The Effect Of Fluctuating Foreign Exchange Rate On Nigeria Currency (A Case Study Of Central Bank Of Nigeria, Enugu Branch)

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Abstract

This study examines the effect of fluctuating foreign exchange rate on Nigeria currency. The study used a simple percentage approach which helped estimate the Volatility persistence and asymmetric properties for the Nigerian foreign exchange market. The regression model was used to estimate the relationship between exchange rate and economic growth. The results show that there is a positive but insignificant relationship between economic growth and exchange rate fluctuations in the short run. This study recommends that government should encourage the export promotion strategies in order to maintain a surplus balance of trade and also conducive environment, adequate security, effective fiscal and monetary, as well as infrastructural facilities should be provided so that foreign investors will be attracted to invest in Nigeria, and the exchange rate of Naira should be stabilized to achieve economic growth because of the current high fluctuation of naira exchange value.

Chapter One

Introduction

1.1 Background of the Study

The inter-bank market in foreign exchange is used for trading in foreign currencies – main vehicle for generating autonomous inflow of foreign exchange into the banking system. La licensed banks, development banks and the central bank are active traders the market. These banks intermediate for their corporate and individual customers that engage in international trade and investment. They are always prepared to buy form or sell foreign currencies to their customers in both the spot and forward markets. In addition, authorized dealers open and maintain foreign currency domiciliary accounts for their customers, especially the exporting customers. Exchange rates ruling in the inter-bank market fluctuate in response to the forces of supply and demand for foreign currencies, subject to a maximum spread of one percent between the buying and selling. 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 contributes to internal balance in price stability (CBN, 2011). It is not surprising therefore, that monetary authorities attach much importance to proper management of a country‘s foreign exchange since its behaviour is said to determine the behaviour of several other macroeconomic variables (Oyejide, 1989). It is even more so for Nigeria which had embarked on a course of rapid economic growth with its attendant high import dependency. An exchange rate, as a price of one country‘s money in terms of another‘s, is among the most important prices in an open economy. It influences the flow of goods, services, and capital in a country, and exerts strong pressure on the balance of payments, inflation and other macroeconomic variables. In this way, the choice and management of an exchange rate regime is a critical aspect of economic management to safeguard competitiveness, macroeconomic stability, and growth (Cooper, 1999). 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 the correlation between the actual (de facto) exchange rate regimes and macroeconomic performance. The main findings include:

Fixed exchange rate regimes seem to have no significant impact on the inflation level when compared with pure floats, while intermediate regimes are the clear under-performers;
Pegs are significantly and negatively correlated with per capita output growth in non-industrial countries;
Output volatility declines monotonically with the degree of regime flexibility; and
Real interest rates appear to be lower under fixed rates than under floating rates because of lower uncertainty associated with fixed rates.

Locally, in Nigeria, several works also exist. Ofurum and Torbira, (2011) examined the effect of the demand and supply of foreign exchange on the gross domestic product of the Nigerian economy over a fourteen (14) year-period (1995-2008), it was revealed that supply of foreign exchange has a positive and significant relationship with output level of Gross Domestic Product while the demand for foreign exchange has a negative relationship with gross demand product. This study implies that the growth in supply of foreign exchange has resulted in an increase in the Gross Domestic Product in Nigeria hence the determinants of the demand for foreign exchange should be annualized in order to understand what occasioned the negative relationship with Gross Domestic Product. Looking at the impact of exchange on the manufacturing sector of Nigeria, Opaluwa, Umeh and Ameh (2010) argue that fluctuations in exchange rate adversely affect output of the manufacturing sector. This according to them is because Nigerian manufacturing is highly dependent on import of inputs and capital goods. These are paid for in foreign exchange whose rate of exchange is unstable. Thus, this apparent fluctuation is bound to adversely affect activities in the sector that is dependent on external sources for its productive inputs.

Exchange rate tends to be paramountto every country because it contributes to the economic development of nations by influencing the amount of foreign exchange reserves as well as the level of imports a country can afford. The subject of exchange rate fluctuation came to surface and became a topical issue in Nigeria because it is the goal of every economy to have a stable rate of exchange with its trading partners. In Nigeria, this goal was not realized in spite of the fact that they embarked on the devaluation of the naira and adopted the Structural Adjustment Program (SAP) in 1986. The failure to realize this goal subjected the Nigerian manufacturing sector to the challenge of a constantly fluctuating exchange rate. One objective of the SAP was the restructuring of the production base of the economy with a positive bias for the production of agricultural export. The foreign exchange reforms that facilitated a cumulative depreciation of the effective exchange rate were expected to increase the domestic prices of agricultural exports and hence boost domestic production.

