THE EFFECT OF EXCHANGE RATE FLUCTUATION ON THE NIGERIA ECONOMY

THE EFFECT OF EXCHANGE RATE FLUCTUATION ON THE NIGERIA ECONOMY

ABSTRACT

This research work is centered on examining effect of exchange rate fluctuation on the Nigeria’s economic growth from 2007 to 2018. The specific objectives of the study is to determine the effects of exchange rate fluctuation on the Nigeria economy, evaluate the effects of interest rate on economic growth in Nigeria and examine the effects of inflation rate on economic growth in Nigeria. The main type of data used in this study is secondary; sourced from Central Bank of Nigeria Statistical Bulletin of various issues. The regression analysis was used to analyze the data. The result revealed that exchange rate fluctuation has significant effects on Nigeria economic growth and development, interest rate has no significant effects on Nigeria’s economic growth (GDP) and inflation rate has no significant effects on Nigeria’s economic growth (GDP). Therefore, the study recommended that the effort of the government should be geared towards maintaining a stable and sustainable exchange rate, since the stability of these could enhance industrial output. There should be an increase in the exchange rate of Naira in order to enhance economic growth, Interest rate should be at a minimum, in order for the purchasing power of an average Nigeria to increase. And that the government should encourage domestic production and consumption of goods and services and necessary policies in place to improve the value of Nigerian currency so as to reduce inflation.

CHAPTER ONE

1.0     INTRODUCTION

1.1     BACKGROUND OF THE STUDY

The exchange rate is perhaps one of the most widely discussed topic in Nigeria today. This is not surprising given it’s macro-economic importance especially in a highly import dependent economy as Nigeria (Olisadebe, 2015). 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 desire 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.

Exchange rate policy involves choosing where foreign transaction will take place (Oladipupo,  & Onotaniyohuwo, 2016). Exchange rate policy is therefore a component of macroeconomic management policies the monetary authorities in any given economy uses to achieve internal balance in medium term. 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. 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 (Obadan, 2016). 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).

The key element of structural adjustment programme (SAP) was the free market determination of the naira exchange rate through an auction system. This was the beginning of the unstable exchange rate; the government had 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. Between 1986 and 2018, the federal Government experimented with different exchange rate policies without the any of them to make a remarkable effects in the economy before it was changed. For instance from 1982 – 1983, the Nigerian currency was pegged to the British pound sterling on a 1.1 ration. Before then, the Nigerian naira has been devalued by 10% and also between 2015 to 2018 the Central Bank of Nigeria fixed the Nigeria Naira at between N300 to N350 against one dollar ($1) (CBN, 2015). Apart from this policy measures, the Central Bank of Nigeria (CBN) applied the basket of currencies approach as the guide in determining the exchange rate which 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, 2016). 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. This inconsistency in policies and lack of continuity in exchange rate policies aggregated unstable nature of the naira rate (Gbosi, 2014). It is against this background that this study seeks to examine the effects of exchange rate fluctuation on the Nigeria economy.

1.2     STATEMENT OF THE PROBLEM

Exchange rate fluctuation is generally considered undesirable in any economy because of its perceived effects on the economy. The fluctuation of exchange rate in Nigeria therefore, raises an important research and policy problem on its effects on the economy. The use of exchange rate to stimulate economic growth is as old as the history of international trade. For instance, extensive literature has documented different exchange rate regimes adopted by countries, in order to stimulate economic growth. Exchange rate volatility might strongly affect the growth performance of open economies through the trade channels on the short-run (IMF 2014, European Commission 1990). From a long-term perspective, fluctuations in the exchange rate level constitute a risk for growth in emerging markets economies as they affect the balance sheets of banks and enterprises where foreign debt tends to be denominated in foreign currency (Eichengreen and Hausmann, 2015). That is, exchange rate fluctuation inflates the liabilities in terms of domestic currency thereby increasing the probability of default and crisis.  Thus, it has become imperative to empirically establish the effects of exchange rate fluctuation on the Nigerian economy. Relying on past empirical evidence on this subject matter given so recent developments in the economy might be misleading. It is against this problem that this study seeks to examine the effects of exchange rate fluctuation on the Nigeria economy.

1.3     OBJECTIVE OF THE STUDY

The objective of the study is to examine the effects of exchange rate fluctuation on Nigeria economy. The specific objectives of the study include:

1. To determine the effects of exchange rate fluctuation on the Nigeria economy.
2. To evaluate the effects of interest rate on economic growth in Nigeria.
3. To examine the effects of inflation rate on economic growth in Nigeria.

1.4     RESEARCH QUESTIONS

The researcher seeks to find the answer to the following three questions:

1. Does exchange rate fluctuation in Nigeria have any significant effects on economic growth?
2. Is there any significant relationship between interest rate and Nigeria’s economic growth?
3. Does inflation rate have any significant effects on Nigeria’s economic growth?

1.5     RESEARCH HYPOTHESES

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

H_o1: Exchange rate fluctuation has no significant effects on Nigeria economic growth and development.

H₀₂: Interest rate has no significant effects on Nigeria’s economic growth (GDP).

H₀₃: Inflation rate has no significant effects on Nigeria’s economic growth (GDP).

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 advance 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 openess 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 also serve as a guide to future researchers on this subject.

1.7     SCOPE OF THE STUDY

This research work is designed to examine of the effects of exchange rate fluctuation on the Nigeria economy between 2001-2018 a period of seventeen years. The scope consist of the regulatory and deregulatory exchange rate period i.e. the fixed exchange rate and the floating exchange rate period. The main type of data used in this study is secondary; sourced from Central Bank of Nigeria Statistical Bulletin of various issues. The study is further limited to the following variables used in the models; dependent variable – Gross Domestic Products (GDP) while the independent variables are Exchange Rate (ENRT); Interest Rate (INRT) and Inflation Rate (INFRT) for the period 2001 – 2018.

1.8     DEFINITION OF TERMS

Gross Domestic Product (GDP): Gross Domestic Product is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.

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.

Exchange control: This is a foreign exchange arrangement in which the government purchase all coming foreign exchange and is the only source from which foreign exchange can be purchased legally.

Exchange rate: An exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.

Interest rate: An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited or borrowed (called the principal sum)

Inflation rate: inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.