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PROJECT TOPIC AND MATERIAL ON IMPACT OF EXCHANGE RATE FLUCTUATIONS ON THE NIGERIAN ECONOMIC GROWTH
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- Name: IMPACT OF EXCHANGE RATE FLUCTUATIONS ON THE NIGERIAN ECONOMIC GROWTH
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The deterioration of the nation’s output growth is alarming and exchange rate fluctuations has been attributed as one of the causative factors and this calls for policies that are designed to keep the real exchange rate highly competitive in order to promote exports and output growth. The purpose of this study is to analyze the impact of exchange rate fluctuations on the Nigerian economy spanning from the period 1980 – 2014. The data used in the analysis is a secondary data sourced from the Central Bank of Nigeria Statistical Bulletin and the World Bank Online Data. The ADF unit root test was employed to test for the stationarity of all the macro economic variables employed for the study and the result showed that all the variables tested were not stationary at level and were stationary only at first difference. The Johansen Co-integration test was employed to test for co-integration and the result showed that there is co-integration among the variables. The ARCH/GARCH analysis was also conducted and it produced a result whose coefficient indicates that exchange rate fluctuations significantly influence economic performance in Nigeria. The empirical findings suggest that exchange rate is a necessary and sufficient policy instrument for influencing gross domestic product growth rate. The study concludes that exchange rate fluctuation has proven to influence gross domestic product in Nigeria positively between the study period. Hence, it becomes pertinent that monetary authorities should adopt measures that will strengthen the naira against other currencies and also the government should provide good business operating environment that will enhance Foreign Direct Investment which will promote economic growth in Nigeria.
- Background to the Study:
Exchange rate can be defined as the price of one country’s currency expressed in terms of some other currency. It expresses the relative prices of domestic and foreign goods as well as the strength of the external sector participation in the international trade.
Exchange rate is an important variable as its appreciation or depreciation affects the economic performance or other macroeconomic variables in any economy. Its value can be used to assess the overall performance of an economy.
It is also a very important variable in policy decision making of an economy. Any government at any point in time seeks the stability of the exchange rate because it provides economic agents the opportunity to plan ahead without fear of varying costs and prices of goods and services. On the other hand, instability of exchange rate can cause a negative distortion in any economy (Hashim and Zarma, 1996). Exchange rate influences the flow of goods and services and capital in a country and exerts strong pressures on the balance of payments, inflation and other macroeconomic variables.
Exchange rate is associated with inflation which represents persistent increase in the general price level of goods and services in a particular economic setting. Exchange rate exerts strong influence on the economic growth and a country’s stability through its effect on the value of domestic currency, inflation, the external sector, macroeconomic credibility, capital flow, balance of payment and other macroeconomic variables.
Economic growth refers to the continuous increase in a country’s national income or the total volume of goods and services, a good indicator of economic growth is the increase in Gross National Product (GNP) over a long period of time. Economic development on the other hand implies both the structural and functional transformation of all the economic indexes from a low to a high state. Economic growth can also be defined as the increase in the goods and services produced by an economy, typically a nation, over a long period of time. It is measured as percentage increase in real gross domestic product (GDP) which is gross domestic product (GDP adjusted for inflation).
Choice and management of an exchange rate regime is a critical aspect of economic management to safeguard competitiveness, macroeconomic stability and growth. One of the surest ways to achieve afore-stated goals is to pursue vigorously rapid and sustainable economic growth and development via well managed exchange rate policy (Obi, Oniore & Nnadi, 2016). Rodrick (2007) in recognition of this crucial role of the exchange rate policy argues that poorly managed exchange rates can be disastrous for a nation’s economic growth. The exchange rate thus, serves as an international price for determining the competitiveness of a country. Similarly, Takaendesa (2006) explains that exchange rate plays a crucial role in guiding the broad allocation of production and spending in the domestic economy between foregoing and domestic goods. Therefore, in order to achieve a rapid and sustainable economic growth, the exchange reform adopted by the country’s monetary policy must put the economy on the path of macroeconomic stability and sustainable development.
