ABSTRACT
This research study investigates the
determinants of exchange rate in Nigeria and to establish the position
of balance of payments and Gross Domestic Product from year 1980 to
2010. Though the fundamental problems to exchange rate and its
determinants still persist.
The study therefore seeks primarily to
analyze the determinants of foreign exchange by employing the ordinary
least square method of estimation with the help of statistic package for
social science (SPSS) version 17 with special references to the
influence of inflation rate, money supply, balance. Of payment and Gross
Domestic Product.
From the analyses, the results show the
degree of variation among the variables. The co-efficient of
determination was 0.673, which is 67.3 percent variation in exchange
rate is accounted- for by the independent variables. Overall, the
findings confirmed the hypotheses which states that high productivity
differentials (GDP) leads-to exchange rate appreciation and inflation,
money supply and balance of payments have impact on exchange rate. Thus,
we propose policies that would preserve the international value of the
domestic currency, maintain a favourable external reserves position and
the overall goal of macroeconomic stability.
TABLE OF CONTENTS
CHAPTER ONE
1.0 Introduction
1.1 State of Problem
1.2 Research Questions
1. 3 Aim and Objectives
1.4 Justification of the Study
1.5 Scope and Limitation
1.6 Operational Definition of Terms
CHAPTER TWO
2.0 Literature Review
2.1 Theoretical
2.2 Conceptual Framework
2.3 A Review of Exchange Rate Policies Implemented in Nigeria
2.3.1 Fixed Exchange Rate System
2.3.2 Flexible Exchange Rate System
2.4 Structure of Nigeria’s Foreign Exchange Market
2.5 Foreign Exchange Management since 1986
2.6 Hypotheses
CHAPTER THREE .
3.0 Research Methodology
3.1 Research Methods
3.2 Variables in the Analysis
3.3 Model specification
3.4 Sources of Data
CHAPTER FOUR
4.0 Data Analysis and Interpretation
4.1 Methods of Data Analysis
4.2 Data Presentation and Analysis
4.3 Regression and Variance Analysis
4.3.1 Model 1 Regression Result .
4.3.2 Model 2 Regression Result
4.4 Policy Implication
CHAPTER FIVE
5.0 Summary
5.1 Conclusion
5.2 Policy Recommendation
References
Appendices
CHAPTER ONE
1.0 INTRODUCTION
The role of exchange rate and its
effects on macroeconomic performance has continued to generate interest
among economists. Many economists argue that exchange rate stability
facilitates production activities and economic growth. They are also of
the view that misalignment in real exchange rate could distort
production activities and consequently hinders exports growth and
generate macroeconomic instability (Mamta Chowdhury, 1999) Exchange rate
policy guides investors on the, best way they can strike a balance
between their trading partners, and investing at home or abroad
(Balogun, 2007). Mordi (2006) argued that the exchange rate movements
have effects on inflation, prices incentives, fiscal viability, and
competitiveness of exports, efficiency in resource allocation,
international confidence and balance of payments equilibrium.
Exchange rate is one of the key
'barometers' of economics performance, indicating growth (output),
demand conditions, the levels and trends in monetary and fiscal policy
stance (Afolabi, 1991). Exchange rate policy emerged as one of the
controversial policy instruments in developing countries in the 1980s,
with intense opposition for fear of its inflationary impact, among other
effects. Nigeria faced such a situation and there has been interest,
therefore, in economic performance and the role of the exchange rate in
the process (Afolabi 1991).
The exchange rate, when applied in
conjunction with other macroeconomic policies is expected to lead to the
achievement of the goals of price stability, improved and sustained
economic growth, reduced unemployment and balance of payment stability.
An optimal and stable exchange rate has to be right and stable since it
is an important relative price that influences other prices. When the
exchange rate is not optimal, however, the achievement of these
objectives becomes different and often impossible according to Afolabi
1991. For example, if the exchange rate is not in equilibrium, it allows
rent-seekers and speculators to exploit the subsidy element involved.
The situation is worse when a parallel market develops as a result of
restriction in the official market and inability of the market to
satisfy the demand for foreign exchange. Thus, the opportunity cost of
transacting business in the official market is the value of the subsidy
or the premiums that would otherwise be lost by the official sector but
gained by third party arbitrators and speculators. The disability nature
of foreign exchange subsidy (premium) is the fundamental reason why
unification of exchange rate is canvassed as a short to medium term
objectives of exchange rate management. The smaller the parallel market
relative to the official market, and the higher the demand and supply
elasticity of foreign exchange in the official market relative the
closer the unified equilibrium rate is likely to be the official rate.
