ABSTRACT
Nigeria is a mono-product economy in term of generating revenue from Crude oil price,
which constituted its major export commodity, changes in oil prices have
continued to have implications for the
Nigerian economy and, in particular on the exchange rate movements. This study
examined the effects of crude oil price and exchange rate on the Nigeria
economy using quarterly data from the year 1985 to 2015.
Relevant descriptive and econometric analyses were
employed. The econometric tests used which include the unit root tests,
Johansen co-integration technique and the Vector Error Correction Model (VECM),
the unit root tests was carried out using the ADF, Phillip perron and ADF-GLS;
all the variables were stationary at first difference. The long run
relationship among the variables was determined using the Johansen
Co-integration technique and there were 3 co-integrating vectors in total, the
vector error correction model was used to examine the speed of adjustment of
the variables from the short run dynamics to the long run and the impulse
response function was used to determine the causal impact of shocks of the
independent variables to response of the dependent variables.
The result findings revealed that there is no
significant relationship among Crude oil price, exchange rate and RGDP, no
significant relationship among Crude oil price, exchange rate and external reserve
and no significant relationship among Crude oil price, exchange rate and CPI.
The study concluded that there exist a strong
empirical evidence of timing importance in the crude oil price and exchange
rate relationship. And recommendations were that the country should diversify
from crude oil dependency because as crude oil price increases, the CPI also
increases largely. Second,
government pursuit of managed float exchange rate is desirable to ensure a
substantial increase in the external reserve without significant damage of the
exchange rate of the country. Third, an effective management and stabilization
of crude oil price by Organization of Petroleum Exporting Countries (OPEC)
could reduce the effect of its shocks on economic performance of Nigeria.
CHAPTER
ONE
INTRODUCTION
1.1 Background to the Study
The
search for oil which began in 1907 when Nigeria Bitumen Corporation conducted
exploratory work in the country; however the firm left the country at the onset
of world war. Thereafter licenses were given to D’Arcy Exploration Company and
Whitehall petroleum. However, neither company found oil of commercial value and
they returned their licenses in 1923 (Frynas, 1999). A new license covering
357,000sq.miles was given to a new firm called shell D’Arcy petroleum
Development Company of Nigeria. The new firm was a consortium of Shell and
British petroleum (then known as Anglo-Iranian). The company began exploratory
work in 1937. Oil was discovered in non-commercial quantity at Akata near Eket
in 1953 (Frynas, 1999).Shell BP in the pursuit of commercially available
petroleum found oil in Oloibiri,
Niger Delta which is in present Bayelsa
state in 1956. Since the discovery of
oil in commercial quantity, Nigeria has been largely a mono-product economy.
The value of Nigeria’s total export revenue in 2010 stood at US$70,579 million,
while income from petroleum exports of the total export revenue was US$61,804
million representing about 87.6 percent (Ogundipe&ojeaga, 2014).The
discovery of oil brought in the eastern and mid-eastern regions of Nigeria,
this brought hope of a brighter future for Nigeria in terms of economic
development as Nigeria became independent. In 1969 the Nigerian government
enacted decree 51 to strengthen its hold on the oil industry. With this decree
the country (Nigeria) took greater control over the granting of concession and
more involvement in the refining, distributing, and price of crude oil (Genova
and Falola, 2003). It is clear that Nigeria realized the importance of its oil
industry as well as the need to control it.
Prior to the discovery of Oil, Nigeria (like
many other African countries) strongly relied on agricultural exports to other
countries to supply to their economies (Andrew, 2009). Agriculture was the
dominant source of Nigeria’s revenue earning and hence the sustenance of the
economy accounting for 64.1% of the GDP before the discovery of petroleum of
commercial quantity in 1956 (Oluwasanmi, 1960).Palm oil became an export
commodity in Nigeria as far back as 1558; and by 1830, the Niger Delta, which
now produces crude oil, had become the major source of palm oil which dominated
Nigeria’s export list for more than 50 years (Olukoju, 2009). Cotton joined the
export list in 1856, while cocoa was introduced and became an export cropin
1895 (Olukoju, 2009). Together with rubber, groundnut, palm kernel and
Bennie-seed in later years formed the major valuable crops. These cash crops
formed the main source of revenue, export and foreign exchange for the
government (Udo, 1967). The savannah grassland to the north supports the
planting of cereal and leguminous crops such as sorghum, millet, ground nuts as
well as animal rearing mostly for hide and skin (Ekundare, 1973). Agriculture
was the mainstay of Nigeria’s economy from the earliest time up to 1950s.
