The Impact Of Exchange Rate Volatility On Nigeria Economic Growth
This paper investigates the impact of volatility of exchange rates on the Nigeria economy. After a short introduction of the underlying theories and empirical literature, the relationship between these two variables is estimated. The model formulated depicts Real GDP as the dependent variable while Exchange Rate (EXR), Balance of Payment (BOP) Oil Revenue (OREV) and inflation (INF) are independent variables. These data were sourced and extracted from CBN Statistical Bulletin. We employ the Johansen Co-integration estimation techniques to test for the short and long runs effect of the variables used. The results obtained are positive but are insignificant, and do not support the position that excessive volatility or shifting of exchange rate regimes has pronounced effects on the economy. These results are consistent with what we obtain from the impulse responses. We recommend that graft should be tackled frontally in the oil sector to ensure better utilization of oil revenue. Also the monetary authorities should pursue policies that would curb inflation and ensure exchange rate stability for a sustainable economic growth in Nigeria.
1.1 Background of the Study
Since the adoption of financial liberalization policies, most developing countries have been exposed to sharp exchange rate fluctuations. This situation has attracted the attention of economists and previous research has been focused on the effects of exchange rate volatility on trade flows (Cho and Corriston 2002, Soleymani and Chua 2014, Karemera et al. 2015, Wong 2017). Previous studies dealing with the effects of exchange rate volatility on economic growth, have often yielded mixed results. This is explained at least by two reasons. First, the effects of exchange rate volatility on the dynamics of growth are contradictory. On the one hand, exchange rate volatility may be considered as a shock absorber and seems to be more appropriate for countries experiencing frequent real shocks; on the other hand, volatility may be associated with higher macroeconomic volatility in terms of international trade, investment, and economic growth. Second, the relationship between exchange rates and economic growth also depends on other control variables such as financial development (Aghion et al. 2009, Ndambendia and AlHayky 2011), and exchange rate regime (Jha 2003).
Consequent upon the collapse of the Bretton Woods system and the resultant adoption of the flexible exchange rate system in 1973, economists and policy makers have been concerned about the significant effects of exchange rate fluctuations on the economy in general and trade, in particular (Isitua& Neville: 2006). One of the most dramatic events in Nigeria over the past decade was the devaluation of the Nigerian naira with the adoption of a structural adjustment programme (SAP) in 1986. A cardinal objective of the SAP was the restructuring of the production base of the economy with a positive bias for the production of agricultural exports. 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. Significantly, this depreciation resulted in changes in the structure and volume of Nigeria‟s exports as determined empirically by many researchers (Oyejide: 1986, Ihimodu: 1993 and World bank: 1994). The depreciation increased the prices of agricultural exports and the result indicated a marked increase in the volume of agricultural exports over the years.
Exchange rate management has been a topical issue among academics and policy makers for a very long time. This started predominantly when the Gold standard collapsed in the 1930‟s and subsequent emergence of the Breton Wood System of adjustment peg from the 1940’sthrough to the flexible exchange rate given by the developing nation in 1970 and those carrying out structural reforms in the 1980s as well as in the wake of the currency crises in developing economies in the 1990s. Flexible exchange rate is accompanied by the fluctuation of exchange rate making it the major focus in the debate due to its impact on business outcome as nations‟ business partners would prefer a stable exchange rate to a volatile one. It has been recognized in previous studies that maintaining a relatively stable exchange rate is important in boosting economic growth. Volatility of exchange rate induces uncertainty and risk in investment decision with destabilizing impact on the macroeconomic performance (Mahmood and Ali, 2011). Mordi (2006) noted that operators in the private sector are concerned about volatility of exchange rate because of its effect on their investment which may be capital gains or losses. Exchange rate volatility has asymmetric effects on macro economic variables. Aliyu (2011) cited that appreciation of exchange rate results in increased imports and reduced export while depreciation would expand export and discourage import. Also, depreciation of exchange rate tends to cause a shift from foreign goods to domestic goods. Hence, it leads to diversion of income from importing countries to countries exporting through a shift in terms of trade, and this tends to have impact on the exporting and importing countries‟ economic growth. Exchange rate depreciation has a negative effect on developing countries (Razaxadehkarsalari, Haghiri and Behrooznia, 2011). Exchange rate is the price of one country‟s currency in relation to another country. It is the required amount of units of a currency that can buy another amount of units of another currency. In Nigeria, the management of the exchange rate is carried out by the Central Bank of Nigeria. Following the adoption of Structural Adjustment Policy (SAP) in 1986, the country has moved from a peg regime to a flexible exchange rate regime in practice, no exchange rate is clean or pure float, that is, a situation where it is left completely to be determined by market forces but rather the prevailing system is the managed float whereby monetary authorities intervene periodically in the foreign exchange market in order to attain some strategic objectives (Mordi, 2006). Despite various efforts by the government to maintain a stable exchange rate, the naira has depreciated throughout the 80‟s (Iyeli, Nenbee and Opue, 2011). It depreciated from No. 61 in 1981 to N2.02 in 1986 and further to N7.901 in 1990, all against the US dollar. The policy of guided or managed deregulation pegged the naira at N21.886 against the US dollar in 1994. Further deregulation pushed it to N86.322 = S1.00 in 1999 (Aliyu, 2011). It depreciated further to N120.97 in 2002 and 135.5 in 2004. Thereafter, the exchange rate appreciated to N132.15 in2005 and later N118.57 in 2008. Towards the end of 2008 when the Global Financial Crisis took its toll, the naira depreciated to N150.0124 at the end of 2009. It is against this background, that the paper seeks to examine the effect of volatility of exchange rate on economic growth in Nigeria as the major objective of the study.