However, if there is a large unsatisfied demand in the official market
which cannot be diverted to the parallel market because of
administrative restrictions, the equilibrium rate in a unified market
would tend to be closer to the parallel market rate or could even be
beyond it (John, IMF, 1985). The retention of a dual exchange rate
system for a long time would be counter productive in the long run by
undermining the objective of exchange rate stability and structural
reform of an economy. The continued existence of dual or multiple rates
would be encouraging wasteful allocation of resource, thereby stunting
economic recovery and groups. Foreign exchange liberalization,
accompanies by appropriate demand management policies targeted at
ensuring macro economic stability is necessary for exchange rate
convergence, if the costs(subsidy) are to be reduced. This is because
the burden of adjustment is often borne by the official exchange rate.
One of the broad objectives of the Structural Adjustment Programme (SAP)
introduced in Nigeria 1986 was to
achieve macroeconomic stability by reducing the level of inflation
through the achievement of a stale and realistic exchange rate. Towards
this and government deduced to deregulate exchange rate determination
and the foreign exchange allocation system by relying largely on market
focus. In this regard, various allocation mechanism, beginning from the
second-tier foreign exchange market (SFEM),the interbalance foreign
exchange market (IFEM), the Dutch, Auction system (DAS) to the pro-rate
system and, lately, fixing of the official exchange rate and application
of a free market exchange rate for purely commercial transactions, were
adopted in order to achieve the goals of policy.
Nigeria is currently the second largest
oil exporting country in the Organization of Petroleum Exporting
Countries (OPEC) and is heavily reliant on its crude oil exports which
accounts for 95% of its exports and foreign exchange earnings and about
80% of government revenue annual budgets (EIA, 2010). Oil has been the
dominant factor in Nigeria's economy since its discovery in 1956 (Budina
et al, 2006). Oil exporting nations may experience exchange rate
appreciation when oil price rise, conversely exchange rate of oil
exporting nations may depreciate when oil price falls.
From 1980 to 1985 following the oil
price increase, it has be observed that an upward trend with the real
exchange rate appreciating significantly leading to loss of
competitiveness for the Nigeria economy. In 1986, Nigeria experiences a
sharp decline in its real exchange rate following declining oil prices
and the Structural Adjustment Programme (SAP) which led to the
devaluation of the Nigerian currency - the naira. Between 1993and 2000,
there were substantial movements in the real exchange rate. Since then,
the real exchange rate index fluctuated around a constant trend with
evidence of mild appreciation of the real exchange rate. In recent
years, owing to rising global oil prices and increased oil exports,
Nigeria experienced large foreign exchange inflows. The real exchange
appreciate could be described to be a response to the large foreign
exchange inflow that characterized the Nigerian economy or it could as
well be a response to productivity gains.
Approaches employed to analyze the
problems of exchange rate determination ranged from the traditional
balance of payment approach to the modem approaches of exchange rate
determination, consisting of the monetary and port-folio balance
approaches (that is after deregulation) argues that the exchange rate,
being a relative of the two natural monies, is determine primarily by
the relative supplies and demands for the monies. The approach is also
referred to as asset market approaches to the determination of exchange
rate, since the demand for the various national monies depends on
expectations, income and rates of return and other factors relevant for
port-folio choice.
1.1 STATEMENT OF PROBLEM
There has been several exchange rate
systems in use in historical times out of which is the Gold Standard
System which has been the first historical system in modern times, the
free exchange rate system was determined by the supply and demand for
foreign currencies or the demand and supply of domestic currencies, none
of the two systems stated above have given a stabilizing foreign
exchange market (Akinmoladun, 1990).
The exchange rate under the Gold
Standard System brought about a subordination of the demand for domestic
equilibrium to the vicissitudes of the external sector.
The case against the free exchange rate
is similar though allowed for external and internal equilibrium, but had
disadvantages since the fluctuating deter exporters
and importers where as stable rates give
them more confidence. In Nigeria, during the regime of exchange
controls, the black markets rates were much higher than the official
rates for foreign exchange and this underscored the high over-valuation
of the naira and the consequent deficit disequilibrium which the black
market supply was geared to full.
Nigeria's high external indebtedness as a
result of continuing disequilibrium in the balance of payment has
really posed the problem of how to fund a correct exchange rate in the
face of dynamic changes in underlying conditions behind autonomous
transactions. A rate that is set too high under values domestic currency
and a rate that is set too low over values the domestic currency.
