study investigates the determinants of exchange rate in Nigeria and to
establish the position of balance of payments and Gross Domestic Product from
year 1980 to 2010. Though the fundamental problems to exchange rate and its
determinants still persist.
therefore seeks primarily to analyze the determinants of foreign exchange by
employing the ordinary least square method of estimation with the help of statistic
package for social science (SPSS) version 17 with special references to the
influence of inflation rate, money supply,
balance. Of payment and Gross Domestic Product.
From the analyses,
the results show the degree of variation among the variables. The co-efficient
of determination was 0.673, which is 67.3 percent variation in exchange rate is
accounted- for by the independent variables. Overall, the findings confirmed
the hypotheses which states that high productivity differentials (GDP) leads-to
exchange rate appreciation and inflation, money supply and balance of payments
have impact on exchange rate. Thus, we propose policies that would preserve the
international value of the domestic currency, maintain a favourable external
reserves position and the overall goal of macroeconomic stability.
TABLE OF CONTENTS
1.1 State of Problem
1.2 Research Questions
1. 3 Aim and
1.4 Justification of the Study
1.5 Scope and Limitation
1.6 Operational Definition of Terms
2.0 Literature Review
2.2 Conceptual Framework
2.3 A Review of Exchange Rate Policies Implemented in Nigeria
2.3.1 Fixed Exchange Rate System
2.3.2 Flexible Exchange Rate System
2.4 Structure of Nigeria’s Foreign Exchange Market
2.5 Foreign Exchange Management since 1986
CHAPTER THREE .
3.1 Research Methods
3.2 Variables in the Analysis
3.3 Model specification
Analysis and Interpretation
of Data Analysis
Presentation and Analysis
and Variance Analysis
1 Regression Result .
2 Regression Result
4.4 Policy Implication
5.2 Policy Recommendation
The role of
exchange rate and its effects on macroeconomic performance has continued to
generate interest among economists. Many economists argue that exchange rate
stability facilitates production activities and economic growth. They are also of the view that misalignment in real
exchange rate could distort production activities and consequently hinders
exports growth and generate macroeconomic instability (Mamta Chowdhury, 1999) Exchange rate policy guides investors
on the, best way they can strike a balance between their trading partners, and
investing at home or abroad (Balogun, 2007). Mordi (2006) argued that the
exchange rate movements have effects on inflation, prices incentives, fiscal
viability, and competitiveness of exports, efficiency in resource allocation,
international confidence and balance of payments equilibrium.
is one of the key 'barometers' of economics performance, indicating growth
(output), demand conditions, the levels and trends in monetary and fiscal
policy stance (Afolabi, 1991). Exchange rate policy emerged as one of
the controversial policy instruments in developing countries in the 1980s, with intense opposition for fear of
its inflationary impact, among other effects. Nigeria faced such a situation
and there has been interest, therefore, in economic performance and the role of
the exchange rate in the process (Afolabi 1991).
rate, when applied in conjunction with other macroeconomic policies is expected
to lead to the achievement of the goals of price stability, improved and sustained
economic growth, reduced unemployment and balance of payment stability. An
optimal and stable exchange rate has to be right and stable since it is an
important relative price that influences other prices. When the exchange rate
is not optimal, however, the achievement of these objectives becomes different
and often impossible according to Afolabi 1991. For example, if the exchange
rate is not in equilibrium, it allows rent-seekers and speculators to exploit
the subsidy element involved. The situation is worse when a parallel market
develops as a result of restriction in the official market and inability of the
market to satisfy the demand for foreign exchange. Thus, the opportunity cost
of transacting business in the official market is the value of the subsidy or
the premiums that would otherwise be lost by the official sector but gained by
third party arbitrators and speculators. The disability nature of foreign
exchange subsidy (premium) is the fundamental reason why unification of
exchange rate is canvassed as a short to medium term objectives of exchange
rate management. The smaller the parallel market relative to the official
market, and the higher the demand and supply elasticity of foreign exchange in
the official market relative the closer the unified equilibrium rate is likely
to be the official rate. However, if there is a large unsatisfied demand in the
official market which cannot be diverted to the parallel market because of
administrative restrictions, the equilibrium rate
in a unified market would tend
to be closer to the parallel market rate or could even be beyond it (John, IMF,
1985). The retention of a dual exchange rate system for a long time would be
counter productive in the long run by undermining the objective of exchange rate
stability and structural reform of an economy. The continued existence of dual
or multiple rates would be encouraging wasteful allocation of resource, thereby
stunting economic recovery and groups. Foreign exchange liberalization,
accompanies by appropriate demand management policies targeted at ensuring
macro economic stability is necessary for exchange rate convergence, if the costs(subsidy)
are to be reduced. This is because the burden of adjustment is
often borne by the official exchange rate.
