BALANCE OF PAYMENTS AND ECONOMIC GROWTH IN WEST AFRICA

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BALANCE OF PAYMENTS AND ECONOMIC GROWTH IN WEST AFRICA

CHAPTER ONE:

INTRODUCTION

1.1 Background of the Study

Balance of Payments (BoP) plays a pivotal role in the economic landscape of any nation, influencing its economic stability and growth trajectory. West Africa, a region known for its diverse economies and resource-rich nations, faces unique challenges and opportunities concerning its balance of payments. Understanding the relationship between balance of payments and economic growth in West Africa is essential for policymakers, economists, and stakeholders seeking sustainable development strategies.

West Africa encompasses a group of countries with varying economic structures, including both landlocked and coastal nations. The region is characterized by significant agricultural, mineral, and energy resources, contributing to its economic vibrancy. However, challenges such as structural imbalances, external shocks, and global economic dynamics can impact the balance of payments, affecting the overall economic growth of these nations.

The sustainability of current account balance or imbalance is an indicator, which provides information on the state of the economy, the level of productivity, and the extent of the susceptibility of the economy or otherwise to external shocks that could trigger economic crisis.

Nigeria is one of the countries whose current account position should be a source of concern to policy makers. This is because the Nigerian economy is external sector driven, which suggests the dependence of the economy on external sector to generate foreign exchange to import capital goods for increased economic activities in the real sector. In addition, export proceeds, particularly from oil, have constituted more than 60.0 per cent of government revenue in the last two decades. Thus, the capacity of the government to provide good infrastructure, such as road network, railway and stable power supply, has a direct link on performance of the external sector of the economy.

Thus, a study on Nigeria’s current account balance and economic growth is desirable to establish their relationship and highlight the policy issues required to put the economy on a sustainable economic growth trajectory. Consequently, this paper seeks to empirically investigate the relationship between current account balance and economic growth in Nigeria, and highlight policy issues to improve current account balance in Nigeria. This study contributes to the literature by examining the relationship between current account and economic growth on country-specific basis, as most literature focused on crosscountry, regional and global studies, whose findings could not be applied to country-specific issues.

recommendations to guide policy on current account and economic growth in Nigeria.

The current account balance measures the inflow and outflow of goods and services as well as investment incomes (primary and secondary), unrequited transfers and compensation of employees, usually in domestic currency. It is one of the two major accounts in the balance of payments account.

The current account balance mirrors a country’s performance in foreign trade in goods and services and could be in surplus or deficit. A surplus position indicates that a country is exporting more goods and services than is importing; while a deficit shows that a country’s import from the rest of the world exceeds its exports. Current account balance can also be expressed as the difference between national savings and investment, known as the savings-investment gap. In other words, it is the difference between income and absorption in the economy. In this case, a country is said to have a deficit in current account if it is absorbing more than it produces; indicating that the country’s greater portion of domestic investment is financed by foreign savings. It signifies low levels of national savings, which triggers depletion of external reserves for financing economic activities. On the other hand, a country is said to have a current account surplus, if it is producing more than it absorbs. This reflects a high level of national savings relative to national investments.

The current account balance is an important indicator of competitiveness. The balance is used by international creditors, to determine the creditworthiness of a particular economy. It guides investment decisions of non-residents as it helps to gauge the viability of the economy, assists policymakers to determine the efficacy of macroeconomic policies, especially growth-stimulating and export promotion policies. It also, shows, at a glance, which sector of the economy deserves attention. However, an evaluation based on the robustness of the current account position is necessary but not sufficient to determine sustainability because of the specific characteristics of different economies. What is sustainable for one economy may not be sustainable for others. Studies have been conducted to develop other measures of sustainability, such as solvency and excessiveness of current account (Aysu and Fazil, 2012).

However, the key measure of the overall health of an economy is the size and direction of its economic growth, often measured by the change in GDP from one period to another. Economic growth can be defined as the increase in goods and services produced by an economy or a nation within a given or measurable period of time. It is a positive and sustained increase in aggregate goods and services produced in an economy within a given period. The gross domestic product (GDP) is used to proxy for economic growth; and when it is adjusted for inflation, it is called the real GDP, which stands as a value for all final goods and services produced in a country.

The balance of trade is the difference between exports and imports of goods and services. It takes the form of surplus if exports exceed imports or deficit when imports are greater than exports. The trade balance is a major component of the balance of payment and a key indicator of a country’s health. Its fluctuations is a major concern especially for developing countries facing chronic trade deficits. Therefore, examining its driving factors is important for creating an appropriate trade-led growth strategy.

