Impact of Exchange Rate Fluctuation on Nigeria’s Economic Growth

Impact of Exchange Rate Fluctuation on Nigeria’s Economic Growth 1981-2015, full project materials. Exchange rate is an important economy metric as it reflects underlying strength and competitiveness with world economies (Asinya and Takon, 2014; Akonji, 2013).

CHAPTER ONE

INTRODUCTION

  • Background of the Study

Exchange rate is an important economy metric as it reflects underlying strength and competitiveness with world economies (Asinya and Takon, 2014; Akonji, 2013). Whether fixed or floating, exchange rate affects macroeconomic variables such as import, export, output, interest rate, inflation rate etc. Chong and Tan (2008) empirical analysis revealed that the exchange rate is responsible for changes in macroeconomic fundamentals for the developing economies. Mehdi et al (2014)

stated that the effect of exchange rate fluctuations on economic growth varies in different countries asserting that one of the factors determining the way exchange rate fluctuations affect economic growth is the development level of each country’s financial markets revealing that new theories emphasize the high correlation between economic growth and innovation.                                                 Exchange rate fluctuations influence domestic prices through their effects on aggregate supply and demand. In general, when a currency depreciates it will result in higher import prices if the country is an international price taker, while lower import prices result from appreciation. The potentially higher cost of imported inputs associated with an exchange rate depreciation increases marginal costs and leads to higher price of domestically produced goods (Kandil, 2004). Also, import-competing firms might increase prices in response to foreign competitor rice increases to improve profit margins. However, the extent of such price adjustment depends on a variety of factors such as market structure, the relative number of domestic and foreign firms in the market, the nature of government exchange rate policy and product substitutability (Fouquin et al, 2001).              In the bid to achieve macroeconomic stability, Nigeria’s monetary authorities have adopted various exchange rate arrangements over the years. It shifted from a fixed regime in the 1960s to a pegged arrangement between the 1970s and the mid-1980s, and finally, to the various types of the floating regime since 1986 (Eze and Okpala, 2014; Dada and Oyeranti, 2012), following the adoption of the Structural Adjustment Programme (SAP). The fixed exchange rate regime induced an overvaluation of the naira and was supported by exchange control regulations that engendered significant distortions in the economy. That gave vent to massive importation of finished goods with the adverse consequences for domestic production, balance of payments position and the nation’s external reserves level (Akonji, 2013). Moreover, the period was bedeviled by sharp practices perpetrated by dealers and end-users of foreign exchange (Adelowokan (2012). These and many other problems informed the adoption of a more flexible exchange rate regime in the context of the SAP, adopted in 1986. A regime of managed float has been the predominant characteristic of the floating regime in Nigeria since 1986. Although the Naira exchange rate has witnessed some period of relative stability since the implementation of the Structural Adjustment Programme (SAP) in 1986, its continued depreciation, however, mars the economic performance of the country. The challenge of the combined effect of hikes in oil prices and exchange rate instabilities on macroeconomic economic stability and economic growth for oil producing nations like Nigeria is really enormous. Usman (2009) states that huge inflow of oil revenues in Nigeria are more often associated with expansion in the level of Government spending while periods of dwindling oil revenues are usually accompanied by budget deficits.                                               Macroeconomic policy formulation is a process by which the agencies responsible for the conduct of economic policies manipulate a set of instrumental variables in order to achieve some desired objectives. In Nigeria, these objectives include achievements of domestic price stability, balance of payment equilibrium, efficiency, equitable distribution of income and economic growth and development. Economic growth refers to the continuous increase in a country’s national income or the total volume of goods and services, a good indicator of economic growth is the increase in Gross National Product (GNP) over a long period. Economic development, on the other hand implies both structural and functional transformation of all the economic indexes from a low to a high state (Siyan, 2000:150). One of the macro-economic variables of importance is the exchange rate policy of the country. Exchange rate policy involves choosing where foreign transaction will take place (Obadan, 1996). Exchange rate policy is therefore a component of macroeconomic management policies which the monetary authorities in any given economy uses to achieve internal balance in medium run. Specifically internal balance means the level of economic activity that is consistent with the satisfactory control of inflation. On the contrary, external or sustainable current account deficit financed on lasting basis expected capital inflow.                                                                                                                   It is important to know that economic objectives are usually the main consideration in determining the exchange control. For instance from 1982 – 1983, the Nigerian currency was pegged to the British pound sterling on a 1.1 ratio. Before then, the Nigerian naira has been devalued by 10%. Apart from these policy measures discussed above, the Central Bank of Nigeria (CBN) applied the basket of currencies approach from 1979 as the guide in determining the exchange rate was determined by the relative strength of the currencies of the country’s trading partner and the volume of trade with such countries. Specifically weights were attached to these countries with the American dollars and British pound sterling on the exchange rate mechanism (CBN, 1994). One of the objectives of the various macro–economic policies adopted under the Structural Adjustment Programme (SAP) in July 1986 was to establish a realistic and sustainable exchange rate for the naira; this policy was recommended in 1986 by the International Monetary Fund (IMF) on exchange mechanism and was adopted in 1986. The key element of Structural Adjustment Programme (SAP) was the free market determination of the naira exchange rate through an auction system.

