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PROJECT TOPIC AND MATERIAL ON IMPACT OF EXCHANGE RATE FLUCTUATION ON THE ECONOMIC GROWTH OF NIGERIA
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- Name: IMPACT OF EXCHANGE RATE FLUCTUATION ON THE ECONOMIC GROWTH OF NIGERIA
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- Background to the Study
The exchange rate is perhaps one of the most widely discussed topics in Nigeria today. This is not surprising given its macro-economic importance especially in a highly import dependent economy as Nigeria (Olisadebe, 1995) Exchange rate is the price of one country’s currency expressed in terms of some other currency. It determines the relative prices of domestic and foreign goods, as well as the strength of external sector participation in international trade. Exchange rate regime and interest rate remain important issues of discourse in International finance as well as in developing nations, with more economies embracing trade liberalization as a requisite for economic growth (Obansa, Okoroafor, Aluko and Millicent, 2013).
Perhaps one of the greatest development challenges that have confronted Nigeria since 1986 was when the fixed exchange rate system was abolished and replaced with the flexible exchange rate system as the designing of policy measures to enhance exchange rate appreciation in Nigeria. This particularly is the case after the abysmal failure of the Structural Adjustment Program me (SAP) devaluation policy package designed to aggressively promote export in Nigeria. Nigeria being an import dependent nation particularly for her capital goods and considering the centrality of the rate of exchange of such a country’s currency to her trading partner’s currency, a good number of writers have expressed their interest and position on this important subject. Interest rate in this area has significantly increased over the years as being generated by the fluctuations and the depreciating nature of such an important economic variable as well as its effect on other sectors of the economy. Data provided by (Ekanem 1997) shows that manufacturing companies are operating below 40% capacity and they are import dependent. For several years, the manufacturing sector has concentrated basically on the import of raw materials. This seems to be attributable to the overcrowding of this important sector of the Nigerian economy by multinational corporations. As a result, this sector has been deviled by high interest rates, raising inflation, naira depreciation, foreign earning shortages and consumer’s strong resistance to local products.
Olisadebe (1991) expressed that the naira exchange rate given its macroeconomic impact especially in Nigeria is perhaps one of the most widely discussed topic today. According to him one of the worrisome development in the naira exchange rate in recent years, especially since the introduction of the Structural Adjustment Program me (SAP) in 1986 is that it has continued to depreciate as a result of which some people have called for fixing of the exchange rate even at par with United States dollar. On the equilibrium of exchange rate, the author remarked that such rates ensures the simultaneous attainment of internal and external balance. Exchange rate policy involves choosing where foreign transaction will take place(Obadan,1996). Exchange rate policy is therefore a component of macroeconomic management policies the monetary authorities in any given economy uses to achieve internal balance in medium run. Specifically internal balance means the level of economic activity that is consistent with the satisfactory control of inflation. On the contrary, external or sustainable current account deficit financed on lasting basis expected capital inflow.
In Nigeria, exchange rate has changed within the time frame from regulated to deregulated regimes. Ewa, (2011) agreed that the exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom era and when agricultural products accounted for more than 70% of the nation’s gross domestic products (GDP). In 1986 when Federal government adopted Structural Adjustment Policy (SAP) the country moved from a peg regime to a flexible exchange rate regime where exchange rate 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). This inconsistency in policies and lack of continuity in the exchange rate policies aggravated unstable nature of the naira rate (Gbosi, 2005).
It is important to know that economic objectives are usually the main consideration in determining the exchange control. For instance from 1982 – 1983, the Nigerian currency was pegged to the British pound sterling on a 1.1 ratio. Before then, the Nigerian naira has been devalued by 10%. Apart from these policy measures discussed above, the Central Bank of Nigeria (CBN) applied the basket of currencies approach from 1979 as a guide in determining the exchange rate which was determined by the relative strength of the currencies of the country’s trading partner and the volume of trade with such countries. Specifically weights were attached to these countries with the American dollars and British pound sterling on the exchange rate mechanism (CBN, 1994). One of the objectives of the various macroeconomic policies adopted under the structural adjustment program me (SPA) in July, 1986 was to establish a realistic and sustainable exchange rate for the naira, this policy was recommended in 1986 by the International Monetary Fund (IMF). On exchange mechanism and was adopted in 1986.
The key element of structural adjustment program me (SAP) was the free market determination of the naira exchange rate through an auction system. This was the beginning of the unstable exchange rate; the government had to establish the foreign exchange market (FEM) to stabilize the exchange rate depending on the state of balance of payments, the rate of inflation, Domestic liquidity and employment. Between 1986 and 2003, the federal Government experimented with different exchange rate policies without allowing any of them to make a remarkable impact in the economy before it was changed. This inconsistency in policies and lack of continuity in exchange rate policies aggravated unstable nature of the naira rate (Gbosi, 1994).
Benson and Victor, (2012) and Aliyu, (2011) noted that despite various efforts by the government to maintain a stable exchange rate, the naira has depreciated throughout the 80’s to date. Against this background, this research study intends to investigate the impact of exchange rate fluctuation on economic growth in Nigeria over a period of 33 years (1981 – 2014).
