FOREIGN EXCHANGE MARKET & THE BALANCE OF PAYMENTS. Elements, Policies and Nigerian Experience

Transcription

1 FOREIGN EXCHANGE MARKET & THE BALANCE OF PAYMENTS Elements, Policies and Nigerian Experience Mike I. Obadan, ph.d, FNES, FIMC Professor of Economic; University of Benin, Benin City, and former Director-General, NCEMA Ibadan, Nigeria Goldmark Press Limited Abuja and Benin City

2 Table of Contents Dedication Preface Chapter 1: Basics of the Foreign Exchange Market and International Payments 1.0 Introduction Key Currencies, Foreign Exchange and International Transactions Making International Payments Domestic versus International Payments Instruments of International Finance Effects of Making International Payments Concept of Foreign Exchange Market Functions of the Foreign Exchange Market Operators in the Foreign Exchange Market Spot and Forward Foreign Exchange Markets The Nominal Exchange Rate Demand for and Supply of Foreign Exchange Foreign Exchange Supply and Demand Curves and the Equilibrium Exchange Rate 28 iv

3 1.10 Stability of Exchange Rate Equilibrium Rates of Devaluation/Depreciation of acurrency Aims and Effects of Devaluation Overvaluation and Undervaluation of a Currency Nominal Exchange Rate Changes TheoreticalDeterminantsof Nominal Exchange Rates Empirical Findings on Nominal Exchange Rate Determinants Key Points and Conclusions Annex 1.1: Relationship between Elasticity of Demand for Dollars and the Elasticity of Supply of Naira 53 Chapter 2: Hedging, Arbitrage and Speculation in the Foreign Exchange Market 2.0 Introduction Hedging Foreign Exchange Speculation Foreign Exchange Arbitrage InterestArbitrage InterestParity Condition for Arbitrage Key Points and Conclusions 68 Chapter 3: Exchange Rate Regimes: Multiple and Fixed Exchange Rates 3.0 Introduction Concepts of Exchange Rate Policy and Exchange Rate Regime Unified versus Multiple Exchange Rates Fixed Exchange Rate Regimes The Gold Standard The Gold Exchange Standard/Bretton Woods System Currency Boards 88 v

4 3.3.4 Dollarization Monetary Union Currency Peg Crawling Peg/Crawling Band or Target Zone Prerequisites for Adopting Firmly-fixed Exchange Rate Regimes Key Points and Conclusions 3.6 Annex 3.1: Balance of Payments Adjustmentunder the Gold Exchange Standard 96 Chapter 4: Flexible Exchange Rate Regimes and Choice of Exchange Rate Regimes 4.0 Introduction Typesof Flexible Exchange Rate Regimes Clean Float versus Managed Float Interbank and Auction Systems Floating Exchange Rates and the Balance of Payments Case for and against Flexible Exchange Rates The Case for Flexible Exchange Rates The Case against Flexible Exchange Rates Floating Exchange Rates from 1973 Onwards Prerequisites for Successful Floating Exchange Rate Regimes Considerations in the Choice of an Exchange Rate Regime Further Issues in the Choice of an Exchange Rate Regime Some Lessons and Policy Conclusions on Exchange Rate Regimes Key Points and Conclusions 127 Chapter 5: Real Exchange Rates 5.0 Introduction The Bilateral Rea! Exchange Rate 132 vi

5 5.2 Nominal and Real Effective Exchange Rates Nominal Effective Exchange Rates Real Effective Exchange Rates (RER) Equilibrium Exchange Rate Equilibrium Exchange Rate for Internal and External Balance Short-run RER versus Long-run Equilibrium RER The Purchasing Power Parity Doctrine (PPPD) Elements of the PPPD Assessment of the PPPD Empirical Findings on Misalignments of Nigeria's Exchange Rate Using PPPD Significance of Real Exchange Rates Factors Affecting RER Movements and Empirical Findings Key Points and Conclusions 157 Chapter 6: Elements of the Balance of Payments 6.0 Introduction Meaning of B alance of Payments Sources of Balance of Payments Data Changes in Balance of Payments Classification Significance of the Accounting Balance of Payments Balance of Payments Accounting Balance of Payments Accounting and Notions of Balance Current Account Capital and Financial Account Balance on Capital and Financial Account The Balance of International Indebtedness Key Points and Conclusions 191 Chapter 7: Measures of Balance of Payments Disequilibrium 7.0 Introduction 195 VII