Empirically many researchers like Oyejide (1986), Ihimodu (1993) and World Bank (1994) analyzed the effects of cumulative depreciation of the effective exchange rate, as it resulted in the change in the structure and value of Nigeria’s exports. The depreciation increased the prices of agricultural exports and the result indicated a worked increase in the volume of agricultural exports over the years. However, very little achievements were made in stabilizing the rate exchange. Consequently, the problem of exchange rate fluctuations in Nigeria persists up till date.

Fluctuation is a major constraint on development of an economy, making planning more problematic and investment more risky. For instance, fluctuation in exchange rate may reduce the activities of potential investors in Nigeria because it increases uncertainty over the returns of a given investment. Potential investors will invest in a foreign location only if the expected returns are high enough to cover for the currency risk (Gerado, 2002). Risk in international commodity trade usually arises from two main sources; changes in world prices or fluctuation in exchange rate. Therefore, understanding the behavior of the exchange rate is very important for many reasons.

First, the relationship between a country’s exchange rate and economic growth via trade is a crucial issue from both the descriptive and policy prescription perspective. As Edwards (1994; 61) asserts; “it is not an overstatement to say that the issue of real exchange rate behavior now occupies a central rate in policy evaluation and design”. A country’s exchange rate behavior is an important determinant of the growth rate of its exports and it serves as a measure of its international competitiveness (Bath and Amusa, 2003), Chukwu (2007)observed the instability exchange rate as a determinant of trade in Nigeria; having a positive influence on export trade and at other times a negative influence. This suggests an erratic change in its value having a long-run effect on export and economic growth. This research aims to determine the impact of fluctuations in the naira exchange rate on Nigerian’s export performance.

1.2 Statement of the Problem

Despite the existence of literature on the influence of exchange rate fluctuations on economic growth in Nigeria, theoretical and empirical works on the subject are yet to produce a consensus. The two major trends in the literature review indicate thus; the first argues that exchange rate fluctuations represent uncertainty and will impose costs on risk- adverse economic agents which as a result respond by favoring domestic- foreign trade just at the margin. In other words, it might hamper the growth of international trade (Chowdhury, 1993, Cushiman, 1983, 1988 Kenen and Rodrik, 1986). The second strand of literature argues that if the economic agents are sufficiently risk lovers, an increase in exchange rate raises the expected marginal utility of export revenue and thus induces them to increase their exports in order to maximize their revenue. Therefore, exchange rate fluctuations may actually catalyze trade flows (De Grauwe: 1988, IMF: 1984, Klein: 1990 and Chambers, R. G. and Just, R. E. (1991). Only few attempts have been made to examine them for developing countries, Nigeria inclusive because of the lack of reliable time –series data. The available instances include Vergil (2002) for turkey and Bah and
AMUSA (2003) and Takendesa, (2005) for South Africa, Ajayi (1988), Adubi, A. A. and Okunmadewa, F. (1999), Osagie (1985) for Nigeria.

The research will carefully examine exchange rate fluctuation on economic growth for both the oil sector and non-oil sectors. Previous studies assessed only the influence of exchange rate fluctuation on either oil export, neglecting the non-oil export or on non-oil export alone excluding the oil export. They failed to ascertain its effect on both the oil and non-oil (like agricultural and manufacturing) sectors export. Analyzing only oil exports or non-oil exports exclusively may not really give a value judgment and conclusion on the effect of exchange rate fluctuations and export performances in Nigeria. Furthermore, the study will provide deep insight into the relationship existing between exchange rate fluctuations on economic growth in Nigeria. In view of the above problem, the following research questions are raised:

How does the Nigerian economy respond to exchange rate fluctuation?
How does manufacturing companies respond to exchange rate fluctuation?
How does agricultural export respond to exchange rate fluctuation?

1.3 Objectives of the Study

The main objective of this study is to examine the impact of exchange rate fluctuations on economic growth in Nigeria.