One of the
broad objectives of the Structural Adjustment Programme (SAP)
Nigeria 1986 was to achieve macroeconomic stability by reducing the level of
inflation through the achievement of a stale and realistic exchange rate.
Towards this and government deduced to deregulate exchange rate determination
and the foreign exchange allocation system by relying largely on market focus.
In this regard, various allocation mechanism, beginning from the second-tier
foreign exchange market (SFEM),the interbalance foreign exchange market (IFEM),
the Dutch, Auction system (DAS) to the pro-rate system and, lately, fixing of
the official exchange rate and application of a free market exchange rate for
purely commercial transactions, were adopted in order to achieve the goals of
currently the second largest oil exporting country in the Organization of
Petroleum Exporting Countries (OPEC) and is heavily reliant on its crude oil
exports which accounts for 95% of its exports and foreign exchange earnings and
about 80% of government revenue annual budgets (EIA, 2010). Oil has been the
dominant factor in Nigeria's economy since its discovery in 1956 (Budina et al,
2006). Oil exporting nations may experience exchange rate appreciation when oil
price rise, conversely exchange rate of oil exporting nations may depreciate
when oil price falls.
From 1980 to
1985 following the oil price increase, it has be observed that an upward trend
with the real exchange rate appreciating significantly leading to loss of competitiveness
for the Nigeria economy. In 1986,
Nigeria experiences a sharp decline in its real exchange rate following
declining oil prices and the Structural Adjustment Programme (SAP) which led to
the devaluation of the Nigerian currency - the naira. Between 1993and 2000,
there were substantial movements in the real exchange rate. Since then, the
real exchange rate index fluctuated around a constant trend with evidence of
mild appreciation of the real exchange rate. In recent years, owing to rising global
oil prices and increased oil exports, Nigeria experienced large foreign
exchange inflows. The real exchange appreciate could be described to be a
response to the large foreign exchange inflow that characterized the Nigerian
economy or it could as well be a response to productivity gains.
employed to analyze the problems of exchange rate determination ranged from the
traditional balance of payment approach to the modem approaches of exchange rate
determination, consisting of the monetary and port-folio balance approaches
(that is after deregulation) argues that the exchange rate, being a relative of
the two natural monies, is determine primarily by the relative supplies and
demands for the monies. The approach is also referred to as asset market
approaches to the determination of exchange rate, since the demand for the
various national monies depends on expectations, income and rates of return and
other factors relevant for port-folio choice.
1.1 STATEMENT OF PROBLEM
There has been
several exchange rate systems in use in historical times out of which is the
Gold Standard System which has been the first historical system in modern
times, the free exchange rate system was determined by the supply and demand
for foreign currencies or the demand and supply of domestic currencies, none of
the two systems stated above have given a stabilizing
foreign exchange market (Akinmoladun, 1990).
rate under the Gold Standard System brought about a subordination of the demand
for domestic equilibrium to the vicissitudes of the external sector.
against the free exchange rate is similar though allowed for external and
internal equilibrium, but had disadvantages since the fluctuating deter
where as stable rates give them more confidence. In Nigeria, during the regime
of exchange controls, the black markets rates were much higher than the
official rates for foreign exchange and this underscored the high
over-valuation of the naira and the consequent deficit disequilibrium which the
black market supply was geared to full.
external indebtedness as a result of continuing disequilibrium in the balance
of payment has really posed the problem of how to fund a correct exchange rate
in the face of dynamic changes in underlying conditions behind autonomous
transactions. A rate that is set too high under values domestic currency and a
rate that is set too low over values the domestic currency.
