ABSTRACT
Foreign exchange volatility affects the
performance of macroeconomic indicators positively and negatively. Most
import-dependent economies like Nigeria face the problem of foreign exchange
rate volatility. Nigeria’s over dependence in the oil and gas sector of the
economy has affected the major macro economic variables, and adverse foreign
exchange rate regimes have affected the Nigerian economy over the years.
Nigeria’s major foreign earning is from oil; hence, volatility of crude oil
prices in the world market has made the economy highly susceptible to the ever
changing exchange rates. Nigeria’s failure to diversify its economy which would
have helped cushion the effect of the constant changes in oil prices has made
the country susceptible to fluctuations in exchange rate. This has had a heavy
toll on our foreign reserves and invariably on our balance of trade and balance
of payment. A proper foreign exchange
rate management in many ways strives to balance the level of imports with that
of exports of goods that the country has comparative advantage. Such balance is
necessary for an economy to develop to levels beyond subsistence. However, lack
of government support for the real sector of the Nigerian economy as a result
of its focus on foreign exchange earned from oil has also contributed immensely
to the abysmal performance of the all other sectors especially the
manufacturing sector. Manufacturers, who account for substantial contributions
to Nigeria’s gross domestic product before now have been unable to produce,
hence fewer jobs, are created. The
Nigerian economy is in dire need of effective foreign exchange rate management
that will aid its diversification, break the dominance of the oil sector, and
give more opportunities to other sectors of the economy such as the
manufacturing, agriculture, solid mineral mining etc and ultimately improve its
balance of payment. It is against this background that this study sought to
examine the impact exchange rate fluctuations on economic growth, balance of
payment position, consumer price stability, and foreign private investment in
Nigeria. The study adopted the ex-post
facto research design. Annual time series data for 25-years were collated
from Central Bank of Nigeria – Statistical bulletin, for the period, 1987-2011.
Four major hypotheses were formulated and tested using the 2Stage Least Square
(2SLS) estimation. Gross domestic product (GDP), balance of payment (BOP)
consumer price index (CPI) and foreign private investment (FPI) were used as
the independent variables while exchange rate (EXR) was the dependent variable
for the four hypotheses respectively. Export rate (EXPR) and Import rate (IMPR)
were introduced as control variables. The results reveal that exchange rate fluctuations had a positive and non-significant
impact on Nigeria’s gross domestic product growth rate (coefficient of
EXR = 0.033, t-value = 1.327); Exchange rate fluctuations had positive and
non-significant impact on Nigeria’s balance of payment (coefficient of EXR =
0.005, t-value = 1.449); Exchange rate fluctuations had negative and
significant impact on Nigeria’s consumer price index (coefficient of EXR = -0.411,
t-value = -3.554); and Exchange rate fluctuations had positive and significant
impact on Nigeria’s foreign private investment (coefficient of EXR = 0.007,
t-value = 5.906). This study contributes to literature by modifying Serven and
Soilmano (1992) model, by including in-flow channel of foreign exchange (export
rate) and outflow of foreign exchange (import rate) into the model. Thus, the
study therefore, recommends amongst others, that an aggressive expansion of the
Nigerian economy especially investment in the real sectors of the Nigerian
economy will obviously lead to less dependence on oil revenue which is
determined by fluctuations in exchange rate prices.