Specifically, the study is meant to addresses the following sub objectives:

To trace how the Nigerian economy respond to exchange rate fluctuation.
To trace how manufacturing companies respond to exchange rate fluctuations.
To trace how agricultural export respond to exchange rate fluctuation.
To ascertain if there is any significant relationship between exchange rate and the Nigerian economy.

1.4 Research Hypotheses

Based on the research questions and the objectives, the following null and alternate hypotheses were formulated by the researcher;

Ho: Exchange rate has no positive significant impact on economic growth of Nigeria.
H1: Exchange rate has a positive significant impact on economic growth of Nigeria.
Ho: There is no causal relationship between exchange rate and export growth in Nigeria.
H2: There is a causal relationship between exchange rate and export growth in Nigeria.

1.5 Significance of the Study

It is believed that at the end of this study, the findings will serve as a future guide to policy makers in the formulation of better and efficient policy options for managing exchange rate fluctuations in Nigeria. Also, the research will be of immense help to the general economy, as it will provide possible measures the monetary authority could adopt in order to maintain exchange rate stability so that exchange rate can influence importantly export growth, consumption, resource allocation, employment and private and foreign investments as research has shown. Above all, it will add to the existing literature thus, providing relevant information that could guide further researchers on this subject.

1.6 Scope and Limitation of the Study

This study intends to look at the export performances and exchange rate fluctuations in Nigeria. The study covers the period from1982 -2015. This range is chosen to give room for enough degree of freedom that will ensure reliable estimates. The researcher encountered some constraint in the course of the study; Little time and inadequate funds limited the researcher’s ability to generate complete and concrete research material, this is because of time and money constraints at the disposal of the researchers, on the other hand, the unwillingness and the busy schedule of the bank officials delayed the study, in order to provide us with more appeal cases and their valued opinions.

However, we had to convince the respondents by giving gentlemen word that the names would not be disclosed in our study and the materials would be used for this study purpose only.

Finally, there was no enough previous research work been carried out on this study, thus creating a lump sum of work for the researcher, and extending the duration initially budgeted for the completion of the research study.

1.7 Definition of Terms

Exchange Rate:

In finance, an exchange rate of two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.

Fluctuation:

Price fluctuations are upward or downward swings in the prices of products in an economy. Fluctuations in prices are a common phenomenon in the economic world, particularly among producers of agricultural products.

Economic Growth:

Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP, usually in per capita terms.

Nigerian Capital Market:

The Nigerian Stock Exchange (NSE) was established in 1960 as the Lagos Stock Exchange. In 1977, its name was changed from the Lagos Stock Exchange to the Nigerian Stock Exchange. As at March 7, 2017, it has 176 listed companies with a total market capitalization of about N8.5 trillion. All listings are included in the Nigerian Stock Exchange All Shares index. In terms of market capitalization, the Nigerian Stock Exchange is the third largest stock exchange in Africa.

Stock Price Index:

A stock index or stock market index is a measurement of the value of a section of the stock market. It is computed from the prices of selected stocks (typically a weighted average). It is a tool used by investors and financial managers to describe the market, and to compare the return on specific investments.

Market Capitalization:

This refers to the total market value of the equity in publicity traded entity. It also refers to the value of all listed securities based on their market prices.

1.8 Justification of the Study

Impact of exchange rate on economic growth and development in Nigeria is not a strange topic as quite a number of researches have been carried out in relation to this issue. Unfortunately, many of the studies earlier conducted in have not utilized extended period and modern estimation methods as employed in this study. For instance, Udegbunam (2002) in his study has examined the effect of openness, stock market development and industrial growth in Nigeria, utilizing annual time series data covering the period from 1970 to 1997 and employing Ordinary Least squares (OLS) as estimation technique. In another study, Oke (2012) has examined the effect of capital market activities on the development of the Nigerian oil industries, utilizing annual time series data covering the period from 1999 to 2009 under the framework of cointegration technique and error correction mechanism. Meanwhile, Victor, Kenechukwu and Richard (2013) have undertook analysis into the effect of capital market on Nigeria’s industrial sector development, using data from 1980 to 2008 employing descriptive statistic methods. This study contributes to the current debate but differs from the previous scopes and studies by using a fairly large period of time as well as using current data in analyzing the effects of exchange rate fluctuation on economic growth in Nigeria.

