Is the Naira-US Dollar Real Exchange Rate Misaligned?

Abstract

Policy makers are generally interested in knowing the degree of real exchange rate (RER) misalignment because of its connection to currency crises and other external sector imbalances. In Nigeria, the Naira-US Dollar RER appreciated by 81.3 per cent between 2000 and 2008 and depreciated afterwards by 10.10 per cent to close at an average of N150.72 in 2009, due to the impacts of the global financial crisis. The main thesis of this study is: Are the movements in Naira RER during Q1:2000 to Q2:2011 in line with the economic fundamentals or not? Based on the theory of cointegration and error correction models as well as calibrated values of relevant explanatory variables, the study obtained estimates of sustainable Naira equilibrium RER and computed the corresponding misalignment levels in a time series perspective. It was confirmed that the RER appreciation of 2002-2008 and depreciation of 2009 were consistent with the long run equilibrium trend. It was also found that the RER oscillated quite closely around its equilibrium path during the study period as it was misaligned by 0.29 per cent. Lastly, the study found a slight RER misalignment (0.03 per cent) during the RDAS/WDAS regimes and thus recommends that the current exchange rate policy in the country be retained while ensuring that official interventions in the foreign exchange market are guided by movements in relevant macroeconomic fundamentals.

Keywords: real exchange rate, cointegration, misalignment, overvaluation, undervaluation

JEL Classification: E58, F31, F41, O55