Waning Growth Impact of Real Exchange Rate: Why a Real Undervaluation Has Never Spurred Economic Growth in Nigeria

Abstract

With the pressure from international multilateral organizations, like the IMF and the World Bank, for Nigeria to devalue its currency in order to experience a stronger economic growth and Nigeria's subsequent adamancy to obey; I explore the relationship between real exchange rate and growth, bearing in mind that a nominal currency devaluation or appreciation has a real effect. I address the following questions to uncover if Nigeria's defiance is justified: What is the relationship between real exchange rate and economic growth? Does this relationship hold true for developing nations ‐ specifically defined, in my research, as the very poorest ‐ ? Finally, if there is a relationship, does this relationship apply to countries dependent on natural resources? My research presents four main facts: ( i ) there is a general negative relationship between real exchange rate and growth (ie. a real undervaluation stimulates growth while a real overvaluation hampers growth); ( ii ) this relationship is very strong for richer countries and very weak for poorer countries; ( iii ) this relationship fades away in the later time period considered in my research (2005‐2016); ( iv ) this relationship never holds true for countries dependent on natural resources. Given these facts, I explore the channels through which real exchange rate could affect economic growth in richer countries but not in poorer countries or resource‐dependent countries. By building a simple analytical model, I find that an increase in exports is the most likely channel through which real exchange rate impacts economic growth in richer countries. A real undervaluation leads to an increase in exports for richer countries but not for poorer countries because of the difference in export demand elasticity ‐ richer countries have a price elastic demand for their exports while poorer countries have a price inelastic demand for their exports. Furthermore, I suggest that the decline in export and economic growth impact of real exchange rate in recent times is due to a possible shift in export demand elasticity, from price elastic to price inelastic. Finally, I apply these facts on Nigeria to conclude that Nigeria is justified in holding off against undervaluation as long as the benefits of her actions outweigh the costs.