ABSTRACT

The purpose of this study was to investigate the effects of Devaluation on the economic growth of Cameroon. As specific objectives the study had to investigate the effect of devaluation on the consumption, investment and gross domestic product of Cameroon. For this to be accomplished relevant literature was reviewed and necessary theories stated. The area of study is Cameroon and the data used are mainly secondary data of GDP, consumption and investment gotten from World Development Indicators (WDI). The method of analysis used is the ordinary least square method done through the SPSS software.  The results showed that devaluation has a negative effect on the consumption of Cameroon. Devaluation has a negative effect on the investment of Cameroon. Devaluation has a negative effect on the GDP of Cameroon. And for any policy recommendation intending to improve the economic growth the government is advised to put a keen eye on the level of devaluation the country is witnessing and it will eventually affect the economic growth of Cameroon.

CHAPTER ONE

INTRODUCTION

1.1            Background of the study

In recent years, currency devaluation has been a topic of interest in the international economy. From the 20th century until recent years, many developing economies experienced currency crises at a point, leading to the contemplation on whether devaluation of their currency is the solution or perhaps another economic and financialreform. There are several arguments on whether currency devaluation is contractionary or expansionary, whether it exerts positive or negative effects on output growth, orwhether it is advisable for a country with large amount of debt denominated in foreigncurrency to undertake currency devaluation (Saibene & Sicouri, 2012)

Devaluation policy is adopted to increase the exports of the country, as it is expected that if the local currency of the country is devalued, relative to other currencies, the export commodities of that country become cheaper, as long as the importing countries do not replicate this action. As the currency of any country is devalued the other countries goods becomes costly to import from that country. So the people reduce their demands for foreign goods. As earlier mentioned, export promotion is one key reason why evaluation is mooted among policy makers, and now the question arises, how does devaluation affect export performance? The answer to this question depends on whether the country in question is a developed or developing country, as well as the price elasticity of demand for the main exports of that country.

If demand for the export product is price inelastic, then a fall in the price of exports will lead to only a small rise in quantity demanded for these exports, thus implying that the value of exports may actually fall. On the other hand, if the exports of that country are price elastic, then a fall in export prices will invariably lead to a significant rise in demand for these products. Taylor, L. & Rosensweig, J. (1984).

If demand is price inelastic, a fall in the price of exports will lead to only a small rise in quantity. Therefore, the value of exports may actually fall. An improvement in the current account on the Balance of Payments depends upon the Marshall Lerner condition and the elasticity of demand for exports and imports. If PEDx  + PEDm> 1 then a devaluation will improve the current account. The impact of devaluation may take time to have effect. In the short term, demand may be inelastic, but over time demand may become more price elastic and have a bigger effect. If the global economy is in recession, then devaluation may be insufficient to boost export demand. If growth is strong, then there will be a greater increase in demand. However, in a boom, devaluation is likely to exacerbate inflation. Spare capacity in the economy. E.g. in a recession, a devaluation is unlikely to cause inflation do firms pass increased import costs onto consumers? Firms may reduce their profit margins, at least in theshort run. Import prices are not the only determinant of inflation. Other factors affecting inflation such as wage increases may be important. It also depends on the reason why the currency is being devalued. If it is due to a loss of competitiveness, then devaluation can help to restore competitiveness and economic growth. If the devaluation is aiming to meet a certain exchange rate target, it may be inappropriate for the economy. Taylor, L. &Rosensweig, J.(1984).

In recent period, devaluation has become the basic macroeconomic policy issue in most developing countries. The effect is contractionary or expansionary depending on the structural adjustment program, the international monetary fund (IMF) suggested for developing countries to devalue their currency for the development of domestic firms. Devaluation increases the demand for domestic product and protects infants firms from outside competition (Eenye, 2010). Nigeria‟s first step towards devaluation was the adoption of the Structural Adjustment Program of 1986. This comprehensive program was adopted by the Babangida administration with the intention to make Nigeria more competitive in the globalmarket.

Devaluation will change depends upon the elasticity of foreign demand for the country’s exports and the elasticity of domestic supply of export good. A point that should be emphasized is perhaps the changing character of devaluation policies. Until the 1980s the vast majority of developing countries followed fixed exchange rate policies. Starting from the late 1970s and early 1980s, however, many developing countries switched from a fixed to a flexible exchange rate system as a result of a series of internal and external factors. For this reason, we have to deal with not only devaluation, but also depreciation. Devaluation and depreciation function in the same way, in the sense that they both change relative prices in favor of tradable commodities. Therefore, the fact that some LDCs have switched to a floating exchange-rate system does not create a major problem in terms of the focus of our analysis. Another interesting observation in international economic relations in recent years is worthnoting.

