Real Exchange Rate Assessment for Nigeria: An Evaluation of Determinants, Strategies for Identification and Correction of Misalignments

Abstract

By using monthly data for the 2004–2010 period and a vector error correction model approach, this paper evaluates the determinants of real exchange rates for the Nigerian Naira. Estimations suggest that oil prices, broad money supply, level of foreign reserves held by the Central Bank and interest rate differentials with trading partners can be used as good predictors of the long run Naira equilibrium real exchange rate. It is shown that the recent increases in the world price of oil have a significant appreciating effect in the real Naira rate, while increases in the money supply have the opposite impact. The study also uses the behavioural equilibrium exchange rate approach to identify the misalignments in the real Naira rate. Findings point out to the undervaluation of the Naira at the end of 2010.