Exchange rate fluctuations have remained an important issue of discourse both in international finance as well as in developing nations like Nigeria. This is 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 despite the fact that the country embarked on devaluation to promote export and stabilize the rate of exchange. The failure to realize this goal was not only necessitated by the devaluation of the naira but the weak and narrow productive base of the economy, also the rising import bills also strengthened it. In order to ensure a stable exchange rate, the monetary authority has put in place a plethora of exchange rate policies and these policies vary depending on the type of exchange rate arrangement adopted.
Exchange rate arrangements are broadly classified into three namely: fixed or pegged arrangements, flexible arrangements and in-between category of arrangements with “limited flexibility”. Each variety or alternative has different implications which determine the extent to which countries participate in foreign exchange markets. When a monetary authority decides to fix exchange rates against other countries, they make a commitment to intervene in the market, buying and selling their currency whenever necessary to keep the exchange rate from changing. When, on the other hand, the monetary authority abstains completely from intervening in the market for exchange rates, they have chosen to let their exchange rates float freely (Eze &Okpala, 2014). Exchange rate policy formulations aim at evolving real exchange rate (RER) that maintains internal and external balance in any economy. Internal balance is defined in terms of the level of economic activities consistent with satisfactory control of inflation and full employment of resources. External balance on the other hand is defined in terms of balance of payments equilibrium or sustainable current account deficit financed on a lasting basis by expected capital inflow ( Dernburg McDougall, 1980).
Exchange rate policy in Nigeria has oscillated basically between the fixed exchange rate system since the immediate post independence era 1960 and then from 1986 when a market based exchange rate system was introduced in the context of the Structural Adjustment Programme (SAP). The Nigerian exchange rate policy developed from a fixed parity in 1960 when it was solely tied with the British Pound Sterling. By 1967, following the devaluation of the Pound Sterling, the U.S. dollar was included in the parity exchange. In 1972, the parity exchange with the British pound was suspended as a result of the emergence of a stronger U.S. dollar. In 1973, Nigeria reversed to a fixed parity with the British Pounds following the devaluation of the U.S. dollar. In 1974, in order to minimize the effect of devaluation of a single individual currency, Nigerian currency was tied to both the pound sterling and the U.S. dollar. Almost throughout the 1970’s, there was persistent appreciation of the nominal exchange rate of the naira occasioned by increase in the price of oil in the international market. These appreciations in the nominal exchange rates gave rise to over reliance on imports with its accompanying capital flight, discouraging non-oil exports which ultimately led to balance of payments problems and depletion of external reserves. With the increase in marginal propensity to import, according to Kandil (2004), the agricultural sector in Nigeria collapsed. In 1978, the naira was pegged to a basket of 12 currencies comprising Nigeria’s major trading partners. However, the 1978 policy was jettisoned in 1985 in favour of quoting the naira against the dollar. Before, 1986, the prevailing exchange rate policies encouraged over-valuation of the naira.
To solve the problem associated with the over-valuation of the naira, naira was deregulated in September 1986 under the Structural Adjustment Program, and then the Second-tier Foreign Exchange Market (SFEM) was introduced. The essential objectives of SFEM as stated by Mordi (2006) include: to achieve a realistic naira exchange rate through the market forces of demand and supply; more efficient allocation of resources; stimulation of non-oil efforts; to encourage foreign exchange inflow and discourage outflow; eliminate currency trafficking by wiping out unofficial parallel foreign exchange markets; and then to improve on the country’s balance of payments.
Several modifications were made in order to achieve the objectives of the SFEM, from Foreign Exchange Market (FEM) to Autonomous Foreign Exchange Market (AFEM) to Dutch Auction System. The FEM was introduced as a result of the problem arising from the first and the second tier market rates in July 1987. Bureau de Change was introduced in 1989 with a view to enlarging the scope of FEM. In 1994, the exchange rate system was reintroduced. In 1995, there was a policy reversal of guided deregulation referred to as the Autonomous Foreign Exchange Market (AFEM). In 1999, there was the introduction of the inter-bank foreign exchange market (IFEM). This brought about the merger of the dual exchange rate, following the abolition of the official exchange rate from January 1, 1999. In 2002, the re-introduction of the Dutch Auction System (DAS) as a result of the intensification of the demand pressure in the foreign exchange market and the persistence in the depletion of the country’s external reserves. Finally, was the introduction of wholesale DAS in 2006, which further liberalized the market in an attempt to evolve a realistic exchange rate of naira. Up till now, the exchange rate regime in Nigeria is characterized as oscillating between fully managed and freely floating regimes.
