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Project Topic:

THE IMPACTS OF EXCHANGE RATE FLUCTUATIONS ON THE NIGERIAN ECONOMIC GROWTH

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 Format: MS WORD ::   Chapters: 1-5 ::   Pages: 60 ::   Attributes: secondary data, abstract, table of content, references ::   435 people found this useful

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CHAPTER ONE

Introduction

  1. Background of the Study

Exchange rate is the price of one country’s currency expressed in terms of some other currency. It determines the relative prices of domestic and foreign goods, as well as the strength of external sector participation in the international trade. Exchange rate regime and interest rate remain important issues of discourse in the International finance as well as in developing nations, with more economies embracing trade liberalization as a requisite for economic growth (Obansa, Okoroafor, Aluko and Millicent, 2013).

In Nigeria, exchange rate has changed within the time frame from regulated to deregulated regimes. Ewa, (2011) agreed that the exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom era and when agricultural products accounted for more than 70% of the nation’s gross domestic products (GDP). In 1986 when Federal government adopted Structural Adjustment Policy (SAP) the country moved from a peg regime to a flexible exchange rate regime where exchange rate is left completely to be determined by market forces but rather the prevailing system is the managed float whereby monetary authorities intervene periodically in the foreign exchange market in order to attain some strategic objectives (Mordi, 2006). This inconsistency in policies and lack of continuity in exchange rate policies aggregated unstable nature of the naira rate (Gbosi, 2005).

Benson and Victor, (2012) and Aliyu, (2011) noted that despite various efforts by the government to maintain a stable exchange rate, the naira has depreciated throughout the 80’s to date.Exchange rate, is the rate at which a currency purchases another (Jhingan, 2003), it is a reflection of the strength of a currency when measured against another country’s currency. According to Oloyede (2002), it is the price of one currency in terms of another, which is an important decision making variable in every nation, thus making it a crucial issue for any country desirous of economic growth as pointed out by Ahmed and Zarma (1997).

Foreign exchange management is described as a technique that involves the generation and disbursement of foreign exchange resources so as to reduce destabilizing short-term capital flows. Consequently, in order to ensure that foreign change allocation and utilization are in consonance with economic priorities and the foreign exchange budget, the CBN monitors the use of scarce foreign exchange resources.

Foreign Exchange Rate Management in Nigeria

Exchange rate management policy in Nigeria has passed through four major stages, which are; fixed parity solely with the British pound sterling and the US dollar (1959-1985), adoption of the second-tier foreign exchange market (SFEM) 1986-1994, introduction of the autonomous foreign exchange market (AFEM) 1995-1999, introduction of the inter-bank foreign exchange market (IFEM) 2000-2010. The first Ease of the Nigerian exchange rate policy began in 1959 with the establishment of the Central Bank of Nigeria (CBN). The CBN was specifically set up to manage the country's currency with the objective of attaining a sound and stable national currency. The pegged exchange rate system was the first exchange rate regime adopted in Nigeria. The Nigerian pound was fixed by the 195 a Central bank Ordinance at par with the pound sterling (Obaseki, 1991) and the CBN was responsible for buying and selling foreign currency in Nigeria. In 1962, the Exchange Control Act was enacted by the CBN; it vested the Minister of Finance with the authority to grant approvals for foreign exchange transactions, while the CBN handled private sector transactions through authorized dealers, i.e., commercial banks.

There was a major change (the first) in 1962 that unpegged the Nigerian pound from the pound sterling. The change, through the 1962 Act, defined the Nigerian pound in terms of gold, which meant that Nigeria could at any time decide on whatever adjustments needed to be made in the official rate between her currency and other currencies including the pound sterling. This, of course, was supposed to send strong signals to the international community that Nigeria, as an independent nation, was free to make decisions on her own. The wisdom of the action was later justified when in 1967 the pound sterling was devalued without any effects on the Nigerian pound.