TABLE OF CONTENTS
Title page . . . . . . . i
Declaration . . . . . . . ii
Approval page . . . . . . . iii
Dedication . . . . . . . iv
Acknowledgments . . . . . . . v
Abstract . . . . . . . vi
Table of Contents . . . . . . . vii
List of Tables . . . . . . . x
List of Figures . . . . . . . ix
CHAPTER ONE INTRODUCTION. . . . . . 1
1.1 Background of the Study. . . . . . 1
1.2 Statement of the Problem. . . . . . 5
1.3 Objectives of the Study. . . . . . . 7
1.4 Research Questions. . . . . . . . 7
1.5 Research Hypotheses. . . . . . 7
1.6 Scope of the Study. . . . . . . . 8
1.7 Significance of the Study. . . . . . . 8
References. . . . . . . . . . 10
CHAPTER TWO REVIEW OF RELATED LITERATURE. . 12
2.1 Theoretical Framework. . . . . . 12
2.1.1 Definition of Exchange Rate. . . . . . . 12
2.1.2 Overview of Exchange Rate Policies. . . . 13
2.1.3 Foreign Exchange Management in Nigeria. . . . 16
2.1.4 Types of Exchange Rate Policies. . . . . 18
2.1.5 Flexible Exchange Rate Policy. . . . . . 18
2.1.6 Fixed Exchange Rate Policy. . . . . . . 21
2.1.7 The Concept of Exchange Rate Fluctuations. . . 22
2.1.8 Determinants of Exchange Rate Regimes. . . . 24
2.1.9 Central Bank Intervention and Exchange Rate Fluctuations. 30
2.1.10 Monetary Policy and Macro-Economic Stabilization. . 36
2.1.11 Foreign Exchange Rate Management and
Transmission Mechanism. . 37
2.1.12 Exchange Rate Regimes and Fluctuations. . . 39
2.1.13 Real Exchange Rate and Measurement. . . 42
2.1.14 The Parallel Market and Economic Performance. . 43
2.2 Empirical Review. . . . . . . 49
2.2.1 Exchange Rate and Economic Growth. . . 49
2.2.2 Exchange Rate and Balance of Payment. . . 52
2.2.3 Exchange Rate and Inflation. . . . . . 57
2.2.4 Exchange Rate and Foreign Direct Investment. . 62
2.2.5 Exchange Rate and Investment. . . . 68
2.2.6 Exchange Rate Fluctuations and International Trade. 69
2.2.7 Exchange Rate and Export. . . . . 74
2.2.8 Exchange Rate and Import. . . . . . 76
2.2.9 Exchange Rate and Macroeconomic Fundamentals. . . 77
2.2.10 Exchange Rate and Macroeconomic Performance. . . 82
2.2.11 Foreign Exchange Market and Globalization. . 83
2.2.12 Exchange Rate Systems and Economic Fluctuations. . 85
2.2.13 Exchange Rate and Investment. . . . . 87
2.2.14 Foreign Exchange Rate and Interest Rate. . . . 88
2.3 Review Summary. . . . . . . 91
References. . . . . . . . . . 92
CHAPTER THREE RESEARCH METHODOLOGY. . . . . 115
3.1 Research Design. . . . . . . 115
3.2 Nature and Sources of Data. . . . . 115
3.3 Model Specification. . . . . . . 116
3.3.1 Model. . . . . . . . . 116
3.3.2 Assumptions. . . . . . . . . 117
3.4 Description of Variables. . . . . . 118
3.4.1 Dependent Variables. . . . . . . 118
3.4.2 Independent Variable. . . . . . 119
3.4.3 Control Variables. . . . . . . 120
3.5 Techniques of Analysis. . . . . . . 122
References. . . . . . . . . . 123
CHAPTER FOUR PRESENTATION AND ANALYSIS OF DATA. 125
4.1 Presentation of Data. . . . . . . 125
4.1.1 Prelude. . . . . . . . . 125
4.2 Test of Hypotheses. . . . . . . . 139
4.2.1 Test of Hypothesis One . . . . . 139
4.2.2 Test of Hypothesis Two. . . . . . 140
4.2.3 Test of Hypothesis Three. . . . . . 141
4.2.4 Test of Hypothesis Four. . . . . . 142
4.3 Implication of Results. . . . . . 143
References. . . . . . . . . . 148
CHAPTER FIVE SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS. . . . 150
5.1 Summary of Findings. . . . . . 150
5.2 Conclusion. . . . . . . . 150
5.3 Recommendations. . . . . . . 152
5.4 Contribution to Knowledge. .. . . . . 153
5.5 Recommendations for Further Studies. . . 153
Bibliography. . . . . . . . . . 154
LIST OF TABLES
Table 4.1 Exchange Rate and Economic Growth Indicator (1987-2011). 125
Table 4.2 Exchange Rate and Balance of Payment Indicator (1987-2011). 128
Table 4.3 Exchange Rate and Price Stability (1987-2011). . . 133
Table 4.4 Exchange Rate and Foreign Private Investment from 1987-2011. 136
Table 4.5 Control Variables (Import and Export) 1987-2011. 136
Table 4.6 Regression Result for Hypothesis One. . . 140
Table 4.7 Regression Results of Hypothesis Two. . . . 140
