Project – MACROECONOMIC IMPACT OF EXCHANGE RATE FLUCTUATIONS IN NIGERIA

ABSTRACT

This research work is centred on the Macroeconomic Impact of Exchange Rate Fluctuations in Nigeria with special emphasis on purchasing power of the average Nigeria and the level of international trade transaction. Without exchange rate the exchange of goods and services among trading partners will be faced with a lot of problems, which may virtually narrow it down to trade by barter. This exchange also is used to determine the level of output growth of the country. Hence, the rate at which exchange fluctuates calls for a lot of attention. However, with already existing exchange rate policies, a constant exchange rate has not been attained. The rate by which exchange rate fluctuates brings about uncertainty in the trade transaction, and also the rate of naira has been unleashed and continues to depreciate. This has resulted to declines in standard of living of the population increase in costs of production (this is because most of the raw materials needed by industries are usually imported), which resulted in cost-push inflation. We made use of many tests, like the t-statistics table, f-statistic table and the chi-square etc. When we found out real exchange rate has a positive effect on the GDP.

CHAPTER ONE

1.0       INTRODUCTION

1.1       BACKGROUND OF THE STUDY

The exchange rate is perhaps one of the most widely discussed topic in Nigeria today. This is not surprising given its macro-economic importance especially in a highly import dependent economy as Nigeria (Olisadebe, 1995:20). Macroeconomic policy formulation is a process by which the agencies responsible for the conduct of economic policies manipulate a set of instrumental variables in order to achieve some desire objectives.

In Nigeria these objectives include achievements of domestic price stability, balance of payment equilibrium, efficiency, equitable distribution of income and economic growth and development. 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 overhead implies both structural and functional transformation of all the economic indexes from a low to a high state (Siyan, 2000:150) one of the macro –economic variables of importance is the exchange rate policy country.

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 mean 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.

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 ration. Before then, the Nigerian naira has been devalued by 10%. Apart from this policy measures discussed above, the Central Bank of Nigeria (CBN) applied the basket of currencies approach from 1979 as the guide in determining the exchange rate 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 macro– economic policies adopted under the structural adjustment programme (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 programme (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 effect in the economy before it was changed. This inconsistency in policies and lack of continuity in exchange rate policies aggregated unstable nature of the naira rate. (Gbosi, 1994:70).

1.2   STATEMENT OF THE PROBLEM

The exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom er (regulatory require). 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, 2011:78).

However, as a result of the development in the petroleum oil sector, in 1970’s the share of agriculture in total exports declined significantly while that of oil increased. However, from 1981 the world oil market started to deteriorate and with it’s 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 growth became negative as result of the adoption of structural adjustment programme (SAP).

This major problem which this study is designed to solve is whether the exchange rate has any bearing on Nigerians economic growth an d development. While some Economist dispute the ability of change in the real exchange rate to improve the trade balance of developing countries (Hinkle, 1999:21) because of elasticity of their low export, others believe that structural policies could however change the long-term trends in the terms of trade and the prospects for export led growth. Instabilities of the foreign exchange rate is also a problem to the economy.

1.3. Aim and Objectives of the Study

The aim of the study is to examine the Macroeconomic Impact of Exchange Rate Fluctuations in Nigeria. The specific objectives are:

1. To analyze the relationship between inflation rates and exchange rate fluctuations in Nigeria.
2. To investigate how interest rate affect the exchange rate fluctuations in Nigeria.
3. To assess the relationship between economic growth and exchange rate fluctuations in Nigeria.
4. To find out the effect of Gross Domestic Product (GDP) on exchange rate fluctuations in Nigeria.

1.4.  Research Questions

The research questions are buttressed below:

1. What is the relationship between inflation rates and exchange rate fluctuations in Nigeria?
2. How do interest rates affect exchange rate fluctuations in Nigeria?
3. What is the relationship between economic growth and exchange rate fluctuations in Nigeria?
4. To what extent will Gross Domestic Product (GDP) affect exchange rate fluctuations in Nigeria

1.4 FORMULATION OF THE RESEARCH HYPOTHESIS

Based on the objectives of the study, the following hypothesis were formulated.