Nigerians had an enviable record of food sufficiency but the era did not last
beyond the 1960s when its economy began a descent into an abysmal dependence on
imports (Ake, 1985).Agriculture provided 95% of the food needed to feed
Nigerians, contributed 64.1% Gross Domestic Product (GDP) and employed over 70%
of Nigerian population before oil began to be exported (Oluwasanmi, 1960).
The
oil dependence and volatility of oil prices in international markets often lead
to significant problems in areas of fiscal planning, quality of public
spending, and other financial institutions when oil prices collapse. When oil
prices fall, fiscal budgets sometimes go into deficit; countries badly affected
start taking loans tied to their reserves, and incur more debt. The activities
of cartel pricing policy and oil speculators have also affected the price of
crude oil, growth of speculative activities which often influence exchange
rate. Speculation causes short run fluctuation in exchange rate, and when there
is speculation or expectation of a change in the rate of exchange or oil price,
a state disequilibrium arises. The forex
reserve is at the lowest level since October 2005 when Nigeria recorded $23.92
billion in external reserve. With this, the central bank has ignored calls to
devalue the naira, maintaining an official exchange rate of N197 per dollar
while the currency trades at N350 per dollar at the parallel market (Financial
Nigeria, 2016).
According
to Adedipe (2004), the rise in oil revenue was caused by the Middle East war of
1973. It created extraordinary wealth for Nigeria and the naira appreciated as
foreign exchange influxes offset outflows and Nigeria foreign reserves assets
increased. Between 1973 and March 1974, when OPEC announced an Oil embargo
against a number of western countries for their support for Israel during the
six days war, Oil prices reach $12 per barrel from $3 per barrel( premium
times, 2014). By 1979 to 1980, the new Nigeria narrative was ‘austerity’ as oil
prices fell for two decades thereafter. Until 2003, the Nigeria economy’s boom
and burst cycle was predicted using the oil price outlook( Premium times, 2014)
Oil prices fell sharply in the second half of 2014, bringing to an end a
four-year period of stability of $105 per barrel. The decline, which is much
larger than that of the non-oil commodity price indices compared to early-2011
peaks, may signal an end to a price “super cycle” (Pricewaterhousecoopers,
2015).The economy of Nigeria gradually became dependent on crude oil as
productivity declined in other sectors (Englama, Duke, Ogunleye&Isma., 2010).
Between June 30 2014 and Dec. 31 2014 oil prices declined from $112.78/barrel
to 55.57/barrel, they recorded a decline of 15%, the naira depreciated by 8%
and 13% at the official and interbank market in 2014 and by 5.6% at the
interbank market as at Jan 23 2015(Godwin, 2015).The sources and implications
of the sharp decline in oil prices led to intensive debate,the oil price falls to $50/bbl. in the
second quarter of 2015, before recovering to an equilibrium level of $70/bbl.
in 2016. At $55/bbl. in 2015, the average oil price falls short of Nigeria’s
proposed federal budget benchmark, of $65bbl (PWC, 2015).Oil prices remained
low in 2015 and rose only marginally in 2016.
Exchange
rate is the price for which a country’s currency is exchanged for another’s
country’s currency and is influenced by several factors among which are
interest rates, inflation, or political condition of the country (Oliver &Okpe, 2015).
The exchange rate is perhaps one of the most widely discussed topics in Nigeria
today because of its macro-economic importance especially in a highly import
dependent economy as Nigeria (Olisadebe, 1995).
