence the economy’s trade performances and the value of its currency.

Positive changes in oil price for oil-exporting countries cause exchange rate appreci-

ation, while for oil-importing countries, changes in oil price are expected to depreciate

the value of the currency. However, reverse is the condition for negative changes in oil

price. Considering Nigeria as a country which exports oil in crude form and imports the

products from oil, positive and negative changes in oil price are expected to have

significant impact on the country’s economy. Oil price affects exchange rate through two

major channels: trade patterns and the nation’s wealth (most times referred to as the

current account balances) (Babatunde, 2015). Therefore, oil price, trade and current

account balances can be argued to be an important determinant of exchange rate in an

economy.

Following the trend of trade openness (ratio of export and import services to GDP),

current account (current account balance [% of GDP]), crude oil price (US$, money of

the day) and exchange rate (official exchange rate of naira to dollar) in Nigeria, trade

openness, current account balances and oil price have been moving in the same direction

over the years. For instance, between 1980 and 1986, trade openness falls from 48.57 per

cent to 23.72 per cent accompanied with a fall in the current account balance from 8.07

per cent to 1.08 per cent and oil price from $36.86 to $14.43, while exchange rate rises

from 0.55 to 1.75. Between 1987 and 1992, trade openness, current account balances and

oil price increased to 61.03 per cent, 7.1 per cent and $19.32, respectively, while

exchange rate also increased to #17.2. This implies there are periods increase in trade

openness, current account balances and oil price does not favour the official value of the

country’s currency against the U.S. dollar. In 1998, trade openness, current account and

oil price fall correspondingly with an increase in exchange rate from 76.89 per cent, 0.46

per cent, $19.09 and #21.2 naira in 1997 to 66.03 per cent, 0.31 per cent, $12.72 and

#21.88 in 1998, respectively. Till 2014, trade openness, current account balances and oil

price maintained the tight correlation, while exchange rate continues to increase,

irrespective of the changes in trade openness, current account and oil price. Figure 1

explains better.

©2019 Organization of the Petroleum Exporting Countries OPEC Energy Review December 2019

Oil Price, Trade and Exchange Rate 447