Table 4.8 Regression Results for Hypothesis Three. . . 142
Table 4.9 Regression Results of Hypothesis Four. . . 145
LIST OF FIGURES
Figure 4.1 Exchange
Rate and Gross Domestic Product Growth Rate (1987-2011). . 127
Figure 4.2 Nigeria’s Gross Domestic Product Trend from 1987-2011. . 127
Figure 4.3 Exchange Rates and Balance of Payment per GDP. 130
Figure 4.4 Nigeria’s Balance of Payment Position from 1987 to 2011. 131
Figure 4.5 Trend of
Exchange rate and Consumer Price Indices from 1987-2011. . 133
Figure 4.6 Trend of Exchange Rate and Ratio of Foreign Private Investment to GDP 1987- 2011. . . . . . 133
Figure 4.7 Quantum of Foreign Private Investment in Nigeria 1987-2011. 135
Figure 4.8 Export and Import in Nigeria from 1987-2011. . 136
Figure 4.9 Export Rate and Import Rate in Nigeria from 1987-2011. 138
CHAPTER
ONE
INTRODUCTION
- BACKGROUND
OF THE STUDY
There
is scarcely any country that lives in absolute isolation in this globalised
world. The economies of all the countries of the world are linked directly or
indirectly through asset or/and goods markets, made possible through trade and
foreign exchange. The price of foreign currencies in terms of a local currency
is therefore important to understanding of the growth pattern of economies of
the world.
The history of exchange rate systems in Nigeria is traceable to the early 1960s. According to Bakare (2011:3), …before the establishment of the Central Bank of Nigeria in 1958 and the enactment of the Exchange Control Act of 1962, foreign exchange was earned by the private sector and held in balances abroad by commercial banks that acted as agents for local exporters… The oil boom experienced in the 1970s made it necessary to manage foreign exchange rate in order to avoid shortage. However, shortages in the late 1970s and the early 1980s compelled the government to introduce some ad hoc measures to control excessive demand for foreign exchange. However, it was not until 1982 that a comprehensive exchange controls were applied. Then a fixed exchange rate system was in practice. The increasing demand for foreign exchange and the inability of the exchange control system to evolve an appropriate mechanism for foreign exchange allocation in consonance with the goal of internal balance made it to be discarded in September 26, 1986 while a new mechanism was evolved under the Structural Adjustment Programmes (SAP). The main objectives of exchange rate policy under the Structural Adjustment Programmes were to preserve the value of the domestic currency, maintain a favourable external balance and the overall goal of macroeconomic stability and to determine a realistic exchange rate for the Naira.
In
macroeconomic management, exchange rate policy is an important tool. This is
derived from the fact that changes in the rate of exchange have significant
implications for a country’s balance of payments position and even its income
distribution and growth.
It aids international exchange of goods and services as well as achieving and
maintaining international competitiveness and hence ensures viable balance of
payment position.lt serves as an anchor for domestic prices and contributes to
internal balance in price stability (CBN, 2011). It is not surprising therefore, that monetary
authorities attach much importance to proper management of a country’s foreign
exchange since its behaviour is said to determine the behaviour of several
other macroeconomic variables (Oyejide, 1989). It is even more so for Nigeria
which had embarked on a course of rapid economic growth with its attendant high
import dependency. An exchange rate, as a price of one country’s money in terms
of another’s, is among the most important prices in an open economy. It
influences the flow of goods, services, and capital in a country, and exerts
strong pressure on the balance of payments, inflation and other macroeconomic
variables. In this way, the choice and management of an exchange rate regime is
a critical aspect of economic management to safeguard competitiveness,
macroeconomic stability, and growth (Cooper, 1999).