On august 11, 2015, the people’s bank of china surprised markets with three consecutive devaluation of the Yuan, knocking over 3% off its value. Since 2005, China‟ currency had appreciated by 33% against the US dollar, the first devaluation marked the largest dropin20 years. While the move was unexpected and believed by many to be a desperate attempt by china to boost exports in support of an economy that was growing slowest rate in a quarter century. The people bank of china claimed that the devaluation was part of its reforms to move towards a more market-oriented economy. The move had substantial repercussions worldwide.

The emergence of regional trading blocs in different parts of the world, i.e. the European Union (EU) in Europe, the North American Free Trade Agreement (NAFTA) in North America, and the Association of South East Asian Nations (ASEAN) in the Asia-Pacific Rim is phenomenal.

These blocs directly affect more than half of the world’s trade. Exchange-rate systems seem to be affected by this process as well. For instance, members of the EU have been trying to peg their currencies with respect to one another within certain limits.  This observation implies that the possibility of going back to some form of fixed exchange rate system, at least within a certain group of countries, is not totally out of question as far as the potential policy implications of this analysis are. In other words, if the objective of the policy makers of a developing country is to achieve economic development through export promotion, the effect of devaluation on the rate of export becomes very crucial. Also important is whether the effect of devaluation on export is the same for all LDCs regardless of their income level, infrastructure, or export composition.

Devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged. It also means official lowering of the value of a country’s currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. The opposite of devaluation is called revaluation. Devaluation is a monetary policy tool of countries that have a fixed exchange rate or semi-fixed exchange rate.

By relying on this vision, the International Monetary Fund (IMF) introduced the monetary devaluation as a component of the stabilization program to be applied in certain developing countries. This political reorientation faced a lot of criticisms from researchers and political leaders. These latter consider that the restoration of the balance of equilibrium in the balance of trade through currency devaluation is expensive in terms of production and employment. They advanced several arguments, such as the contraction of the demand; further to a redistribution of income in favor of the actors for strong marginal inclination to be saved and the braking  finally reducing  the supply due to the increase of the cost of imported of inputs. These reasons are used to explain that instead of being an economic control lever, the devaluation would rather cause a degradation or a slowing down of the economic activity. The devaluation of the CFA franc which intervened in January, 1994 raised numerous controversies. Before this date, the African Countries of the Franc Zone lost market shares with regard to their Asian or African competitors who had all considerably devalued their currency during the 80s. A good number of studies found that “the real adjustment ” and the policy of competitive deflation had affected their limits and that only a currency adjustment would allow to durably reduce the deficits (Nashashibi, Bazzoni,  1994). On the other hand, the possibilities of replacement of import and the elasticities of export seemed low, the controversial legitimacy of the governments could be the worry of an inflationary skid, the development of fraud and fiscal lack of civic virtue, and finally a severe contraction of income. The devaluation could be “contractionary”, according to a configuration known for several Latin American countries. However, empirical literature does not unanimous give answer to the question relative to the effect of devaluation on the real sector. Concerning the empirical studies on the data of developing countries, a first group of authors (Connolly, 1983; Kamin, 1988; Bahmani-Oskooee and Rhee, 1997) still supports the traditional thesis of an expansionist effect of devaluation. A second group (Krueger, 1978; Gylfason, 1987, Edwards 1989a) did not find significant impact of devaluation on production. The last group of authors (Diaz-Alejandro, 1965; Cooper, 1971a; Edwards, 1989b; Agenor, 1991, Morley, 1992; Bahmani-Oskooee (1996) asserts that devaluation leads to a contraction of activities in these countries. This difference in results led Bahmani-Oskooee and Miteza (2003) to conclude that the results of empirical.Studies relative to the impact of devaluation on production differ from country to country and depend on the model as well as on the technique of estimation used. Seventeen years after the devaluation, it is important to make a balance sheet and look into the future. Lived as a real trauma by the populations of zones WAEMU (the West African Economic and monetary Union) and CAMEC (Central Africa Economic and Monetary community), the devaluation of 50 % of the CFA franc was justified by the increasing disconnection between the fundamental of savings for both zones and the value of the CFA franc. This disconnection became famous in the time for structural deficits of the balance of payments further to the loss of competitiveness of savings, degradation of economic performances and the continues fall in international reserves. The cover rate for the monetary  issue of the CFA franc was lower than 20 %, what was against the agreements of the Account of Operations which bind the French Treasury to the central banks BCEAO (Central Bank of the States of western Africa) and BEAC (Bank of the States of Central Africa). Furthermore, the political context of that time, illustrated by the “doctrine of Abidjan (note 3) “, widely favored the adoption of the principle of devaluation and its application. Today, we can wonder if devaluation did allow to place the savings of the Franc zone countries on a path of high and long-lasting growth.  To this question, is added the persistent rumors relative to the imminence of a new devaluation of the CFA franc. Besides, the stiff anchoring of the CFA franc to the Euro which also seems to raise problems of competitiveness in the export of the countries of the Franc zone, as far as the US Dollar remains the reference currency of international commercial transactions. explanations on the question issue of devaluation impact in the franc zone

