EFFECT OF EXCHANGE RATE FLUCTUATIONS ON ECONOMIC GROWTH IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1       Background to the Study

Exchange rate is perhaps one of the most widely discussed subjects in Nigeria today. This is not surprising given its macroeconomic importance especially in a highly import dependent economy as Nigeria (Olisadebe, 1999). Exchange rate is one of the issues taken care of by macroeconomic policy of any nation. Macroeconomic policy formulation is a process by which the agencies responsible for the conduct of economic policies manipulate a set of  variables in order to achieve some desired  objectives.

In Nigeria, these objectives include achievement of domestic price stability, balance of payment equilibrium, efficiency, equitable distribution of income, economic growth and development. While economic growth refers to the continuous increase in a country’s national income or the total volume of goods and services, it is a good indicator of economic growth depending on its increased contribution in Gross National Product (GNP) over a long period of time. Economic development on the other hand, refers to both structural and functional transformation of all the economic indices from a low to a high state (Siyan, 2000).

Furthermore, another macro-economic variable of importance is the exchange rate policy. Exchange rate policy entails choosing where foreign transaction will take place (Obadan, 1996). As such, exchange rate policy is a component of macroeconomic management policies the monetary authorities in any given economy use to achieve internal balance in medium run.

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 the 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 (SAP) 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) as an exchange mechanism and was adopted same year.

Nevertheless, the idea behind the initiation of Structural Adjustment Program was the free market determination of the naira exchange rate through an auction system. Hence, the introduction of SAP was as a result of the unstable exchange rate thus, prompting government to establish the Foreign Exchange Market (FEM) to stabilize the exchange rate based on the state of balance of payments, the rate of inflation, domestic liquidity and employment. Progressively, between 1986 and 2003, the federal Government experimented 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 the   unstable nature of the naira (Gbosi, 1994).

1.2       Statement of the Problem

When a country trades in the   international market, fluctuation of prices in the world market could affect the growth and development of such a nation as the local currency and trade pattern of such a nation will be affected. This was also the situation prior to 1990 when agricultural products were predominantly the mainstay of the economy by accounting for more than 70% of the nation’s Gross Domestic Products (Ewa, 2011).

However, as a result of the discovery of oil in large quantities and the subsequent development of petroleum oil sector in the 1970s, the share of agriculture in total exports declined significantly while that of oil increased. From 1981, there were fluctuations in the world oil market which engineered a decline in world oil prices and with this economic crises emerged in Nigeria because of the country’s dependence on oil sales for her export earnings. To underscore  the importance of oil export to Nigerian economy, the GNP fell from $76 billion in 1980 to $40 billion in 1996, a number of economic growth indicators became negative as a result of the spiral downturn in world oil prices.

More so, while some foreign exchange literatures argue that the fluctuating exchange may not necessarily have a negative impact on a nation’s growth and development since the real exchange rate has the ability to improve the  balance of  trade  in an economy (Hinkle, 1999).Because of elasticity of their low export, others believe that fluctuating exchange rate could actually affect a nation’s economy hence the need for structural policies that could aid change in the long-term trends in terms of trade and the prospects of export. This study investigates these issues.

1.3       Objectives of the Study

The general objective of this study is to evaluate the effect of exchange rate on economic growth of   Nigeria. Nevertheless, the specific objectives of this study are to:

(1)      Examine the relationship between foreign exchange rate fluctuation and economic growth in Nigeria;

(2)      To assess the effects of foreign exchange rate fluctuation on economic  growth in Nigeria, and;

(3)        To find out the immediate factors responsible for foreign exchange rate fluctuation in Nigeria.

1.4       Research Questions

The following research questions were raised for this study:

1.      What is the relationship between foreign exchange rate fluctuation and economic growth in Nigeria?

2.      What is the effect of fluctuating exchange rate on Nigeria’s economic growth?

3.      What are the immediate factors responsible for foreign exchange rate fluctuation in Nigeria?

1.5       Research Hypotheses

Based on the objectives of the study, the following null hypotheses were formulated.

H01:      There is no relationship between foreign exchange rate fluctuation and economic growth and development in Nigeria.

H02:      Exchange rate fluctuation has no effect on Nigeria’s economic growth.

H03:      There are no immediate factors responsible for foreign exchange rate fluctuation in Nigeria.

1.6       Significance of the Study.

The findings of this study will be significant in utilizing the knowledge derived, in stabilizing the economic growth of the economy. This will be achieved if the cause of the unstable exchange rate of the naira is identified and addressed thus, aiding the economy to rapidly grow and develop into an advanced  one.  Importantly, this study would help the government and the central bank of Nigeria (CBN) to identify the strengths and weaknesses of each foreign exchange system towards adopting an exchange rate policy that suits the economy best as this will definitely enhance growth and development of the economy. This study will also serve as a guide to future researchers on this subject.

1.7       The Scope of the Study

The study investigated the impact of exchange rate on the economic growth of  Nigeria. The study’s key areas of concern are exchange rate, inflation rate and interest rate. This research work covered the period 1990 – 2015, a period of twenty-five years.

1.8       Limitation of the Study

The study was faced with a number of limitations which include;

inadequate data availability, the problem is experience by most developing economic such as Nigeria due to inability to keep records of transactions over a specific period, and this serves as a constraint to research generally.

The study was limited due to financial constraints which led to insufficient materials (i.e. Books, articles, etc).These limitations however are not sufficient to undermine the reliability of the information provided.

1.9       Definition of Terms

Fluctuation– Upward and downward changes in prices of goods and services.

Exchange Rate– the rate at which a currency purchases another.

Economic Growth– Increase in the productive capacity of a nation as measured by comparing its Gross National Product (GNP) in a year with GNP in the previous year.

Economic Development– A general improvement in the standard of living of a nation.

Foreign Exchange Market– A global decentralized market for the selling and buying of currencies.

Gross Domestic Product (GDP) –This the monetary value of all the finished goods and services produced within a country’s border in a specific period of time.