This study investigates the determinants of the trade balance for the West African Economic and Monetary Union (WAEMU) countries over the period from 1975 to 2017. The WAEMU is made up of eight countries (Benin, Burkina Faso, Cote d’Ivoire, Guinea Bissau, Mali, Niger, Senegal and Togo) which use the CFA Franc as currency. The CFA Franc was pegged to French franc and to the euro since January 1999 at a fixed rate. They follow a common monetary policy under the coordination of the Central Bank of West African States (BCEAO). WAEMU countries are experiencing persistent trade deficits, except for Côte d’Ivoire which records structurally trade surplus. Over the period 1990–1993, the trade balance deficit of the union averaged 10.7% of GDP, and the economic growth rate was 0.3%. In January 1994, the CFA franc was devalued raising the parity rate from 50 CFA francs per French franc to 100 CFA francs per French franc. It was expected that this devaluation would improve the competitiveness and the economic growth of WAEMU countries. From 1994 to 2006, the real effective exchange rate appreciated leading to a loss of competitiveness of 22%. The annual economic growth rate averaged 3.2% over the period 1997–2000. Despite this recovery, the balance of payment of the Union was characterized by persistent trade deficit which increased from 3.2% during 1990–1999 to 7% over the period 2000–2012. The reason for this chronic deficit is higher growth in imports as compared to exports. Like most of the Sub-Saharan African countries, WAEMU countries rely heavily on the export of few primary commodities meanwhile import a lot of manufactured goods, capital goods, raw materials, and intermediate products. According to the Prebisch–Singer Hypothesis, the prices of primary commodities decline relative to those of manufactured goods over the long term, causing a deterioration of the terms of trade. As primary products have a low price elasticity of demand, a decline in their prices tends to reduce export earnings, causing a deterioration of the trade balance. Determining the driving factors of the trade balance of WAEMU countries is important in order to understand the problem leading to chronic trade deficits.

A growing body of empirical studies has investigated the effects of some macroeconomic variables on the trade balance such as real exchange rate, domestic income and foreign income. Most of these studies focused on the effect of real exchange rate on the trade balance with the view of testing the Marshall-Lerner condition and the J-curve effect. The evidence from this literature is mixed and inconclusive. While a number of studies found that real exchange rate depreciation improves the trade balance (e.g., Baharumshah, Citation2001; Boyd et al., Citation2001; Kale, Citation2001; Musila & Newark, Citation2003), many others reported a negative or insignificant relationship between the two variables (e.g., Akpansung & Babalola, Citation2013; Bahmani-Oskooee, Citation1991; Rose, Citation1991; Rose & Yellen, Citation1989; Upadhyaya & Dhakal, Citation1997).

The lack of conclusive evidence regarding the determinants of the trade balance is the primary motivation for this research. The major factors responsible for controversial results in the empirical literature include, inter alia, the time period, the data measurement and the estimation method used. At the methodological level, most previous studies have relied on traditional panel estimation methods that assume cross-country homogeneity in the slope coefficients of the trade balance relationship with real exchange rate, domestic and foreign income. Accordingly, this study makes use of the Mean Group (MG) estimator suggested by Pesaran and Smith (Citation1995) and the group mean versions of Fully Modified OLS (FMOLS) and Dynamic OLS (DOLS) estimators suggested by Pedroni (Citation2001). It is expected that the effects of real exchange rate, domestic and foreign income on the trade balance differ across countries. To the best of our knowledge, the paper is the first study that employs heterogeneous panel data estimation techniques in identifying the determinants of trade balance in African countries.

The rest of the study is organized as follows. Section 2 reviews the empirical literature regarding the determinants of the trade balance. Section 3 outlines the empirical model and describes the data. Section 4 reports the econometric methodology of the study. Section 5 discusses the empirical results. Section 6 concludes the study and gives some policy recommendations.

1.2 Statement of the Problem

Despite the economic potential in West Africa, persistent trade imbalances, fluctuating exchange rates, and external debt issues have raised concerns about the impact of the balance of payments on the economic growth of individual countries and the region as a whole. There is a need for a comprehensive understanding of the specific factors influencing the balance of payments and how they, in turn, affect economic growth in West Africa.

This study aims to address the following key questions:

What are the current trends and patterns of balance of payments in West African countries?

How do fluctuations in exchange rates impact the balance of payments in the region?

What role do external debts and trade imbalances play in the economic growth of West African nations?

Are there policy measures that can be implemented to enhance the positive contribution of the balance of payments to economic growth?

1.3 Research Questions

1. What are the historical trends and patterns of the balance of payments in West African countries.

2. What is the impact of exchange rate fluctuations on the balance of payments in the region.

3. What is the role of external debts and trade imbalances in influencing economic growth in West Africa.

4. What are the policy recommendations for enhancing the positive contribution of the balance of payments to economic growth.

1.4 Objectives of the Study

The primary objectives of this research are:

1.To analyze the historical trends and patterns of the balance of payments in West African countries.

2.To investigate the impact of exchange rate fluctuations on the balance of payments in the region.

3.To assess the role of external debts and trade imbalances in influencing economic growth in West Africa.

4.To propose policy recommendations for enhancing the positive contribution of the balance of payments to economic growth.

1.5 Research Hypothesis

H0: There is no relationship between balance of payments and economic growth in west Africa

H1: There is a relationship between balance of payment and economic growth in west Africa

H0: Balance of payments does not have a significant impact on economic growth in west Africa

H1: Balance of payments have a significant impact on economic growth in west Africa

1.6 Significance of the Study

This study holds significant importance for various stakeholders, including policymakers, economists, researchers, and development partners. By gaining insights into the intricate relationship between the balance of payments and economic growth in West Africa, it is possible to formulate more effective policies that promote sustainable development, economic stability, and poverty reduction.

Additionally, the findings of this study can contribute to the existing body of knowledge on international economics, providing a specific focus on the West African context. The research outcomes can be utilized to inform decision-making processes at both national and regional levels.

1.7 Scope of the Study

The geographical scope of this study covers the West African region, including countries such as Nigeria, Ghana, Senegal, Côte d’Ivoire, and others. The study will primarily focus on analyzing historical data related to the balance of payments, exchange rates, external debts, and economic growth indicators for these countries.

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