1.2 Statement of the Problem
Fluctuations in the exchange rate movements since the beginning of the floating exchange rate regime have raised concerns particularly on the impact of such movements on trade flows. Fluctuation is a major constraint on development of an economy, making planning more problematic and investment more risky. For instance, if potential foreign investors to Nigeria are risk averse (or even risk neutral), larger exchange rate fluctuations may reduce the overall foreign direct investment inflows since it increases uncertainty over the returns in 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 (Gerardo, et al: 2002). Most developing economies are net debtors and in consequence, changes in the trading partners‟ exchange rates may affect the real cost of servicing their debts. A strong appreciation of the dollar, for example, implies a higher cost of servicing an external debt that is mainly denominated. Furthermore, for a developing country like Nigeria that is highly dependent on trade, the exchange rate, which is the price of foreign exchange, has implications for balance of payments viability and the level of external debt. For instance, if the exchange rate is overvalued, then it would result to unsustainable balance of payments deficit, encourage capital flight and escalate external debt stock, which in turn will lead to declining level of investment. On the other hand, a real depreciation raises the cost of imported capital goods, and since a large chunk of investment goods in developing countries is imported, domestic investment would beexpected to fall with a real depreciation (Iyoha, 1998). All these show that the impact of exchange rate variability on economies especially developing ones is not only in one direction. Furthermore, along the lines of the existing literature, a related question very few researchers have investigated is whether changes in exchange rate regimes or policies which can be associated with a shift in the amplitude of fluctuations cause export flows to decrease. Few others, for reasons known to them, ascertained the impact of these fluctuations on either the oil sector, excluding the non-oil sector or vice versa. Nevertheless, we know that in a country like Nigeria that is so much over-dependent on oil, assessing the effect of exchange rate fluctuations on either oil or non-oil sector trade exclusively may not really give a value judgement and the conclusion thereof. However, to bridge this gap and also avoid the effect of Dutch disease associated with some previous findings, the current study attempts to examine the possible impact of exchange rate volatility on Nigeria economic growth.
1.3 Objective of the Study
The general objective of this study is access the impact of exchange rate volatility on Nigeria economic growth.
Other objectives are;
- Determine the effect of different policy framework on exchange rate in Nigeria.
- Ascertain the transmission level of exchange rate fluctuations on exports and imports (trade) variability in Nigeria.
1.4 Research Hypotheses
- Ho: There is no relationship between exchange rate volatility and economic growth
- Hi: There is a relationship between exchange rate volatility and economic growth
- Ho: exchange rate volatility has a negative effect on Nigeria Economy.
- Hi: exchange rate volatility has a positive effect on Nigeria Economy.
1.5 Significance of the Study
The study is of relevance to the Nigerian economy in the following ways: It serves as a future guide to the policy makers in the formulation of better and efficient policy options for managing exchange rate fluctuations in Nigeria. Also, the research is of immense help to the general economy, as it provides possible measures that monetary authority could adopt in order to maintain stability in exchange rate so that, it can influence importantly export growth, consumption, resource allocation, employment and private and foreign investments as research has shown. Above all, it adds to the existing literature thus, provides relevant information that could guide further researchers on the subject.
1.6 Scope and Limitation of the Study
This study is primarily concerned with the impact of exchange rate volatility on Nigeria economic growth. This study covers the period of 1987-2015.The researcher encountered some constraints, which limited the scope of the study. These constraints include but are not limited to the following.
a) Availability of Research Material:
The research material available to the researcher is insufficient, thereby limiting the study
The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.
1.7 Definition of Terms
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.
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 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.
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 Organization of the Study
This research work is organized in five chapters, for easy understanding, as follows
- Chapter one is concerned with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
- Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
- Chapter three deals on the research design and methodology adopted in the study.
- Chapter four concentrate on the data collection and analysis and presentation of finding.
- Chapter five gives summary, conclusion, and recommendations made of the study
Summary, Conclusion and Recommendation
It is important to ascertain that the objective of this study was to ascertain a critical analysis of the impact of exchange rate volatility on Nigeria economic growth.
In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations are made, which in the opinion of the researcher will be of benefit in addressing the challenges of economic growth in Nigeria.
Volatility in exchange rate affects aggregate demand and supply of any nation but the degree of effectiveness and their consequences depend on the existing economic conditions. This study employs empirical analysis in examining the effect of exchange rate volatility on economic growth using data from 1987 to 2015. ADF was employed in testing for the stationarity of the variables and the hypothesis of non stationarity. The result of the Johansen co-integration test reveals two co-integration equations at 5% level of significant. This is an indication that, there is a tendency for the variables to be at equilibrium in the long run.
Based on the above findings pertaining to the objectives of the study the following conclusions are drawn.
exchange rate is significant in stimulating economic growth even though it violates theoretical postulation. The results shows that a 5% change in exchange rate will stimulate growth by about 5.511%. (ii) OREV and lagged one year period of OREV are both positively and statistically significant in stimulating growth in Nigeria (iii) The statistical significant of the model shows that our model can be relied upon in forecasting the future behavior of real Gross Domestic Product in Nigeria. It therefore follows that appropriate policy is required to enhance sustainable growth. In the light of our findings
- A renewed commitment by the government to frighten graft in the administration of oil wealth will ensure that oil wealth is adequately utilize in stimulating growth process in Nigeria
- Monetary authorities should focus on reversing persistent inflation trend in the economy through appropriate policy mix to an acceptable level favorable to economic growth in Nigeria.
- Also monetary authorities should pursue policies that would ensure stability of the exchange rate for a sustainable economic growth in Nigeria.
- Subsequent studies should explore the relationship between exchange rate volatility and other real sectors of the Nigerian economy to assess the extent to which volatility impact on the performances of such sectors.
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