The second major change occurred in 1973 when the Nigerian currency was 'decimalized and changed from the pound to the naira. This time, seemingly forgetting fee wisdom of autonomy, it was fixed to the US dollar. When the dollar was devalued m 1973, the value of the naira depreciated. The depreciation persisted due to the persistence in the depreciation of the dollar. Consequently, at the end of 1973, the Nigeria government decided to discontinue any direct relationship between the naira either the pound sterling or the US dollar. This led in 1974/75 to the policy of progressive appreciation of the naira. This policy -was greatly enhanced by the oil boom. The naira was pegged to a basket of the currencies of seven of Nigeria's major trading partners - United Kingdom, United States, Germany, France, Japan, Switzerland and The Netherlands, Exchange rate stability was the main objective of the reform. It was believed the naira would thereafter be stable since a loss in value due to the devaluation of one currency in the basket would be compensated by the appreciation of another currency in the basket. The arrangement was therefore a mechanism for dampening the effects of external exchange rate changes on domestic prices and the balance of payments.

It is important to know that from about 1973 to late 1977, Nigeria accumulated sizable foreign reserves arising from the oil boom, which made it possible for the fixed exchange rate policy to be managed through reserve movements. Official reserve depletion helped to meet private excess demand; however, there was a reluctance to devalue when the reserve alter became too low to support the fixed exchange rate. To curb the situation, foreign exchange from the central bank was strictly rationed and controlled through an import licensing system- The problem was that when the level of reserves increased, the naira appreciated, but it was 'never allowed to depreciate when the reserve level fell. This gave an impression that a continuous drain on the official reserves could sustain the fixed exchange rate regime. Subsequently, strict exchange control measures were adopted. These included: the reduction of consultancy and technical fees remit table to foreign consulting companies from 60% to 50%; reduction of business trips from 15 to 14 days maximum per trip; reduction of basic travel allowances to pilgrims and other travellers and so on.

These were supplemented by the establishment of the Exchange Control (anti-sabotage) decree of 1977, which set up tribunals to try foreign exchange offenders, and the Comprehensive Import Supervision Scheme (CISS) in 1979 to ensure a pre-3ment check of prices, volume and quality of imported goods worth over $33,000. the scheme was also expected to check other foreign exchange malpractices, such as over and under-invoicing of imports, importation of obsolete at and machinery at the prices of new ones, importation of out-dated and rotten food items and expired drugs, falsification of documents, foreign exchange claims for ids not imported or services not rendered, and overpricing of federal government projects with a view to keeping the gains abroad in foreign exchange.

From 1980 to 1981, the degree of exchange control was reduced, largely due to improvement in the balance of payments brought about by positive developments in the international oil market. This policy reversal was also due to the difficulty associated with tight exchange control regulations. The relatively more liberal system of exchange controls in the early 1980s was mainly aimed at curbing rampant abuse and malpractices in foreign exchange transactions, such as Over-invoicing of import bills, smuggling of currencies and goods across the borders, and false documentation import bills.The period between 1982 and 1986 marked the last phase of the policy of exchange controls in Nigeria between 1959 and 1993. The stringent exchange control measures as in earlier periods were preceded by severe balance of payments pressures. Foreign exchange receipts on both oil and non-oil exports were consistently less than s disbursements for imports. For example, between 1981 and 1984, the total exports receipts were less than the total imports. This led to a slide in external reserves and subsequently to the accumulation of external debts due to the inevitable reliance on short-term external loans in financing trade deficits.

Foreign exchange is the means of payment for international transactions and it is made up of convertible currencies that are generally acceptable for the settlement of international trade and other external obligations.

It is the goal of every economy to have a stable rate of exchange with its trading partners. In Nigeria, this goal was not reached in spite of the fact that the country embarked on devaluation to promote export as a result, stabilizes the rate of exchange. The government even went further to establish the foreign exchange market (FEM) to stabilize the exchange rate depending on the state of balance of payments, the rate of inflation, Domestic liquidity and employment. The failure to realize this goal subjected the Nigerian economy to the challenge of a constantly fluctuating exchange rate till date.