- Statement of the Problem
In Nigeria, a lot of strategies and exchange rate policies have been formulated by the Nigerian government under different exchange rate systems (that is both the fixed and flexible exchange rate system). Some of these policies include fixed parity with British Pound Sterling in 1960, Parity to both Pound Sterling and the US dollar in 1967, second-tier Foreign Exchange Market (SFEM) in 1986, introduction of the Autonomous Foreign Exchange Market (AFEM) in1995, Re-introduction of Inter-bank Foreign Exchange Market (IFEM) in 1999, Introduction of Wholesale Dutch Auction System in 2006 etc., all geared towards achieving a more stable exchange rate which in turn will reduce uncertainty in economic activity and thus increase total output. However, these exchange rate policies embarked by the government have not been able to achieve the objective for which it was introduced, in the sense that exchange rate keeps fluctuating. In the same vein, the economy has not been able to achieve any meaningful economic growth lately. It is against this backdrop, that this research work seeks to examine the nexus between exchange rate fluctuation and economic growth.
More so, numerous studies have been carried out on the impact of exchange fluctuation. However, most of the researchers adopted the ordinary least square estimation technique to study the relationship between exchange rate fluctuation and economic growth in Nigeria without capturing the volatility factor prevalent in the exchange rate collated data. This has also led to inaccurate results leading to inappropriate recommendations and conclusions; thereby leaving the problem of exchange rate fluctuation yet unsolved.
- Research Questions
- To what extent do exchange rate fluctuations impact on the Nigeria’s economic growth?
- Is there any long run relationship between exchange rate fluctuations and economic growth?
1.4 Objectives of the Study
The aim of this research is to examine the impact of exchange rate fluctuation on the gross domestic product and the researcher shall be guided by the following specific objectives.
- To find out if exchange rate fluctuation has significant impact on the Nigerian economic growth.
- To determine if there exist any long run relationship between exchange rate fluctuations and economic growth.
1.5 Research Hypothesis:
- H0: Exchange rate fluctuation has no significant impact on the Nigerian economic growth. H1: Exchange rate fluctuation has significant impact on the Nigerian economic growth.
- H0: There is no long run relationship between exchange fluctuation and economic growth.
H1: There is exist long run relationship between exchange fluctuation and economic growth.
- H0: Foreign direct investment has no significant impact on economic growth.
H1: Foreign direct investment has significant impact on economic growth.
1.6 Significance of the Study
The findings of this research work will be of immense importance to macroeconomic policy makers, firms, government, financial institutions and the general public in taking both microeconomic and macroeconomic decisions.
The findings from this study will be of great benefit to the Nigerian policy makers in the formulation of effective and efficient policies that will checkmate exchange rate fluctuations and instability as well as enhance rapid growth of the Nigerian economy.
This study will be beneficial to firms in taking decisions regarding the method to employ in production in order to circumvent or alleviate the negative impact of exchange rate fluctuations and efficiently utilize its positive impact. It will also be of immense help to firms in taking pricing decisions.
Importantly, the findings of this research work will help the government and the Central Bank of Nigeria (CBN) to identify the strengths and weaknesses of each foreign exchange system and hence adopt the policy that suits the economy best. This will definitely enhance the growth of the economy.
More so, this study will contribute to the existing literature on exchange rate and the Nigerian economic growth and provide an in-depth explanation on the impact of exchange rate fluctuation on the Nigerian economic growth. The study will also serve as a guide to future researchers on this subject.
1.7 Scope of the Study
This research work covered the period of thirty-five (35) years. The scope consists of the period of exchange rate regulation regime (1980 – 1985) and the period of regulation regime (1985 -2014) i.e. the fixed exchange rate and floating exchange rate period respectively.
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