There has been
an ongoing debate on the appropriate exchange rate policy in developing
countries. The debate focuses on the degree of fluctuations in the exchange
shocks. Exchange rate fluctuations are likely, in turn, to determine economic
performance. In judging the desirability of exchange rate fluctuations, it
becomes. Therefore, necessary to evaluate the macroeconomic factors that
influence the fluctuations. This is the main focus of this study.
1.2 RESEARCH QUESTIONS
questions would be considered in the course of the study:
1. What are the macroeconomic factors that
influence exchange rate in Nigeria?
2. To what extent do inflation and money
supply affect exchange rate in Nigeria?
3. What are the major issues in exchange
rate policy and management in Nigeria?
4. Over the years, is exchange rate stable?
5. How could the exchange rate be influence
to stimulate economic growth in Nigeria?
6. How does the Structural Adjustment
Programme contribute to a realistic exchange rate?
1.3 AIM AND OBJECTIVES OF THE STUDY
as regard this study shall be considered on the followings:
1. To identify the macroeconomic factors
that influence exchange rate in Nigeria;
2. To investigate the effect of inflation,
and money supply on exchange rate, after deregulation;
3. To know whether exchange rate is stable
over the years before and after Structural Adjustment Programme (SAP)
4. To examine the impact of economic
performance and volume of imports on exchange rate;
5. To raise and discuss issues in exchange
rate policy and management.
1.4 JUSTIFICATION OF THE STUDY
The need for
foreign exchange management lies only within the framework of
engaged in international trade in contract to a closed economy. This need is
underscored by the economic theory of comparative advantage, theory of
comparative cost as well as international resources endowment differentials.
The study is
expected to reveal the macroeconomic factors that influence the exchange rate
so that the monetary authorities could manipulate them effectively to
in the economy, ' thereby, enhancing policy formulation and implementation.
The study also
would contribute to knowledge by examining the macroeconomic factors that
influence exchange rate in contrast to existing paper that have examined the
impact of exchange rate on macroeconomic variables, thereby enriching the
lacuna in literature.
1.5 SCOPE OF THE STUDY
exchange market shall be studied and the role it plays on the macroeconomic
objectives. It is important to note that various exchange rate policy ranging
from exchange control, free exchange rate, and Dutch auction method are
important policies to be considered.
empirical investigation of the factors that determines the exchange rate in
Nigeria shall be restricted to the period 1980 to 2010.
of the study is confined to the era when deregulation started in Nigeria, an
attempt will be make to consider the period between 1970-1985 before Structural
Adjustment Programme (SAP) and the period between 1986-2001 which
takes care of
the period during and after SAP;
1.6 DEFINATION OF TERMS
it refers to the rate at which one currency exchange for
another (Jhingan, 2003). Exchange rate is said to depreciate if the amount of
domestic currency require buying a foreign currency increases, while the
exchange rate appreciate if the amount of domestic currency requires buying a
foreign currency reduces. Exchange rate volatility refers to the swings or
fluctuations in the exchange rate over a period of time or the deviation from a
benchmark or equilibrium exchange rate (Mordi, 2006).
Product (GDP): Is the summation of
all the values of goods and services produced in a country by the nationals and
non-nationals. It does not include incomes and property earnings of the
nationals abroad neither does it excludes the income and property earnings of
the non-nationals in the country.
Inflation exists when there is a sustainable increase in the price
level or a persistent tendency for prices and money wages to increase. That is rise in the price of goods and services
as a result of large volume of money in circulation used in the exchange for
the few available goods and services.
Money Supply: The amount of money in an economy. This may be the
country's own money supplied by its banking system, or foreign money used in
preference to domestic money.
Payments is an overall statement of a
country's economic transactions with the rest of the world over some period. A
table of the balance of payments shows amounts received from the rest of the
world and amounts spent abroad.
Market is the 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 transaction.
is the removal or dismantling of restriction and control measures, and this may
be in ranging degrees. .
Structural Adjustment Programme (SAP): SAP was introduced in June 1986 to achieve
structural balances in Nigeria economy. The programme basic strategy was to
deregulate the economy and enhance the role of a realistic exchange rate and
the co-ordination of the country's economic activities.