1.2 Statement of the Problem

The exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom period. This was also the situation prior to 1990 when agricultural products accounted for more than 70% of the nation’s gross domestic products (GDP) (Ewa, 2011:78). However, because of the development in the petroleum oil sector, in 1970s the share of agriculture in total exports declined significantly while that of oil increased.                                       Nevertheless, from 1981 the world oil market started to deteriorate and with its economic crises emerged in Nigeria because of the country’s dependence on oil sales for her export earnings. To underline the importance of oil export to Nigerian economy, the gross national product (GNP) fell from $76 billion in 1980 to $40 billion in 1996, a number of economic growths became negative as result of the adoption of Structural Adjustment Programme (SAP). This major problem, which this study is designed to solve, is whether the exchange rate has any bearing on Nigerians economic growth and development. While some Economists dispute the ability of change in the real exchange rate to improve the trade balance of developing countries (Hinkle, 1999:21) because of elasticity of their low export, others believe that structural policies could however change the long-term trends in the terms of trade and the prospects for export led growth. Instabilities of the foreign exchange rate are also a problem to the economy.

1.3 Research Questions

The following research questions will serve as a guide in carrying out this research work:

  1. Does exchange rate have any significant impact on the economic growth of Nigeria?
  2. To what extent does long-run relationship exist between exchange rate and economic growth of Nigeria?

1.4 Objectives of the Study

          The objectives of this work include:

  1. To find out if exchange rate contributes significantly to Nigeria’s economic growth.
  2. To examine the extent to which long-run relationship exist between exchange rate and economic growth in Nigeria.

 

 

1.5 Hypothesis of the study

Based on the objectives of the study, the following hypotheses were formulated:

H0: Exchange rate fluctuation has no significant impact on Nigeria economic growth and development.

H0: There is no long-run relationship between exchange rate fluctuation and economic growth in Nigeria.

 

1.6 Significance of the Study

The significance of this research work lies in the fact that if the cause of the unstable exchange rate of the naira is identified and corrected, the economy will rapidly grow and develop into an advanced one. This is so because if the unstable exchange rate of naira is proved to be affecting the macro-economy major variables badly, including Real exchange rate, Real interest rate, inflation rate, gross domestic product and trade openness of the country, attempts should be made to stabilize the exchange rate. This is because these variables are gauge for the measurement of growth and development of any economy. Importantly, this study would help the government and the Central Bank of Nigeria (CBN) to identify the strength and weakness of each foreign exchange system and hence adopt the policy that suits the economy best. This will definitely enhance growth and development of the economy, the study will as well serve as a guide to future researchers on this subject.

 

1.8 The Scope of the Study

The study is structured to evaluate the Nigerian exchange rate as the pilot of economic growth and development. The study is therefore focused on the core values of economic growth in Nigeria and not the socio-political factors of the foreign exchange rate. This research work is designed to cover the period 1981-2014 a period of twenty-seven years. The scope consists of the regulatory and deregulatory exchange rate period, that is the fixed exchange rate and the floating exchange rate period.

The limitations of this research work include:

Inadequate data availability, this problem is experienced by most developing economies such as Nigeria due to inability to keep records of transactions or dealings over a specific period, and this serves as a constraint to research generally. Other limitations of the study are financial constraints, and limited time.

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