The foreign exchange market is an arrangement or medium of interaction between the sellers and buyers of foreign exchange in a bid to negotiate a mutually acceptable price for the settlement of international transactions (ile 1999: 325).

Afolabi (1999) defined exchange rate as the price of one currency in terms of the other. In other words, it is the rate at which one currency will exchange for another.

In the Pre-Babangida administration years the Nigeria currency was above the dollar and on par with the pound. However the naira has depreciated in value to a great extent since 1986 with the introduction of the structural adjustment programme (SAP), under the Babangida administration since the introduction of SAP in 1986, exchange management has been at the core of macroeconomic policy. The overriding objective has been to have a realistic and stable exchange rate consistence with the internal rate of naira and to reduce the economy’s dependence on the external sector.

Prior to 1986, one official foreign exchange market existed in Nigeria and exchange rates were officially fixed by the CBN. Then in the September 1986, the foreign exchange market was divided into two: the first-tier foreign market and the second – tier foreign exchange market (STEM). The major aspect of the SFEM was that the prices of foreign currencies as against the naira was determined through competitive bidding with the prices settling at points. Where the available supply of the currencies are cleared the bidding was in terms of one currency. The us dollar, against the naira and the rates for other currencies were correspondingly determined after the determination of the dollar rate. (Essien 1990:129).

 With the establishment of SFEM the rate of naira depreciation by the central bank gathered momentum. With the view of merging the first and second tier markets within the shortest possible time, which was about one year. In July 1987, the first and second tier foreign exchange market were merged and called the foreign exchange market (FEM). On march 20 1987 the central bank introduced the Dutch auction system which was intended to inject more caution in the bidding sessions since dealers who bid above the marginal rate would be made to buy at that rate the Dutch auction system was expected to control the sharp depreciation of the naira.

In 1994 a natural merger of the official market and the parallel market occurred. The parallel market gradually marginalized the official market. The foreign exchange market was liberalized in 1995 with the introduction of the autonomous foreign exchange market (AFEM) for privately sourced fund at market determined exchange rates(CBN Annual Report 2001).

 In 1995, the foreign exchange market was split into three tiers. The administratively fixed through the manipulation of the market mechanism, and the parallel market. Still, there was greater depreciation of the naira. There was also an introduction of dual exchange rate regime in 1995 which was a mixture of both the fixed  and the market determined rate. The dual exchange rate regime was restricted in 1997 with the official selling rate fixed at #21.9960 to US$1for selected priority government transactions. The stability of the nominal exchange rate achieved in 1995 and 1996 at the AFEM was generally sustained in 1997.

      The exchange rate of the naira depreciated in all segments of the foreign exchange market prior to the introduction of IFEM(Inter-Bank Foreign Exchange Market). Which commenced operation on October 25, 1999.The exchange rate depreciated to #97.42 toUS$1.00 and depreciated on the average by 6.5 percent to #101 to US$1) in 2000. There was a phenomenal depreciation in early April 2001 with the naira sinking to #113.2263 to US$1.00 as against the official rate. This fall in value continued as the naira sank again to #126.38883 to US$1.00 in December 2002, and #136.5000 to US$1.00 in December 2003 then to #132.85 in December 2004.the CBN was successful in keeping to its target on growth of broad money M2 in 2004.

 

  1. Statement of problem

In a bid to emphasize the issue of fluctuating exchange rate on the Nigerian economy, we analyzed some of the problems mitigating the fluctuation of exchange rate on the Nigerian economy as seen below.

The exchange rate of the naira was relatively stable between 1975 and 1979 during the oil boom era. This was also the situation prior to 1990 when agricultural products accounted for more than 70% of the nation’s gross domestic product. However as a result of the development in the petroleum oil sector in 1970, the share of agriculture in total export declined significantly while that of oil increased.

