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.
CHAPTER ONE
INTRODUCTION
1.1 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
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....
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