Ho: Exchange rate fluctuation has no significant effect on Nigeria economic growth and development.

Hi: Exchange rate fluctuation has a significant effect on Nigerians economic growth and development.

1.5 SIGNIFICANCE OF THE STUDY.

Economic Stability and Growth: Understanding the macroeconomic impact of exchange rate fluctuations in Nigeria is crucial for maintaining economic stability and fostering growth. Exchange rates influence the cost of imports and exports, which in turn affects the trade balance. For a country like Nigeria, which is heavily reliant on oil exports, fluctuations in the exchange rate can significantly impact revenue. A stable exchange rate can help in planning and executing long-term economic policies, thereby promoting sustainable economic growth.

Inflation Control: Exchange rate fluctuations can have a direct impact on inflation. When the Nigerian Naira depreciates, the cost of imported goods and services rises, leading to higher overall price levels. This imported inflation can erode purchasing power and reduce the standard of living for Nigerian citizens. By studying these impacts, policymakers can devise strategies to mitigate inflationary pressures, such as implementing monetary policies that stabilize the exchange rate or diversifying the economy to reduce dependency on imports.

Investment Decisions: Both domestic and foreign investors closely monitor exchange rate movements as they affect the returns on investment. A volatile exchange rate can deter foreign direct investment (FDI) due to the increased risk of currency depreciation. Conversely, a stable and predictable exchange rate environment can attract investment by providing a more secure economic climate. Understanding the macroeconomic implications of exchange rate fluctuations can help Nigeria create a more attractive investment environment, boosting economic development.

Debt Management: Nigeria, like many developing countries, has a significant amount of external debt. Exchange rate fluctuations can affect the cost of servicing this debt. A depreciation of the Naira means that more local currency is required to meet foreign debt obligations, which can strain public finances. By studying the impact of exchange rate movements, Nigeria can better manage its debt portfolio and develop strategies to minimize the risks associated with currency depreciation, such as hedging or negotiating more favorable terms with creditors.

Competitiveness of Local Industries: Exchange rate fluctuations can affect the competitiveness of Nigerian industries in the global market. A weaker Naira can make Nigerian goods cheaper and more attractive to foreign buyers, potentially boosting exports. However, it can also increase the cost of imported raw materials and intermediate goods, which can hurt local manufacturers. By understanding these dynamics, policymakers can support industries that are likely to benefit from a weaker currency while providing assistance to those that may be adversely affected.

Policy Formulation and Implementation: Finally, a thorough understanding of the macroeconomic impact of exchange rate fluctuations is essential for effective policy formulation and implementation. Policymakers need to consider the multifaceted effects of exchange rate movements on various sectors of the economy. This knowledge can inform decisions on monetary policy, fiscal policy, and trade policy, ensuring that they are well-coordinated and effective in achieving economic stability and growth. By studying these impacts, Nigeria can develop more robust and resilient economic policies that can better withstand external shocks.

In summary, the significance of studying the macroeconomic impact of exchange rate fluctuations in Nigeria lies in its ability to inform and guide economic policy, promote stability, attract investment, manage debt, and enhance the competitiveness of local industries.

1.6       LIMITATIONS OF THE STUDY

The study is structured to evaluate the Nigeria exchange rate as the pilot of economy growth and development. The study is therefore limited to the core economic growth in Nigeria and not the socio-political factors of the foreign exchange rate.

1.7       THE SCOPE OF THE STUDY

The study examines the Macroeconomic Impact of Exchange Rate Fluctuations in Nigeria. 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 core macro-economic performance of Nigeria between 1980-2010 more so, it rests can core economic growth and development in Nigeria for the period of thirty-one years.