1.2            Problem Statement

Up to December 1993, Cameroon’s currency (CFA) has been over-valued vis-a-vis the major currencies and in particular the US dollar. This seems to have greatly affected the country’s production as well as its exports. And given that agriculture is the main support of the economy, it has become a major concern to all interested in the country’s economy in particular and sub-Saharan African economy in general. But there exists little or no quantitative knowledge of the differentdeterminants of outputs and the real exchange rate in the CFA franc countries, particularly in the case of Cameroon. It isbelieved that the over–valued currency has negative effects on agriculture, consequently on the economies of the CFA franc countries. But there has been no quantitative analysis of any kind of the impact of over-valued exchange rates.

According to Saibene&Sicouri (2012), the issue of currency devaluations can be answered conventionally from the analysis in the Mundell-fleming model and the result has a positive impact on the current account. Following this, in respect to GDP, devaluation is expansionary since exports rises more than imports. To examine the level of the reaction of the current account, the model can be extended by putting other important features into consideration like: a) Variation in exports (imports) in response to a variation in real exchange rate i.e. World’s prices elasticity demand for tradable goods. b) Presence of supply shocks effects resulting from the presence of intermediate inputs and raw materials; for example, oil. Nevertheless, considering the fact that the debts of the country are denominated in foreign currencies, variation in real exchange rate also has important effects on the balance sheets (Saibene &Sicouri, 2012). There are effects such as:  Significant reduction in government spending as a result of constraints by laws targeted at avoiding increased deficit since more money would be needed for payments of interest rates above sovereign debt(Saibene &Sicouri, 2012).  There can be a diminished private investment and consumption as though cost of servicing debts increases, profit shrinks and reduced bank lending because it depends on the collateral that can be provided by the firms. This results in an investment level that is negatively affected. Though banking sector can be affected negatively by currency devaluation as a result of the mismatches between the assets and liabilities of currency, hence- the chances that financial crisis rises, something that would seriously worsen the economic state of the country (Saibene&Sicouri, 2012).The national investors can experience a negative wealth effect, with assets majorly denominated in national currency, foreign currency denominated debt can increase the volatility of the flow of capital and the chances of sudden stops, reversals of current account and self-fulfilling crises (Saibene &Sicouri, 2012).

It is usually believed that the policies that encourage exports have a positive impact on economic growth. The export oriented industries have higher marginal product of labor and as a result they pay higher wages than other sectors, whereas an important component of the relative price of exports which matters for sectoral allocation, largely depend on the level of real exchangerate.

The real exchange rate broadly depends on government decision of devaluation of currency, which is a major economic and political agenda. Different countries needed to devalue their currency for a variety of reasons, including correction of price distortion to get right price so that market can function properly, which increases competitiveness in the international markets.

As a result, it would be possible to decrease foreign trade deficit and improve the balance of payments, and above all, to achieve a feasible economic growth. This paper aims at assessing the effect of rapid devaluation of countries currencies‟ on major export items. These selected countries had devaluated their currencies due to other exogenous shock on currency rather than export. This analysis will answer the question whether the currency devaluation affects the export growth or not. To do this different econometric techniques for panel data analysis have been used. The relationship between currency devaluation and export growth has been investigated by different researchers having no consensus among their findings. The role of exports is vital in economic growth and especially the real exchange rate in export promotion features prominently in literature on development and globalization. Servén shows that the volatility of exchange rates has a negative impact on growth, investment and on exports of goods.

1.3            Research Question

1.3.1    Main Research Question

What is the effect of devaluation on the economic growth of Cameroon?

1.3.2    Specific Research Question

What is the effect of devaluation on the balanceof trade of Cameroon?

What is the effect of devaluation on the Investment of   Cameroon?

What is the effect of devaluation on consumption of Cameroon?

1.4            Objective of the Study

1.4.1    Main Objective of the Study

The main objective of this study is to examine the effect of devaluation on the economic growth of Cameroon.

1.4.2    Specific Objectives of the Study

The specific objectives are to;

• Examine the effect of devaluation on the balance of trade ofCameroon.
• Investigate the effect of devaluation on investment ofCameroon.
• Investigate the effect of devaluation on consumption ofCameroon.
• To make some policyrecommendations.

1.5            Hypotheses of theStudy

H1: Devaluation has a significant effect on the economic growth of Cameroon.

H2: Devaluation has a significant effect on investment of Cameroon.

H3: Devaluation has a significant effect on balance of trade of Cameroon.

H4: Devaluation has a significant effect on consumption of Cameroon.