Although the Naira exchange rate witnessed some period of relative calm between
July to November 1986 since the implementation of the structural adjustment
programme (SAP) in July, 1986, its continued depreciation form December 1986,
however, may have implications on the level of real sector activities in the
country. The Naira which traded at N0.960 = US$1.00 in December 1985
depreciated to N3.18 to $1.00 by December 1986 and further to N8.71 against the
US dollar in December 1990. To stem the
trend, the policy of guided deregulation pegged the naira at N21.89 against the
dollar in 1994.
Further deregulation of the foreign exchange
market in 1999, however, pushed the exchange rate to N97.60 to US$1.00 by
December (CBN statistical bulletin, 2015). With huge inflow of oil revenue due
to hike in the oil price, the end-period rate stood at N118.21 in December,
2007. This remained stable until towards the end of 2008 when the global
financial crisis took its toll on the oil sector thereby causing naira exchange
rate to depreciatefrom 117.74, 2008 to N126.48 in December, 2008 and further to
N149.68 in December 2009, (Aliyu, 2009).In
December 2010, the exchange rate further depreciated to N150.48 and
157.32 by December 2013. In December, 2014 the exchange rate stood at N169.68
which later depreciated to N196.99 as at December, 2015 (CBN statistical
bulletin, 2015).
1.2 Statement of the Problem
Nigeria
as Africa’s largest oil exporter and the world’s tenth largest oil producing
country has realized over US$ 600 billion in oil revenues since 1960, currently
the 5th highest net oil exporter in the World (CIA World Fact Book, 2015).
Nigeria’s economy is heavily dependent on natural resources where oil and gas
constitutes 90% of total exports, 80% of government revenues and about 35% of
GDP (Opec Annual Bulletin, 2015).Oil price fluctuation has taken the center
stage in national economic consideration in over two decades due to its role in
all facets of life, and thereafter on all macroeconomic variables. Monetary and
financial instability is often caused by unstable oil prices in a nation such
as Nigeria which also result in setbacks in fluctuating oil price has made
planning of the economy difficult due to the multiple crises arising from it.
Oil price fluctuations create shocks in the economy leading to spiral effects
on prices of all other goods and services, and on planning by all segments in
the system, government, firms, consumers and externals. Nigeria’s daily output
level has been recently affected by the militants’ attack on oil wells in Niger
Delta area of the South-South region; OPEC and international market control of
oil prices make the effects of fluctuations harder on citizens.
The
Nigeria economy has been adversely affected by external shocks, particularly a
fall in the global price of crude oil. Growth slowed sharply from 6.2% in 2014
to an estimated 3.0% in 2015. Inflation increased from 7.8% to an estimated
9.0% in 2015. The slow growth is mainly attributed to a slowdown in economic
activity which has been adversely impacted by the inadequate supply of foreign
exchange and aggravated by the foreign exchange restriction targeted at a list
of 41 imports, some of which are inputs for manufacturing and agro industry (Africa
development bank, 2015).
Since
1986, when the market determined exchange rate was introduced, the naira
exchange rate has exhibited the features of continuous depreciation and
instability resulting in decline in the standard of living of the populace,
increased cost of production leading to cost push inflation. Additionally, speculators have made the
exchange rate to continue to suffer, thus making international competitiveness
for our products to be endangered. A good number of small and medium scale
enterprises have been forced out due to high exchange rate and increase in
prices of petroleum components thereby causing untold hardship on the citizens
of the economy (Oliver, 2015). This movement of the exchange rate along the
path of depreciation since 1986 has raised a lot of questions on the effect of
exchange rate on the Nigerian economy.
1.3 Objective of the study
The main objective of this study is
to determine the degree to which fluctuation in exchange rate and oil prices
affect the Nigerian economy.The specific objectives of this study are to:
1.
analyze the relationship between GDP; exchange
rate and crude oil prices in Nigeria;
2.
analyze the relationship between
external reserve; exchange rate and Crude oil price in Nigeriaand
3.
analyze the relationship between
Inflation; exchange rate and crude oil price in Nigeria.
