ABSTRACT
This research study examined the determinants of exchange
rate in Nigeria from 1980-2014. For this purpose, annual figures of interest
rate, inflation and degree of trade openness at the economy were regressed on
exchange rate in a framework of multiple models; ordinary least square (OLS)
technique at estimation was employed.
The result revealed that inflation rate was an insignificant
determinant of exchange rate. Also interest rate was revealed to be
insignificant determinant of exchange rate while trade openness was revealed to
be positive and significant determinant of exchange rate. On the basis of
these, the study recommends the adoption of policies that would encourage and
facilitate improvement in productivity in all sectors of the economy.
CHAPTER ONE
1.0
INTRODUCTION
1.1 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. According to
Dornbusch (2004), exchange rate is the rate at which one country’s currency is
exchanged for the currency of another country. While Mankiw (1997), defined it
as the price at which exchange between two countries takes place.
The role of exchange rate and its
effects on macroeconomic performance has continued to generate interest among
economist. Many economists argue that exchange rate stability facilities
production activities and economic growth. Exchange rate regime and interest
rate remain important issues of discourse in the international Finance as well
as in developing nation with more economics embracing trade liberation as a
requisite for economic growth (Obansa et al, 2013). The relationship it has
with other macroeconomic variables has been argued among economists. They are
also of the view that misalignment in real exchange rate could distort
production activities and consequently hinder exports growth and generate
macroeconomic instability (Mamta Chowdhury, 1999). Mordi (2006) argued that the
exchange rate movements have effects on inflation, prices incentives, fiscal
viability, competitiveness of exports, and efficiency in resources allocation,
international confidence and balance of payment equilibrium.
Prior to
the late 1980s, fixed exchange rate was practiced in Nigeria, when the Naira
was pegged against the British Pound and later on the American Dollar. After
this period, flexible exchange rate policy was adopted and exchange rate was
allowed to float which was determined by demand and supply forces. Since then
the naira rate of exchange against the dollar has experienced significant
fluctuations, such that naira/dollar rate of exchange moved from 0.6091,
0.6369, 3.3166, 9.001, 84.5, 92.52 in 1980, 1981, 1986, 1990, 1995 and 1999
respectively to 132.6, 147.6 and 156.35 in 2004, 2009 and 2013 respectively.
Some of the policies employed to stabilize exchange rate in Nigeria include:
Second Tier Foreign Exchange Market (SFEM), Autonomous Foreign Exchange Market
(AFEM), The Dutch Auction System (DAS) etc. The policies were tried but still
were unable to proffer a solution to exchange rate stability. The Naira
continued to depreciate against the American dollar.
Some economists have attributed the recent depreciation to
the decline in the nation’s foreign exchange reserves. Others argued that the
activities of some market operators (speculators) and banks are responsible for
the recent decline in the values of naira, while some argued that the over
dependency on importation, heavy debt burden, weak balance of payments position
and capital flight have explained the reasons for the behavior of exchange rate
in Nigeria from the period of regulation to deregulation.
Entrenching a realistic and
sustainable macroeconomic policy in Nigeria has been a huge challenge for
years. Although successive administrations have considered carious
macroeconomic policies to strengthen the economy, reduce inflation and
stabilize the Naira. Economists believe that much still needed to be done to
get it right. Economists believe that many of the measures by previous
administrations did not yield the desired results, as the Naira remained
unstable. Despite efforts by government to maintain a stable exchange rate, the
naira rate of exchange still remains volatile (Benson and Victor 2012, Aliyu
2011. This calls for further research efforts to determine the variable that
account for levels of exchange rate in Nigeria. Against this background, this
research study intends to investigate the empirical analysis of the
determinants of exchange rate in Nigeria over a period of 35 years (1980 –
2014)
1.2 Statement of the Problem
Since the
fall of Bretton – wood system in 1970s and the subsequent introduction of
floating exchange rates, the exchange rates have in some cases become extremely
volatile. It may be quite interesting to note that the naira remained quite
stable in the mid 90s i.e. 84.57, 74.6, 84.3 and 92.53 against the American
dollar in 19955, 1996, 1997, 1998 and 1999 respectively. In early 2007, the
Naira depreciated to N117.968 against the American dollar which could be
attributed to decline in foreign exchange reserves and sovereign wealth fund.
In a nutshell, the exchange rate of Nigeria Naira to American dollar has been
volatile and fluctuating over time. According to Obadan (2006), some of the
factors that led to the depreciation of the Nigerian exchange rate include over
importation and fragile export base economy.