Furthermore, since Nigeria as a nation is highly dependent on import of input and capital goods for its production process, the sectors involved in the production of goods and services have become increasingly dependent on the external sector for import of non-labour input. This indeed has affected the local content of the nation as resources lie untapped and attended to. Incessant import of raw materials and foreign goods has also led to the abandonment of the local industries, another problem worth mentioning here is that since this import of raw materials has become a way of life for the economy, the government tend to get used to it and as a result The impact of fluctuation in exchange rate on the economy has not received adequate attention from various regimes of government.

Instabilities of foreign exchange rate also pose many problems on international trade between economies. As a result exported goods from economies with unfavorable exchange rate will be of price advantage to the importing nation while imported goods from nations with formidable exchange rate will be of price disadvantage to the exporting nations with unfavorable exchange rate. This indeed will affect the balance of payment of the exporting nation negatively if the import bills becomes higher that export receipts yet if a nation must attain economic growth, it needs a reasonable level of import and inability to import therefore can impact negatively on a nation as well as its inability to export, little wonder Jhingan (1997), emphasized that exchange rate fluctuation cause uncertainty and impede on international trade.

This uncertainties however in trade transaction post a lot of problems such as inflation, which determine the internal balance of a country, it also tend to undermine the international competitiveness of non-oil export and make planning and projection difficult at both micro and macro levels of the economy, some small and medium scale enterprise have been strangled out as a result of low dollar to naira exchange rate, unemployment, balance of payment problems and increase in the level of poverty. Some of the measures adopted by the government to help reduce the incessant depreciation of the naira include the introduction of IFEM in 1999, the AFEM and the re-introduction of the Dutch Auction System (DAS) in July 2002,with the objectives of realigning the exchange rate of the naira, conserving external reserves, enhancing market transparency and curbing capital flight from the country. Under this system, the Bank intervened twice weekly and end-users through authorized dealers bought foreign exchange at their bid rates. The rate that cleared the market (marginal rate) was adopted as the ruling rate exchange rate for the period, up to the next auction. DAS brought a good measure of stability in exchange rate as well a reduction in the arbitrage premium between the official and parallel market rates. Other measures adopted to enhance the operational efficiency of the foreign exchange market included the unfettered access granted holders of ordinary domiciliary accounts to their funds, while utilization of funds in the non-oil export domiciliary accounts were permitted for eligible transactions. Inspite of these measures, the value of naira has continued to cascade downwards.

 

 

  1. Objective of the Study

In a highly import dependent economy like Nigeria, the continuous naira exchange rate has become one of the most widely controversial issues in the country today. This is not surprising as this topic has had a lot of impact on the Gross Domestic Product (GDP). The GDP here however is an indicator of economic growth in an economy. Specifically, the objectives of this study include:

To determine the extent to which interest rate has influenced the rate of domestic growth in the economy.

To examine the nature of the relationship between the unstable exchange rate fluctuations and economic growth in Nigeria, and to determine the management of interest rate and exchange rate in Nigeria.

To investigate the relationship between the exchange rate, inflation rate, interest rate and trade openness of the Nigerian economy to her Gross Domestic Product (GDP).

To determine if the continuous fluctuation of exchange rate of naira have an impact on the standard of living of the citizen, export and to what extent.

1.4Research Hypothesis

The following hypotheses were formulated with emphasis to the objectives of this study.

H0: There is no significant relationship between exchange rate fluctuations and the Nigerian economic growth.

H1: There is a significant relationship between changes exchange rate fluctuations and the Nigerian economic growth.

 

 

1.5Significance of the Study

This study would identify the strengths and weakness of exchange rate policy and management will identify those parts that are mostly affected by instability in exchange rate, provide the general public with adequate information on the foreign exchange transaction and its impact on the Nigerian economy. In general, the study benefits the following;

  1. The government will benefit as it will enable them ascertain the extent of which the variation of exchange rate affect the macro-economic variables in the nation.
  2. The government will also determine from this study how the unstable exchange rate of the economy affects the demand for local products in contrast to foreign products.
  3. This study will benefit exchange rate policy makers in helping them formulate the best policy necessary to move the economy towards growth.
  4. The citizens will also benefit if the policies formulated as a result of the findings from this study pose a positive impact on the economy in the short or long-run.
  5. Future researchers will also benefit as this study will serve as a future guide.

