BACKGROUND OF THE STUDY
Foreign exchange is the means of
payment for international transactions and it is made up of convertible
currencies that are generally acceptable for the settlement of international
trade and other external obugations.
The foreign exchange market is an
arrangement or 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 transactions (ile 1999: 325)
Afolabi (1999) defined
exchange rate as the price of one currency in terms of the other. In other
words, it is the rate at which one currency will exchange for another.
In the pre-babangida administration
years the Nigeria currency was above the dollar and on par with the pound.
However the naira has depreciated in value to a great extent since 1986 with
the introduction of the structural adjustment programme (SAP) , under the
babangida administration since the introduction of SAP in 1986, exchange
management has been at the core of macroeconomic policy. The overriding
objective has been to have a realistic and stable exchange rate consistence
with the internal rate of naira and to reduce the economy’s dependence on the
Prior to 1986, one official foreign
exchange market existed in Nigeria and exchange rates were officially fixed by
the CBN. Then in the September 1986, the foreign exchange market was divided
into two : the first-tier foreign market and the second – tier foreign exchange
market (STEM). The major aspect of the SFEM was that the prices of foreign
currencies as against the naira was determined through competitive bidding with
the prices settling at points. Where the available supply of the currencies are
cleared the bidding was in terms of one currency. The us dollar, against the
naira and the rates for other currencies were correspondingly determined after
the determination of the dollar rate.(essien 1990 : 129).
With the establishment of SFEM the rate
of naira depreciation by the central bank gathered momentum. With the view of
merging the first and second tier markets within the shortest possible time,
which was about one year. In July 1987, the first and second tier foreign
exchange market were merged and called the foreign exchange market (FEM). On
march 20 1987 the central bank introduced the Dutch auction system which was
intended to inject more caution in the bidding sessions since dealers who bid
above the marginal rate would be made to buy at that rate the Dutch auction
system was expected to control the sharp depreciation of the naira.
In 1994 a natural merger of the official
market and the parallel market occurred. The
parallel market gradually marginalized the official market. The foreign
exchange market was liberalized in 1995 with the introduction of the autonomous
foreign exchange market (AFEM) for privately sourced fund at market determined
exchange rates(CBN Annual Report 2001).
In 1995, the foreign exchange market
was split into three tiers. The administratively fixed through the manipulation
of the market mechanism, and the parallel market. Still, there was greater
depreciation of the naira. There was also an introduction of dual exchange rate
regime in 1995 which was a mixture of both the fixed and the market determined rate. The dual
exchange rate regime was restricted in 1997 with the official selling rate
fixed at #21.9960 to us$1for selected priority government transactions. The
stability of the nominal exchange rate achieved in 1995 and 1996 at the AFEM
was generally sustained in 1997.
The exchange rate of the naira
depreciated in all segments of the foreign exchange market prior to the
introduction of IFEM(Inter-Bank Foreign Exchange Market). Which commenced
operation on October 25,1999. the exchange rate depreciated to #97.42 toUS$1.00
and depreciated on the average by 6.5 percent to #101 to US$!>)) in 2000.
there was a phenomenal depreciation in early April 2001 with the naira sinking
to #113.2263 to US$1.00 as against the official rate. This fall in value
continued as the naira sank again to #126.38883 to US$1.00 in December 2002,and
#136.5000 to US$1.00 in December 2003 then to #132.85 in December 2004.the CBN
was successful in keeping to its target on growth of broad money M2 in
2004. from 2002 – 2005. The naira has performed 15 times better than in both
2000 and 2001.