Macroeconomic
performances under different exchange rate regimes have been a subject of
continuing research and controversy. Ghosh, et. al., (1996) using a three-way
classification analyzed the link between exchange rate regimes, inflation and
growth. The result indicates that pegged exchange rates are associated with
lower inflation and less variability. They therefore argued that this was due
to a discipline effect the political
costs of failure of defending the peg induce disciplined monetary and fiscal
policy and a confidence effect to the extent that the peg is credible, there is
a stronger readiness to hold domestic currency, which reduces the inflationary
consequences of a given expansion in money supply. The study also found that
pegged rates are associated with higher investment but correlated with slower
productivity growth. On net, output growth is slightly lower under pegged
exchange rates compared to floating and intermediate regimes (Ghosh, et. al.,
1996)
A
study by IMF that extends the period of analysis to mid-1990s reports similar
findings (IMF 1997). However, in an analysis of experience with increasing
capital market integration and the replacement of fixed exchange rates in the 1990s,
Caramaza and Aziz (1998) found that the differences in inflation and output
growth between fixed and flexible regimes are no longer significant.
Also,
using data from 159 countries for the 1974-99 periods, Levy-Yeyati and
Sturzenegger (2000) reclassified the exchange rates into three groups (float,
intermediate, fixed) and estimated the correlation between the actual (de
facto) exchange rate regimes and macroeconomic performance. The main findings
include: (a) fixed exchange rate regimes seem to have no significant impact on
the inflation level when compared with pure floats, while intermediate regimes
are the clear under-performers; (b) pegs are significantly and negatively
correlated with per capita output growth in non-industrial countries; (c) output
volatility declines monotonically with the degree of regime flexibility; and
(d) real interest rates appear to be lower under fixed rates than under
floating rates because of lower uncertainty associated with fixed rates.
More
recent studies both in Nigeria and abroad abound with different perspectives on
the impact of exchange rate on macro-economic fundamental of a country. Yougbare (2006),investigating
the effect of exchange rate regimes on growth volatility found that fixity in
nominal exchange rates increases the volatility of real GDP growth. Moreover,
it amplifies the adverse impact of terms of trade instability on growth
volatility whereas the negative impact of exchange rate fixity on growth
stability is attenuated by a higher financial development. These results also
suggest that as countries develop, they would gain more in terms of reduced
growth volatility by adopting more flexible exchange rate arrangements.
Bacchetta
and Wincoop (2009) posit that it is well known from anecdotal, survey and
econometric evidence that the relationship between the exchange rate and macro
fundamentals is highly unstable. This could be explained when structural
parameters are known and very volatile, neither of which seems plausible hence
they argue that large and frequent variations in the relationship between the
exchange rate and macro fundamentals naturally develop when structural
parameters in the economy are unknown and change very slowly.
Junye-Li andWeiwei-Yin (2008),investigated the relationship between short-run exchange rate dynamics
and macroeconomic fundamentals by adopting a no-arbitrage international
macro-finance approach, under which the macroeconomic fundamentals enter into
the exchange rate dynamics in a nonlinear form and having been amplified by the
time-varying market prices of risks, the macroeconomic innovations help capture
large volatility of exchange rate changes. The foreign exchange risk premium
can largely alleviate the forward premium anomaly.
Mahmood, Ehsanullah, and Ahmed (2011) posit that therole of exchange rate in affecting the macroeconomic performance of any country is of leading nature. Hence, their study was conducted to investigate whether uncertainty or fluctuations in exchange rate affect the macroeconomic variables in Pakistan. If so, what is the direction of this effect will be? Although, there are large numbers of macroeconomic variables, but out of these only four variables i.e, GDP, FDI, growth rate and trade openness was included in this study. Finding of this study confirmed the impact of exchange rate volatility on macro economic variables in Pakistan. It was also concluded that exchange rate volatility positively affects GDP, Growth rate and trade openness and negatively affects the FDI.
IMPACT OF FOREIGN EXCHANGE RATE FLUCTUATIONS ON MAJOR MACROECONOMIC VARIABLES IN NIGERIA (1987-2011)