 

1.5      Scope and Limitation of the Study

This research work is designed to cover a very long period that is (1970-2015). The scope consists of the regulatory deregulatory exchange rate period i.e. the fixed exchange rate and floating rate period. The study is structured to evaluate Nigerian exchange rate as the pilot of economic growth. Thus, this study is therefore limited to the effect of exchange rate fluctuation in the Nigerian economy.

 

 

1.6      Definition of Terms

1.         Exchange rate: This is the currency in price terms of another currency

2.         Autonomous foreign Exchange market (AFEM): this is a market where banks are allowed to source their foreign exchange and sale and used at market determined rates.

3.         Current factor cost: this is used to measure the rate of Gross Domestic Product (GDP).

4.         Dual exchange rate:  This situation exists where two exchange rates are in existence in an economy.

5.         Dutch Auction System (DAS):This is a method of determining the exchange rate through auction, where the bidders pay according to their bid rates.

6.         First – Tier Foreign Exchange Market (FFEM): This was the market where government and its agencies buy foreign currency a foreign currency at officially determined rate of exchange.

7.         Inter-Bank foreign Exchange Market(IFEM):  This was conceived to deepen the foreign exchange market through active participation of other player’se.g. bank, oil companies, non- bank financial institutions. It is the market where banks can sale foreign exchange to one another and to other users at their own rates

8.         Para.lopee market: This is also known as blank market’. It is the unofficial market where foreign currencies are bought and sold.

9.         Second-tier foreign exchange market (SFEM): This was the market where non-governmental bodies buy and sale foreign exchange at a market determined exchange rate.

10.       Foreign exchange: Foreign exchange is a means of payment for international transaction; it is made up of currencies of other countries that are freely acceptable in settling international transactions.

 

 

 

 

 

 

 

 

 

 

 

 

 

References

Ahmed, H.I. & Zarma, A. (1997).The impact of parallel market on the stability of exchange rate: evidence from Nigeria. NDIC Quaterly Publication. 7(2), 42 – 61.

Jhingan, M.L. (2003). Money, banking, international trade and public finance. New A.S. Offset Press: Delhi

Obaseki, P.J. (1991).Foreign exchange management in Nigeria; past, present and future.CBN Economic and Financial Review. 29, 57 – 78.

Oloyede, J. A. (2002). Principles of international finance.Forthright educational publishers, Lagos.

Ewa, A. (2011) & Asher, O. J (2012).The impact of exchange rate fluctuation on the Nigeria economic growth (1980 – 2010).Unpublished B.Sc thesis of Caritas University Emene, Enugu State, Nigeria.

Gbosi, A. N. (2005). Money, monetary policy and the economy. Port Harcourt: Sodek.

Mordi, M.C. (2006). Challenges of exchange rate volatility in economic management of Nigeria, In the dynamics of exchange rate in Nigeria, CBN Bullion. 30 (3), July-September.17-25.

Obansa, S. A. J., Okoroafor, O. K. D., Aluko, O. O., and Millicent Eze (2013).Percieved relationship between exchange rate, interest rate and economic growth in Nigeria: 1970-2010. American Journal of Humanities and Social Sciences: 1(3), 116-124.

Afolabi, L. (1999).Monetary economics.(Ibadan, Heinemann educational books Nig. Plc).

Essian, E. (1990).Nigeria under structural adjustment (Ibadan, Fountain publications).

Central Bank of Nigeria.(2001). Annual report and statement of Accounts.Lagos, CBN publications.

Ile, N.M. (1999). Economics for business studies (Enugu Ochumba publications company Ltd).

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