1.4 Research Questions
1.
What is the relationship between
exchange rate, Crude oil price and GDP?
2.
What is the relationship between
exchange rate, Crude oil price and External reserve?
3.
What is the relationship between
exchange rate, Crude oil price and Inflation?
1.5 Hypotheses
The following
are the research hypothesis for the study at 0.05 level of significance
H01: There is no
relationship between exchange rate, crude oil price and GDP.
H02: There is no relationship between exchange rate,
crude oil price and external reserve.
H03: There is norelationship between
exchange rate, crude oil price and Inflation.
1.6 Scope of the Study
The study covered the period of1985
to 2015; to account for the various fluctuations in the trend of the oil prices.
Data used were quarterly because CBN publishes quarterly which served the
purpose of this study rather than annual publicationsand the main variable of
concern were the Real Gross Domestic product,External Reserve , Consumer Price Index, Crude
Oil Price and Exchange rate.
1.7 Justification for the Study
The
justification of the study is to examine the extent to which crude oil price
and exchange rate affect the Nigeria’s economy. Oil price changes directly
affects the inflow of foreign exchange into the country, therefore there is a
need to investigate its effect on the naira exchange rates; as crude oil is a
key source of energy in Nigeria and in the world. Oil being an important part
of the economy of Nigeria plays a strong role in influencing the economic and
political fate of the country, crude oil has generated great wealth for
Nigeria, but its effect on the growth of the Nigerian economy as regards
returns and productivity is still questionable (Odularu, 2007).
Oil
prices have received important considerations for their presumed role on
macroeconomic variables. Higher oil prices may reduce economic growth, generate
stock exchange panics and produce inflation which eventually leads to monetary
and financial instability. It will also lead to high interest rates and even a
plunge into recession (Mckillop, 2004). Since oil price volatility directly
affects the inflow of foreign exchange into the country, there is a need to
investigate if it has direct impact on the Naira exchange rate volatility
(Englamaet al., 2010). The oil market has been and will continue to be
an ever changing arena. This is because oil is so vital to the world economy,
it is present in everyone’s daily lives and its market is truly global
(El-badri, 2011).
Thus, it is on this note that this study seeks
to examine the relationship between crude oil price and exchange rates and its
effects on the Nigeria economy, as well as suggest methods of minimizing the
adverse effects it can produce on the economy as a whole.
1.8 Significance of the Study
The
study is important for Nigeria’s economy; it gives a better insight into how
crude oil prices and exchange rates affect the economy which could either be
positive or negative effect. The study would help policy makers develop
economic policies that would capture the specific macroeconomic needs of
Nigeria. The mechanism through which shocks are transmitted would become
channels through which the economy would be rescued. The recent global
financial crisis has caused policy makers around the world to be very cautious
with macroeconomic instability. This study would add to knowledge of the
sources of shocks by looking country specific characteristics and appropriate
policy interventions for specific cases.
The
study is useful in policy recommendation, as it helps to improve the policy
making of the government of Nigeria that is characterized by weak rule of law,
malfunctioning bureaucracy and Corruption. The country often relies on a system
of patronage and do not develop a democratic system based on electoral
competition, scrutiny and civil rights. Thus, oil exporting country like
Nigeria should ensure enforcement of rule of law and reduce corruption and
rent-seeking activities so that oil rents can filter to economic growth.
Moreover, developing countries also need to diversify the production base so
that manufacturing activities can be developed.
1.9 Operational Definition of Terms
Oil
- prices: The price in dollars at which a barrel of crude
oil is sold for in the international market.
Exchange
rate:
The price of one currency in terms of another. It can be expressed in one of
two ways, as units of domestic currency per unit of foreign currency or units
of foreign currency per unit of domestic currency.
Economic
growth: This is the growth of the real output of an
economy overtime.
Volatility:
Fluctuations in the value of a variable, especially price.
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