Since the adoption of the Structural
Adjustment Programme in 1986, Nigeria has adopted different types of exchange
rate regimes to fixed/pegged regimes but
it has not solved the problem of exchange rate fluctuation and maintaining both
internal and external balance. As part of the measures taken to stabilize
exchange rate in Nigeria could be forced to cut further the amount of oil
revenue it uses for government spending if the global crude price continued to
plummet. Another measure by CBN stipulates that customers who purchase foreign
currency through interbank market or an authorized trader must use the funds
within 48 hours. None of these could stabilize the naira against other major
currencies.
Past specific Nigerian studies made
attempts at determining the variables that account or levels of exchange rate
in Nigeria. Some of these include; Udoye (2009), which examined the
determinants of exchange rate in Nigeria for period of 1970 to 2006, using the
Nigeria time series data. The result suggests that one year past value of
exchange rate and immediate past value of trade openness are the major
determinants of exchange rate in Nigeria. The result further indicates that
there is evidence of long-run relationship between rate and two explanatory
variables (gross domestic product growth and trade openness). Again, Ejim
(2010) investigated the empirical analysis of the determinants of exchange rate
in Nigeria for the period of 1989-2010 and found out that inflation is a key
determinant of exchange rate in Nigeria.
According
to Jhingan (2005), to maintain both internal and external balance, a country
must control its exchange rate. This requires good knowledge of the variables
that shape the levels of exchange rate. Therefore, given paucity of empirical
evidence on this macroeconomic issue, it becomes necessary to reexamine the
determinants of exchange rate in Nigeria. To do this, the study shall be guided
by the following research question;
·
What are the determinants
of exchange rate in Nigeria?
1.3 Objectives of the study
The general objective of the study
is to empirically determine the determinant of exchange rate in Nigeria for the
period of 1980 – 2014.
Specifically:
1.
To empirically asses the
variables that determine the levels of exchange rate in Nigeria.
2.
To make policy
recommendations.
1.4 Statement of
Hypothesis
1. There are no significant variables that determine the levels
of exchange rate in Nigeria.
1.5 Scope and
Significance of the Study
This research work is being carried
out to empirically find out the determinants of exchange rate in Nigeria. The
findings of this work will be great use to government ministries like, ministry
of education and department and agencies at federal, state and local level in
solving some macroeconomic problems even intellectual researchers who may be
willing to improve the work subsequently.
The scope of the study covers a span
of 35 years which is 1980 – 2014 and it is within the geographical area of
Nigeria.
1.6 Definition of
Terms
Exchange
Rate: Exchange rate is the rate at which one country’s currency is
exchanged for the currency of another.
Inflation:
is a sustained increase in the general price level of goods and services in an
economy over a period of time. When the price level rises, each unit of
currency buys fewer goods and services. Consequently, inflation reflects a
reduction in the purchasing power per unit of money – a loss of real value in
the medium of exchange and unit of account within the economy.
In other words, can refer to either
an increase in the money supply or a sustained increase in the general price
level of goods and services in an economy over a period of time, normally owing
to an increase in the money supply. In this study, inflation rate is expected
to be negative because a moderate inflation will encourage investors. It is
also one of the independent variables.
Interest Rate: is the proportion of a loan that is charged as interest to
the borrower, typically expressed as an annual percentage of the loan
outstanding. Higher interest rates attract foreign capital and cause the
exchange rate to rise.
In other
words, it is the amount of intrest due per period as a proportion of the amount
lent, deposited or borrowed (called the principal sum). In this study, it is
expected to be negative because a positive outcome depreciates the foreign
exchange rate.
Trade Openness: It is a measure of
economic policies that either restrict or invite trade between countries. For
example, if a country sets a policy of high trade tariffs, thus restricting the
desirability of international trade, it will inhibit other countries from
sundry exports and accepting imports from the country.
In other
words, this concerned with the degree at which the economy is left to interact,
trade and mingle with other countries. If the economy is totally open, it has
an effect on the balance of payment. Conversely, if the economy is allowed to
be closed, the effect would also be seen on the economic activities of such
country. In this study, the variable is expected to be negative hence, it
appreciates foreign exchange rate with other countries.
Fiscal Viability: it is the ability of an entity to continue to achieve its
operating objectives and fulfill its mission of continuous effectiveness.
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