CHAPTER ONE
INTRODUCTION
1.0 BACKGROUND OF THE STUDY
Foreign exchange is the means of payment
for international transaction. It is made up of convertible currencies
that are generally accepted for the settlement of international trade
and other external obligation. Just like every other commodity, a market
is established which works more like any other market having a supply
curve, a demand curve and an equilibrium price and quantity. There are
also conditions which are held constant (creteris paribus). When these
conditions change, the curve shift and there is a change in the
equilibrium price quantity. This market for currencies is known as the
foreign exchange market.
The foreign exchange market
according to the central bank of Nigeria is the medium of interaction
between the sellers and buyers of foreign exchange. The seller of
foreign exchange constitutes the supply while the buyers of foreign
exchange constitutes its demand. The supply of foreign exchange is
derived from oil exports, non-oil export, expenditure of foreign tourist
in Nigeria, capital repatriation by Nigerians resident abroad etc.
The demand for foreign exchange on
the other hand consist of payments for imports, financial commitments to
international organizations, external debt service obligations etc.
Before 1958, when the central bank
was established and the enactment of the exchange control act of 1962,
foreign exchange was earned by the private sectors and held in balances
abroad by commercial banks which acted as agents for local exporters.
Another feature of this period was that agriculture exports contributed
the bulk of foreign exchange receipts. The fact that the British pound
sterling was at par with the Nigerian pound sterling with easy
convertibility delayed the establishment of an active foreign exchange
market.
However by 1958, when the central
bank was established and subsequent centralization of foreign exchange
authority. In banks, the need for a local foreign exchange market is
paramount. Other factors that led to the evolution of the foreign
exchange market in Nigeria include:
The changing pattern of international trade institutional changes in the economy. structural shift in production, etc.
By the early 1970’s, the official
exchange receipt was enhanced following the sharp rise in prices and
demand for crude oil exports which had by now displaced agricultural
exports. The foreign exchange market experienced a boom during this
period and there became a need for the management of foreign exchange
resources. However, it was not until 1982 that comprehensive exchange
controls were applied.
The exchange control system failed
to evolve an appropriate mechanism for foreign exchange allocation. This
led to the development of a dual exchange rate system, comprising of
the first and second tier foreign exchange market which was adopted in
September 1986. The first tier was managed while the second tier was
subjected to market forces. Not only has there been a metamorphosis of
the institutional frame work from second tier foreign exchange market
(SFEM) to foreign exchange market (FEM) to inter bank foreign exchange
market (IFEM) to Autonomous Foreign Exchange market (AFEM) etc, there
have been frequent changes in operational guidelines and procedures.
Various pricing methods, marginal and weighted average exchange rates
determinations and the Dutch Auction System (DAS) among other have also
been adopted.
All those aimed at ensuring more
efficient allocation and utilization of scarce foreign exchange
resources, to enhance the flow of capital into the country, stimulates
domestic industrial production, promote export, increase revenue to the
government, help reschedule our foreign debt at more profitable terms
etc.
When there are fluctuations in
foreign exchange rates, various economic activities are usually affected
such as the purchasing power, balance of payment, prices of goods and
services, import structure, export earning, government revenue, external
reserves among others.
These prevailing instability in
exchange rates and its effects on various economic variables, will be
the areas of concentration of the research work.
1.2. STATEMENT OF THE PROBLEM
Since September 1986, when the market
determined exchange rate system was introduced via the second tier
foreign exchange market, the naira exchange rate has exhibited the
features of continuous depreciation and instability.
This instability and continued
depreciation of the naira in the foreign exchange market has resulted in
declines in the standard of living of the populace, increased cost of
production which also leads to cost push inflation. It has also tended
to undermine the international competitiveness of non-oil exports and
make planning and projections difficult at both micro and macro levels
of the economy. A good number of small and medium scale enterprises have
been strangled out as a result of low dollar/ naira exchange rate and
so many other problems resulting from fluctuations in exchange rates can
also be identified.
This movement of the exchange rate
along the path of depreciation since 1986 has raised a lot of questions
on the impact of exchange rate policies on the Nigerian economy.
1.3 OBJECTIVES OF THE STUDY
Objectives of the study
- To find out the impact of exchange rate fluctuation on economic growth of Nigeria.
- To examine the nature of the relationship between exchange rate fluctuations and economic growth in Nigeria.
- To offer some recommendations based on the findings of the study.
1.4 FORMULATION OF HYPOTHESES
For meaningful findings, conclusions and
recommendations, a set of testable hypothesis based on available data
will be necessary. In the course of this research work, the following
hypothesis would be tested.
Hi: Exchange rate fluctuations has no significant impact on Nigeria Economy.
Hi: Exchange rate fluctuations has significant impact on Nigeria Economy.
1.5 SIGNIFICANCE OF THE STUDY
The study would identify the strengths
and weakness of exchange rate policy and management, identify those
economic variables that are mostly affected by instability in exchange
rate and provide the general public with the awareness on the foreign
exchange transaction and its impact on the economy.
The various findings of this would
enable the government and financial authorizes to device, modify and
adopt a better foreign exchange transaction for the economy.
1.6 SCOPE AND LIMITATION OF THE STUDY
Although there are many economic
variables that operate within the Nigerian economy, this research work
is limited to the study of the effect of fluctuation in exchange rate on
the following economic variables.
- Purchasing power
- Importation
The scope of this research work is also limited to the period between 1986-2011.
This study was also faced with certain constraints such as limited time frame with which to collect all necessary data.
1.7 DEFINITION OF TERMS :
- 1. Foreign Exchange
Foreign exchange is a means of payment
for international transactions. It is made up of currencies of other
countries that are freely acceptable in settling international
transactions.
- 2. Foreign exchange market :
This is a medium of interaction among
buyers and sellers of foreign- exchange with a view of negotiating
acceptable prices for settling international transaction.
- Exchange rate – This is the price of one currency in terms of another
- SEMI- Second tier foreign exchange market. Under this system the exchange rate is largely determined by market forces.
- AFEM – Autonomous foreign exchange market. This exchange rate under
this system are being determined essentially through market forces.
- IFEM – Inter bank foreign exchange market.
- Dutch auction system (DAS) – this is a method of exchange rate
determination through action where the bidders pay last bid rate that
clears the market.
- Dual exchange rate regime- This situation exist when two exchange rates are in existence in an economy.
- Marginal pricing method: This is the method in which bid rates are
arranged in a descending order of magnitude. The last bid rate at which
available foreign exchange is exhausted (marginal rate) is the
applicable exchange rate.
- Exchange control – This is a foreign exchange arrangement in which
the government purchase all incoming foreign exchange and is the only
source from which foreign exchange can be purchased legally.