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The Project File Details
This study analysed Forex Reserves and their impact on the economy of Nigeria using time series data from 1980 to 2016. The study utilized Multiple Linear Regression analysis, Augmented Dickey Fuller (ADF) Test for unit root, Johansen Cointegration Methods and other stability tests. The results of the Augmented Dickey Fuller test, showed that the data became stationary at the first difference thus, integrated of order one while the Johansen Cointegration method was used to test for the existence of long run relationship among the variables and the results showed that there is no long run relationship between forex reserves and economic growth. The results of the Multiple Linear Regression analysis showed that the estimated coefficient of the predictor variable, forex reserves (FOREX) was 0.76729. By implication, a unit increase in External reserves resulted to an increase in economic growth by 0.77% in Nigeria. The policy implication of this is that measures that will enhance the stability and accumulation of foreign reserves should be encouraged. In addition, variables like foreign direct investment (FDI), and Exchange rate (EXR) were all independent variables used as independent variables. FDI has a positive relationship on GDP while EXR has a negative relationship with GDP through their coefficients. It was recommended that accumulation of forex reserves will have long term benefits for the economy of Nigeria.
The relationship between foreign exchange reserves and world economies has increasingly received wide attention in literature. Several studies in the international context have evaluated the relationship between forex reserves and economic growth. In Nigeria, the case has been slightly different. Most studies in this very area have not actually looked into the impact of foreign reserves on growth of the economy. There exists very little contributions of this topic in literature reported in Nigeria. Most researchers in have actually done work on the relationship of reserves on variables such as inflation, exchange rates, interest rates and crude oil price.
Foreign exchange reserves are external assets that are readily available to and controlled by monetary authorities for direct financing of external payments imbalances and for directly regulating the magnitude of such imbalances through intervention in exchange markets to affect currency exchange rate and/or for other purposes (IMF,2001). The level of external reserve in a country is influenced by external sector developments such as international trade transactions, exchange rate, external debt and other related external obligations. However, when foreign reserves are used for financing domestic foreign exchange needs, they could exert pressures on the internal monetary environment. Thus, if a country’s trade volume increases, banks and other financial intermediaries may exert increasing pressure on her foreign reserves.
It is conventional for countries to hold foreign reserves in order to meet certain monetary policy targets. Governments around the world therefore hold these reserves for purposes such as safeguarding the value of local currency, timely meeting of international payment obligations and providing full back-up for unprecedented shocks in the economy. This has induced African countries to hold reserves to allow monetary authorities to intervene in markets to influence the exchange rate and inflation (Lapavitsas, 2007,Elhiraika and Ndikumana, 2007). Many African countries including Nigeria argued that adequate foreign reserves may allow them to borrow abroad, attract foreign capital and promote domestic private investment as a result of strengthened external position and reduced vulnerability to external shocks. Thus, it is believed that maintaining adequate reserves can boost investors’ confidence and enhance investment and growth (Elhiraika and Ndikumana, 2007).
The forex reserve of Nigeria from independence in 1960 increased but not in proportion to the high proceeds from crude oil exportation and other non-oil exports. From the period of structural Adjustment Programme (SAP) in 1986 to the oil boom period of 1970’s, not very much reserves have been accumulated compared to other growing economies of the world with similar experience.However, the holding of large reserves have double opinion, it is believed by many that it supports economic growth while a counter argument holds that it impedes growth. Countries like China, Japan, Switzerland and Saudi Arabia who are leading economies of the world have high forex reserves compared to other countries. Presently, China’s forex reserve is the highest in the world, (International Monetary Fund, 2016). A very important question in the context of Nigeria has remained unanswered, and that is: do foreign reserves have any impact on economic growth in Nigeria?
Many countries of the world have been holding large reserves in order to establish sovereign wealth funds (SWF) which are basically used for investment purposes which impact significantly on the economic growth of such country(the Nigeria SWF was set up in 2011). The Nigerian reserves have depleted on yearly basis, after reaching its highest point of $63 billion in 2008 (National bureau of statistics, 2008), the reserves slowly reduced and on the average has been reducing more compared to its increases. Does this depletion have any negative influence on the economic growth of the country?Dooley et al (2004) argued that “the resulting accumulation of foreign reserves can be seen as a collateral which is used for attracting foreign investment and as a self-insurance strategy for smoothening the vulnerability impact of shocks”. If this is the case, it therefore suggests that the low rate of Nigeria reserves has serious implications to the economy of the country.
What inspires this study is the need to provide empirical evidence to know whether the low level of reserves in Nigeria actually increases growth or reduces it. In other words, the study is set to examine the impact of forex reserves on the economy of Nigeria.
1.2 Statement Of The Problem
Forex reserves held by a country through its monetary authorities have been observed to play significant roles in the growth of the country’s economy. Certain postulations have been put forward by policy makers and authorities on the issue of reserve accumulation. In today’s world, large reserves partly symbolizes a country’s strength as it indicates strong backing of the domestic currency and attraction of foreign direct investment. Alternatively, they can be used for investment, revamping and sustaining or improving significantly an economy in the event of shocks like high inflation, recession or depression. In addition, their accumulation are made as insurance against shocks in foreign exchange rate and also for mercantilist purposes.
Developing economies of the world according to empirical studies are involved in massive accumulation of reserves, most especially the top leading Asian countries. The growth of these economies is largely attributable to the growth of their foreign reserves. Central bank reserves are seen as a last resort stock of foreign currency for unpredictable shocks which is consistent with the precautionary motive for holding foreign assets.
In Nigeria however, the forex reserves have been depleting and not being able to meet the expectations of shock absorbing, boosting the country’s credit worthiness, providing back-up for the naira, providing a buffer against external shocks and providing investment alternative. The forex reserves of the country are significantly low compared to that of other emerging economies like China and in proportion to the large proceeds from the sale of both oil and non-oil products. Does this situation have any effect on the economy? In consideration of the current economic situation of the country, what role do forex reserves play in the growth of the country?
Consequent on the foregoing research problem, this study addresses and answers to the following research questions;
The main objective of this study is to examine the impact of forex reserves on the economy of Nigeria. The specific objectives are:
The following research hypotheses are formulated in line with the research objectives stated above:
H0= Foreign exchange reserves do not have any impact on the GDP of Nigeria.
H1 = Foreign exchange reserves have impact on the GDP of Nigeria.
H0 = There is no long run relationship between Nigeria’s foreign exchange reserves and GDP.
H1 = There is a long run relationship between Nigeria’s foreign exchange reserves and GDP.
H0 = There are no variables affecting the level of reserves in Nigeria.
H1 = There are variables affecting the level of reserves in Nigeria.
1.6. Significance of the study
The strategic importance of forex reserves on the economy of Nigeria necessitates the relevance of its study in this particular work. The entire work done in this project is of immense benefit to monetary authorities and policy makers in the country. The foreign reserves management of a country is the responsibility of the central bank. Over the years, the CBN has come with the strategies of either accumulating or depleting reserves, however these policies have their implications. This research work will help provide a strong reserve management path for the CBN which will assist other government agencies to make well informed policies. In addition, it will provide other researchers with useful information and guide in further studies.
This study covers the period of 1986 to 2016. It also covers data on forex reserves, gross domestic product, exchange rate and foreign direct investment for the period under study. The period 1986 to 2016 is be chosen to capture the effect of Structual Adjustment Programme (SAP) of 1986.