Linkages between External Reserves and Economic Performance in Nigeria, 1981-2018: Bounds Test and ARDL Approaches

Abstract

Aims: This study seeks to explore a two-way relationship between Nigeria’s economic performance, measured by the GDP, and her stock of foreign reserves over time.
 Study Design: It uses secondary data - documented time series of Nigeria’s gross domestic product (GDP) and foreign exchange reserves (FER) – collected from various volumes of the Central Bank of Nigeria (CBN) Statistical Bulletin. The annual time series data cover a period of 38 years, from 1981-2018.
 Methodology: The time series properties of the variables were verified using the Augmented Dickey-Fuller (ADF) unit roots’ test procedure. Also, the Bounds test technique was used to test for cointegration while the autoregressive distributed-lag (ARDL) and error correction models were estimated to analyze short- and long-run relationships between the variables. Relevant diagnostic tests were carried out to validate the resultant model estimates.
 Results: Results of unit roots’ test reveal both GDP and foreign reserves as I(1) series. Bounds test for the GDP model revealed an observed F-statistic (.421) that is less than the critical lower bound F-statistic (4.94) at P=.05 and cointegrating relationship was not confirmed. However, Bounds test for the foreign reserves revealed an observed F-statistic (6.445) lager than the critical upper bound F-statistic (5.73) at P=.05 and cointegration was established leading to specification of a long-run error correction model (ECM). Result of ARDL model estimation shows that only one-year-lag of GDP was significant (P=.05) and positive in explaining variations in the current GDP. Previous year’s values of both GDP and foreign reserves have positive influence on the long-run foreign exchange with over 81.8% explanatory power. The adjustment coefficient of the error correction equation is highly significant (P=.001) with the desired negative sign, implying that previous periods’ errors are correctable by adjustments in the subsequent periods, and convergence is attainable. Granger-Causality test result revealed a unidirectional causality that runs from GDP to the external reserves.
 Conclusion: The study establishes a long-run relationship between stock of foreign reserves and economic performance in Nigeria. The finding corroborates the view that a booming economy has the propensity to attract foreign direct investment thereby boosting the stock of the country’s foreign reserves. To attract more FDI in the critical sectors of the Nigerian economy, the government should create enabling and investment-friendly environment, implement policies and programmes capable of amplify ease-of-doing-business, and boost investors’ confidence in the economy.

Relationship between Foreign Exchange Reserves and Economic Growth in Tanzania: Application of Wald Granger-Causality Test

“…Therefore, we reject the null hypothesis so there is a long-run impact of the foreign exchange reserve on economic growth. The above findings (Table 10) are in line with (Ojiako, 2020) examines the two-way relationship between foreign exchange reserve accumulation and economic growth performance in Nigeria for the period 1981-2018. The empirical evidence suggests a cointegrating relationship between the variables.…”

“…Developing countries need more foreign exchange reserves, which could be used as capital to address the development and welfare demands of the nation (Kargbo, 2012). The accumulation of foreign exchange reserves contributes to the economic growth of developing countries by increasing both the investment/ GDP ratio and the capital productivity (Polterovich and Popov, 2003). When foreign reserves increase due to increased export of goods and services, it would be better for the economy to generate more jobs and strengthen the internal economy (Dooley et al, 2003).…”

“…The empirical findings suggest bidirectional linear and nonlinear causality between the two. Ojiako (2020) examines the two-way relationship between foreign exchange reserve accumulation and Nigeria's economic growth performance from 1981-2018. The empirical evidence suggests a cointegrating relationship between the variables, and the Granger causality test results imply a unidirectional causality running from GDP to international reserves.…”

Empirical assessment of the impact of external reserves on economic growth in Nigeria

“…A country's desire to accumulate external reserves is motivated by the benefits associated with doing so. This, according to Ojiako (2020), in the case of Nigeria includes but is not limited to ensuring a sustainable balance of payments, cushioning the shocks occasioned by volatility in oil price at the world market and making foreign exchange available to all buyers so as to prevent the naira from unnecessary depreciation among others. Egbulonu and Akamike (2018) submit that the decision to accumulate foreign reserves or trim them should be necessitated by the prevailing circumstances in the economy, since it does not make sense to keep scarce resources as a reserve when indeed critical sectors like road network, education, health as well as agriculture need to be attended to domestically.…”