1.2 Statement of the Problem
According to mohanty and bhaumurthy (2014)exchange rate stability is crucial for inflation management as a stable rate is expected to reduce domestic inflation pressures through a policy discipline effect restricting money supply growth , and credibility effect inducing higher money demand and reducing the velocity of money. However they note that the impossibility trillium predicts that in the presence of an open capital account a stable exchange rate may lead to lack of control on monetary policy and hence a higher inflation. The effects of high inflation on the economy are generally considered to be harmful. For an open economy as Nigeria, inflation comes from both domestic factors (internal pressures) and overseas factors(external pressures). The external factors results from increase in the world prices of commodities or fluctuations in the real exchange rate. However the influence of exchange rate on inflation is a function of the exchange rate regime as practiced in Nigeria. Fluctuation in the real exchange rate has a major impact on output and prices through the aggregate demand and supply channels. On the supply side, depreciation or devaluation of domestic currency affects the price level and output directly through the importation of goods in which case the country is an international price taker. Indirect effect of depreciation or devaluation is transmitted through the price of capital goods imported by manufacturers as inputs in the production process. Since the 1970s policy makers has been saddled with the responsibility of reducing and stabilizing the inflation rate. Exchange rate arrangement over the years in Nigeria has undergone significant changes over the past three decades making exchange rate policy one of the macroeconomic issues of our time. According to Rustastara(2004), available data from Central Bank of Nigeria shows that inflation is persistent under various exchange rate arrangements in Nigeria (2013). The exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom. This was also the situation prior to 1990 when agricultural products accounted for more than 70% of the nation’s gross domestic products (GDP) (Ewa, 2011). However, from 1981 the world oil market started to deteriorate and with its economic crises emerged in Nigeria because of the country’s dependence on oil sales for her export earnings. To underline the importance of oil export to Nigerian economy, the gross national product (GNP) fell from $76 billion in 1980 to $40 billion in 1996, a number of economic growths became negative as a result of the adoption of structural adjustment program me (SAP).
For instance, the exchange rate moved from N8.04 to $1 in 1990 to N22.05 and N81.65 to a dollar in the same period. When the inflation rate dropped from 72.8 per cent in1995 to 29.3 per cent and 8.5 per cent, in 1996 and 1997 respectively, and rose thereafter to 10.0 per cent in 1998 and averaged 12.5 per cent in 2000- 2009, the exchange rate trended in the same direction. A similar trend was observed for fiscal deficit/GDP ratio and GDP growth rate.
Nigeria’s exchange rate has been more volatile in the post-SAP period due to its excessive exposure to external shocks. The effect of the recent global economic meltdown on Nigerian exchange rate was phenomenon as the Naira exchange rate vis-à-vis the Dollar rose astronomically from about N120/$ to more than N180/$ (about 50% increase) between 2008 and 2009. This is attributable to the sharp drop in foreign earnings of Nigeria as a result of the persistent fall of crude oil price, which plunged from an all time high of US$147 per barrel in July 2007 to a low of US$45 per barrel in December 2008 (CBN, 2008). Although various factors have been adduced to the poor economic performance of Nigeria, it is necessary to examine the growth process of Nigeria under the various exchange regimes that had been adopted in the country, the effect of inflation and interest rate and impact of trade. Nigeria’s over dependent on importation and less emphasis in manufacturing local goods and services depreciated the value of the naira. In summary, a tentative conclusion emerging from the trend analysis is that exchange rate movements engender inflation and there is some association between exchange rate movements and economic growth.
1.3 Research Questions
In the course of the study, the stated question below is sought to be answered.
(1) To what extent has exchange rate fluctuation impacted on Nigeria’s economic growth from 1981-2014.
- Objective of the Study
The objective of the study is to examine the relationship between exchange rate fluctuations and economic growth of Nigeria. However, the specific goal is to:
(1) Evaluate impact of exchange rate fluctuations on economic growth of Nigeria from 1981-2014.
1.5 Research Hypothesis
Based on the objectives of the study, the hypothesis was formulated.
Ho: Exchange rate fluctuation has no long run significant impact on the Nigerian economic growth within the period 1981-2014.
1.6 Significance of the study
The significance of this research work lies in the fact that if the cause of the unstable exchange rate of the naira is identified and corrected, the economy will rapidly grow and develop into an advance one. This is so because if the unstable exchange rate of naira is proved to be affecting the economic growth badly, attempts should be made to stabilize the exchange rate. This is because these variables are gauge for the measurement of growth of any economy. Importantly, this study would help the government and the central bank of Nigeria (CBN) to identify the strength and weakness of each exchange system and hence adopt the policy that suits the economy best. This will definitely enhance growth and development of the economy, the study will also serve as a guide to future researchers on this subject.
1.7 The Scope and limitation of the Study
This research work is designed to cover the period 1981-2014 a period of 33 years. The scope consist of the regulatory and deregulatory exchange rate period i.e. the fixed exchange rate and the floating exchange rate period. The study is based on exchange rate fluctuation of Nigeria’s economy with its impact on economic growth in the country.
The study is structured to evaluate the Nigeria’s exchange rate as the pivot of economy growth. The study is therefore limited to the core economic growth in Nigeria and not the socio- political factors of the foreign exchange rate. More so, the model was restricted to Gross Domestic Product (GDP), Exchange Rate (EXR) and Non oil Exports (NOE).
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