1.8. OPERATIONAL DEFINITION OF TERMS

1. Macroeconomic: This term refers to the branch of economics that studies the behavior, performance, and structure of an economy as a whole. It focuses on aggregate changes and large-scale economic factors such as national income, gross domestic product (GDP), unemployment rates, inflation, and overall economic growth. Macroeconomic analysis is crucial for understanding how different sectors of the economy interact and how policies can influence economic stability and growth.
2. Impact: In the context of economics, “impact” refers to the effect or influence that one variable or event has on another. For example, the impact of exchange rate fluctuations on a country’s GDP would involve examining how changes in the exchange rate affect the overall economic output of that country. Impact assessments are essential for policymakers to understand the potential consequences of economic decisions and external shocks.
3. Exchange Rate Fluctuations: This term describes the variations in the value of one currency relative to another over time. Exchange rates can fluctuate due to a variety of factors, including changes in interest rates, inflation rates, political stability, and economic performance. These fluctuations can have significant implications for international trade, investment, and economic stability, as they affect the cost of imports and exports, foreign investment, and the value of foreign debt.
4. GDP (Gross Domestic Product): GDP is a measure of the total economic output of a country within a specific time period, usually a year or a quarter. It includes the value of all goods and services produced within a country’s borders. GDP is a key indicator of a country’s economic health and is used to compare the economic performance of different countries or regions. It can be measured in nominal terms (current prices) or real terms (adjusted for inflation).
5. Interest Rate: The interest rate is the cost of borrowing money or the return on investment for savings, usually expressed as a percentage. Central banks, such as the Central Bank of Nigeria, set benchmark interest rates to influence economic activity. Changes in interest rates can affect consumer spending, business investment, inflation, and exchange rates. Higher interest rates typically attract foreign investment, leading to an appreciation of the currency, while lower interest rates can have the opposite effect.
6. Inflation Rate: The inflation rate measures the rate at which the general level of prices for goods and services is rising, and subsequently, how purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly. The inflation rate is usually calculated on an annual basis and is an important indicator of economic stability. High inflation can erode purchasing power and savings, while deflation can lead to reduced consumer spending and economic stagnation.
7. Real Exchange Rate (RER): Real exchange rate is that which measures the relative price indicators we have in terms of economic international competiveness, that is to know the extent of international competitiveness. The real exchange rate measures both changes in nominal exchange rate and change relative inflation rate (Obadan, 1994). It is the rate of the price level.

It is also a relative price between you as domestic partner abroad, therefore, it is the rate of the price indicator between the tradable and non-tradable goods.

8. The Nominal Exchange Rate(NER):The nominal exchange rate (NER) is the derivation of the nominal exchange rate index differential ratio relationship to the base exchange rate where the value of the trade weight index of the country under consideration is of importance in computing the indices of all countries (Hinkle and Monties, 1999). The basis of computation of the nominal effective exchange rate index is the average of trade volume of a country (i.e. the value of important export) over a given period of time expressed as a ratio of the average total of the trade volume currencies which are included in the basket.
9. The purchasing power parity (PPP): It is important to know that the Purchasing Parity (PPP) is a major component of the monetary approach. The PPP between two currencies Gustav Cassel is defined as the amount of purchasing power. The purchasing power parity (PPP) is a long-term approach used in the determination of equilibrium exchange rate. It is often applied as a proxy for the monetary model in exchange rate analysis (CBN, 1998). Suppose there was only one commodity for eg. Bread and suppose that a loaf of bread cost $1:00 in USA, £1:00 in Britain and ₦1:00 naira in Nigeria, the exchange of dollar to pound and to naira will be express as $1:00 : £ 1:00 if this is not so, it will be impossible to purchase goods at low prices in one country and result the higher prices in another country.

Project – MACROECONOMIC IMPACT OF EXCHANGE RATE FLUCTUATIONS IN NIGERIA