6 7.1 MeasuringSurplusorDeficitundertheAccountingBalance Autonomous and Accommodating Transactions Overall B alance of Payments in the Context of Autonomous Transactions Different Defmitions of Overall Balance Basic Balance The British Basic Balance Net Liquidity Balance Ofßcial Settlements Balance Some Remarks on Overall Accounting Balance of Payments Overall Balance of Payments and Reserves/DebtAccumulation Current Account Financing and Relation to thebopidentity Appraisal of the Accounting Balance The Market B alance of Payments The Programme Balance Balance of Payments Concepts Used by Nigeria Causal Factors in Balance of Payments Disequilibrium Key Points and Conclusions 215 Chapter 8: Theories of the Balance of Payments: Elasticities and Income-Absorption Approaches 8.0 Introduction Key Features of the Elasticities Approach ADiagrammaticAnalysisof the Elasticities Approach The J-Curve Effect ofdevaluation Impact of Devaluation on Imports and Export Revenue A Brief Evaluation of the Elasticities Approach Basic Features ofthe Income-Absorption Approach The Absorption Approach and Devaluation Elasticities Approach versus Income-Absorption Approach A Brief Evaluation ofthe Income-Absorption Approach Key Points and Conclusions 236 viii

7 Chapter 9: Payments The Monetary Approach to the Balance of 9.0 Introduction Development of the Monetary Approach Features of the General Monetary Approach Assumptions of the Monetary Approach to the Balance of Payments (MAB?) Definition of Payments Imbalance Central Thesis of the MABP B alance of Payments Adjustment Process under Fixed Exchange Rates Global Monetarism The Monetary Approach under Flexible Exchange Rates The Balance of Payments Adjustment Process under Flexible Exchange Rates Determination of Flexible Exchange Rates A Model of the MABP and Implications under Different Exchange Rate Regimes The Model The Model and MABP under Fixed Exchange Rates The Model and MABP under Flexible Exchange Rates The Model and MABP under ManagedFloat Exchange Rate System Implications of the MABP Issue of Sterilization Empirical Aspects of the Monetary Approach Approaches to the Tests The IMF and the Monetary Approach Review of Empirical Findings Evaluation of the Monetary Approach Key Points and Conclusions 267 ix

8 Chapter 10: Keynesian Theory of Balance of Payments Adjustment: The Income Adjustment Mechanism 10.0 Introduction The Basic Keynesian Open-economy Model National Income Multipliers Balance of Payments Multipliers Foreign Sector Di sturbances Domestic Sector Disturbances Income Adjustment with Foreign Repercussions Foreign Repercussions A Model of Income Adjustment with Foreign Repercussions Disadvantages ofthe Income Adjustment Mechanism Key Points and Conclusions 289 Chapter 11: Balance of Payments Adjustment and Policies 11.0 Introduction Benefits and Costs of International Economic Policies Financing of Payments Imbalance Suppression of Imbalance by Quasi-adjustment Policies Concept and Natureof Adjustment Automatic Adjustment Mechanisms Adjustment Policies Typesof Adjustment Policies/Measures Direct Reductions in Income and Expenditure Monetary Policies Fiscal Policies Exchange Rate Changes Key Points and Conclusions Annex 11.1: Balance of Payments Adjustment under Flexible Exchange Rates 317 x