There has been an ongoing debate on the
appropriate exchange rate policy in developing countries. The debate
focuses on the degree of fluctuations in the exchange shocks. Exchange
rate fluctuations are likely, in turn, to determine economic
performance. In judging the desirability of exchange rate fluctuations,
it becomes. Therefore, necessary to evaluate the macroeconomic factors
that influence the fluctuations. This is the main focus of this study.
1.2 RESEARCH QUESTIONS
The following questions would be considered in the course of the study:
1. What are the macroeconomic factors that influence exchange rate in Nigeria?
2. To what extent do inflation and money supply affect exchange rate in Nigeria?
3. What are the major issues in exchange rate policy and management in Nigeria?
4. Over the years, is exchange rate stable?
5. How could the exchange rate be influence to stimulate economic growth in Nigeria?
6. How does the Structural Adjustment Programme contribute to a realistic exchange rate?
1.3 AIM AND OBJECTIVES OF THE STUDY
The objectives as regard this study shall be considered on the followings:
1. To identify the macroeconomic factors that influence exchange rate in Nigeria;
2. To investigate the effect of inflation, and money supply on exchange rate, after deregulation;
3. To know whether exchange rate is stable over the years before and after Structural Adjustment Programme (SAP)
4. To examine the impact of economic performance and volume of imports on exchange rate;
5. To raise and discuss issues in exchange rate policy and management.
1.4 JUSTIFICATION OF THE STUDY
The need for foreign exchange management lies only within the framework of
countries engaged in international trade
in contract to a closed economy. This need is underscored by the
economic theory of comparative advantage, theory of comparative cost as
well as international resources endowment differentials.
The study is expected to reveal the
macroeconomic factors that influence the exchange rate so that the
monetary authorities could manipulate them effectively to
stimulate growth in the economy, ' thereby, enhancing policy formulation and implementation.
The study also would contribute to
knowledge by examining the macroeconomic factors that influence exchange
rate in contrast to existing paper that have examined the impact of
exchange rate on macroeconomic variables, thereby enriching the lacuna
in literature.
1.5 SCOPE OF THE STUDY
The foreign exchange market shall be
studied and the role it plays on the macroeconomic objectives. It is
important to note that various exchange rate policy ranging from
exchange control, free exchange rate, and Dutch auction method are
important policies to be considered.
However, the empirical investigation of
the factors that determines the exchange rate in Nigeria shall be
restricted to the period 1980 to 2010.
The limitation of the study is confined
to the era when deregulation started in Nigeria, an attempt will be make
to consider the period between 1970-1985 before Structural Adjustment
Programme (SAP) and the period between 1986-2001 which
takes care of the period during and after SAP;
1.6 DEFINATION OF TERMS
Exchange Rate: it
refers to the rate at which one currency exchange for another (Jhingan,
2003). Exchange rate is said to depreciate if the amount of domestic
currency require buying a foreign currency increases, while the exchange
rate appreciate if the amount of domestic currency requires buying a
foreign currency reduces. Exchange rate volatility refers to the swings
or fluctuations in the exchange rate over a period of time or the
deviation from a benchmark or equilibrium exchange rate (Mordi, 2006).
Gross Domestic Product (GDP): Is
the summation of all the values of goods and services produced in a
country by the nationals and non-nationals. It does not include incomes
and property earnings of the nationals abroad neither does it excludes
the income and property earnings of the non-nationals in the country.
Inflation exists when
there is a sustainable increase in the price level or a persistent
tendency for prices and money wages to increase. That is rise in the
price of goods and services as a result of large volume of money in
circulation used in the exchange for the few available goods and
services.
Money Supply: The
amount of money in an economy. This may be the country's own money
supplied by its banking system, or foreign money used in preference to
domestic money.
Balance of Payments is
an overall statement of a country's economic transactions with the rest
of the world over some period. A table of the balance of payments shows
amounts received from the rest of the world and amounts spent abroad.
Foreign Exchange Market is
the medium of-interaction between the sellers. and buyers of foreign
exchange in a bid to negotiate a mutually acceptable price for the
settlement of international transaction.
Deregulation is the removal or dismantling of restriction and control measures, and this may be in ranging degrees. .
Structural Adjustment Programme (SAP): SAP
was introduced in June 1986 to achieve structural balances in Nigeria
economy. The programme basic strategy was to deregulate the economy and
enhance the role of a realistic exchange rate and the co-ordination of
the country's economic activities.