1.9 Plan of the Study

The study is divided into 5 chapters. Chapter one consist of introduction to the study and it is sub-divided into 9 headings which are background of the study, statement of problem, research hypotheses etc. Chapter two is the literature review which comprise of the conceptual, empirical and theoretical framework. Chapter three is the research methodology which mainly concerns itself about the design of the study, the method of data collection, sample size, sampling technique, method of data analysis and the decision rule. The second to the last chapter, chapter four comprise of the research data presentation and analysis and the last chapter, chapter five is the summary, conclusion and recommendation of the research.

Chapter Five

Summary Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to examine the effects of exchange rate fluctuation on economic growth in Nigeria.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges associate with the unstable nature of exchange rate on the Nigerian economy.

5.2 Summary

This research study examined the impact of exchange rate on economic growth from 1982 to 2015. The result revealed that exchange rate has positive impact but not significant with (β =0.014, t = 1.783, Pns) this is affirms previous studies that developing countries are relatively better off in the choice of flexible exchange rate regimes. The result also indicated that interest rate and rate of inflation have negative impact on economic growth but not significant with (β = – 0.002, t = – 0.015, Pns) and (β = -0.023, t = – 0.716, Pns) respectively. From the empirical reviewed work, some authors argued that exchange rate is positively related to economic growth, while some authors argued that it is negatively related. However, from empirical analysis of the study, it was found that exchange rate is positively related to output growth. Certain policy implications arise from the findings. Principal among them is that exchange rate depreciation affects both output and money supply in Nigeria. It demonstrates the need for a monetary policy framework that complements the existing exchange rate policy. On the whole, this research has provided empirical estimates of the relation between exchange rate and economic growth in Nigeria. The results ascertain that there is a statistically significant direct relationship between the two variables. The vector auto regression results also demonstrate that real exchange rate and real income are significantly cointegrated. In the long run, the exchange rate and income may drift apart, but in a short run their relationship is strong and direct

5.3 Conclusion

In conclusion, this research work assessed the effects of exchange rate fluctuation on Nigerian economic growth using simple percentage approach which helped estimate the Volatility persistence and asymmetric properties for the Nigerian foreign exchange market. The impact of exchange rate fluctuation on Nigerian economic growth was investigated by incorporating the calculated volatility of exchange rates for the study period in the regression model. The objective of the study was to measure the impact of exchange rate fluctuation on economic growth in Nigeria both in the long and short run. It was established that there is a link between exchange rate. Fluctuation and economic growth in Nigeria in both the long and short run. The regression estimate showed that volatility in exchange rate had no influence on economic growth while its actual exchange rate had positive effect on economic growth in Nigeria in the long run. This study established that there is a positive but insignificant relationship between economic growth and exchange rate fluctuation in the short run. The aforementioned outcome was consistent with the earlier study of Danmola (2013). Empirically, the insignificant positive relationship between exchange rate fluctuation and economic growth was attributed to the influence of the monetary authorities in mitigating exchange rate fluctuation in Nigeria. Observably, the high volatility persistence and its significant impact on the Nigerian economy of oil prices could have been due to OPEC’s regulations, global recession or change in the structure of the Nigerian economy since Nigeria’s foreign exchange earnings are more than 90 per cent dependent on receipts from crude oil Export.

5.4 Recommendation

The study recommended that government should encourage the export promotion strategies in order to maintain a surplus balance of trade and also conducive environment, adequate security, effective fiscal and monetary, as well as infrastructural facilities should be provided so that foreign investors will be attracted to invest in Nigeria.
There should be an increase in the exchange rate of Naira in order to enhance economic growth.
The Nigerian government should endeavour to stabilize the exchange rate of Naira in order to achieve economic growth because of the current high fluctuation of naira exchange value.
Investors should consider fluctuations in other macroeconomic variables rather than fluctuation in the exchange rate market to guide their decisions in order to ascertain where to direct investments for profit maximization.
The Nigerian economy need be diversified to enhance economic growth. 6. The government should encourage domestic production and consumption of goods and services in order to curtail the effects of exchange rate fluctuation on other macroeconomic variables.
Oil price should be stabilized since it was the most volatile variable during the years of study in order to ensure economic growth in Nigeria.
Lastly, to maintain and sustain exchange rate and economic stability, more attention need be paid by the government to other more volatile macroeconomic variables like oil price and inflation rate in Nigeria.

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