9 Chapter 12: Policies for Internal and External Balance 12.0 Introduction Macroeconomic Policy Objecti ves and Instruments Internal Balance with Expenditure-changing Policies and Implications Monetary and Fiscal Policies for Internal and External Balance and the "Assignment Problem" Internal and External Balance with Alternative Fiscal and Monetary Policy Instruments External Balance with Expenditure-switching Policies Internal and External Balance with Expenditure-changing and Switching Policies Direct Controls Key Points and Conclusions 345 Chapter 13: Linkage of the Balance of Payments to the Foreign Exchange Market and the Economy 13.0 Introduction Linkage of the Foreign Exchange Market to the Balance of Payments Equilibrium in the Foreign Exchange Market and the Balance of Payments Implications of Shifts in Foreign Exchange Demand and Supply Curves National Income Accounts and the Balance of Payments Link between the Balance of Payments and the Public Finance Sector Linkage ofthe Balance of Payments to the Monetary Sector Key Points and Conclusions 362 xi

10 Chapter 14: Nigeria's Balance of Payments and Investment FIows 14.0 Introduction The International Environment of Trade Transactions Export Trade Importance of Foreign Trade Export Performance Import Trends and Structure Direction of Trade Balance of Payments and External Reserves before SAP Balance of Payments and External Reserves in the SAP and Post-SAP Period, Balance of Payments Policies Foreign Private Investment Flows Portfolio Investment Foreign Direct Investment Direct Investment Income Remittances from Nigeria Nigeria's Investment Climate Sources of External Sector Problems: A Summaiy Key Points and Conclusions 413 Chapter 15: The Nigerian Foreign Exchange Market Pre SAP: Structure and Developments 15.0 Introduction Institutions and Participants in the Foreign Exchange Market Deposit Money Banks andbureaux de Change Central Bank of Nigeria Public Sector Participants and Retail Customers Segments of the Foreign Exchange Market Official Foreign Exchange Market 420 xii

11 AFEM,IFEMandBureaux dechange Informal Foreign Exchange Market Objectives of Exchange Rate Policy before SAP Exchange Rate Regime before SAP Foreign Exchange Management before SAP Modalities and Procedures Policy Instruments Key Points and Conclusions 439 Chapter 16: The Nigerian Foreign Exchange Market in the SAP and Post-SAP Era 16.0 Introduction Exchange Rate Policy Objectives under SAP Flexible Exchange Rate Regimes and Strategies under the SFEM Framework The Dual Foreign Exchange Market and the Dual Exchange Rate System Deregulated Exchange Rate System GuidedDeregulated Exchange System Interbank Foreign Exchange Market System Dutch Auction System Outcomes of the Foreign Exchange Market Management Strategies Foreign Exchange Market Performance and Exchange Rate Instability Macroeconomic Outcomes and Implications of Exchange Rate Instability Factors in the Depreciation of the Naira Foreign Exchange Flows,Demand and Supply Foreign Exchange Management and the Real Sector Foreign Exchange Management Strategies under SAP 472 xiii

12 16.8 Towards Having a Stable Exchange Rate 16.9 Key Points and Conclusions Chapter 17: The Transfer Problem 17.0 Introduction HistoricalSignificance ofthe Transfer Problem Real and Financial Transfers and the Transfer Problem Real versus Financial Transfer Balance of Payments Entries of a Real and Financial Transfer ADiagrammatic Illustration ofthe Transfer Problem The Transfer Problem in the Context of Classical and Keynesian Theories The Classical Transfer Theory The Modern Keynesian Transfer Theory Effects of a Transfer on the Terms of Trade The Transfer Problem under Flexible Exchange Rates The Transfer Problem under ConditionsofPriceFlexibility Key Points and Conclusions 505 References 509 List of Tables 1.1 Effects of Making Domestic Payments Effects of Making International Payments Considerations in the Choice of Exchange Rate Regimes Bilateral Real Exchange Rate Indices for Nigeria, (a) Average Nominal Effective Exchange Rate Indices for Nigeria, (b) Nominal Effective Exchange Rate Indices for Nigeria, Real Effective Exchange Rate Indices for Nigeria 141 XIV