IMPACT OF EXCHANGE RATE ON THE NIGERIA’S BALANCE OF PAYMENT

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Exchange rate fluctuations have been of serious concern to the monetary authorities, policy makers and business tycoons of developing countries, Nigeria inclusive because of the relevance of exchange rate in international trade, investment and in determining the level of output growth of a country. The movement of goods and services across national frontiers in one direction involves the movement of foreign exchange in the opposite direction. This creates the needs for a rate of exchange between the currencies of two trading partners to settle indebtedness arising from trade involving them (Nzotta, 2004).Exchange rate is a price at which a currency is regulated in the market, which varies at one time or the other. In other words, it links domestic prices with international prices. Through its effects on the volume of imports and exports, exchange rate exerts a powerful influence on a country’s balance of payments position. Paul (1996) defines balance of payments as an accounting record to all monetary transactions between a country and the rest of the world. These transactions include payments for the country’s exports and imports of goods, services and financial capital, as well as financial transfer. It summarizes the international transaction for a specific period usually one year and is prepared in single currency for the country concerned. Consequently, nations in the pursuit of the macroeconomic goals of healthy external balances as reflected in their balance of payments (BOP) position, find it imperative to enunciate an exchange rate policy.

Exchange rate is a key determinant of the balance of payments (BOP) position of any country. If it is judiciously utilized, it can serve as nominal anchor for price stability. Changes in exchange rate have direct effect on demand and supply of goods, investment, employment as well as distribution of income and wealth.

Exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom era and whenagricultural productslike cocoa, palm oil, groundnut, rubber etc accounted for more than 70% of the nation’s gross domestic products (GDP). During this period prior to 1986, Nigeria was on a fixed exchange rate determination system. At that time, naira was very strong in reference to dollar. The exchange rate was to one U.S dollar that is:#1 = $1. The increasing demand for foreign exchange allocation in consonance with the goal of internal balance made the fixed exchange rate determination system to be discarded in September, 26 1986 while the structural Adjustment programme (SAP) came in. One of the objectives of the various macro – economic policies adopted under the structural adjustment programme (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) on exchange mechanism and was adopted in 1986 (Ewa, 2011:78).

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 impact 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).

In Nigeria, exchange rate has changed within the time frame from regulated to deregulated regimes. During the time of fixed exchange rate, the movement of exchange rate seemed to be stable but the economy were getting worse every day, the alarming deterioration of the economy and huge balance of payments deficits called for a change, hence the switch over to flexible exchange rate. The irony of this policy instrument is that our foreign trade structure did not satisfy the condition for a successful balance of payment policy. The country’s foreign structure is characterized by export of crude petroleum and agricultural produce whose prices are predetermined in the world market and low import and export price elasticities of demand. Hence the management of the floating exchange rate has not proved better as the naira deteriorates everyday and many macroeconomic variables are not stable (Anifowose, O.K.1994). .

          Therefore, the effects of various macroeconomic shocks and Balance of payment position depends on the exchange rate policy adopted by the country, it is therefore of importance to investigate the effects of exchange rate on the balance of payment of Nigeria and also the factors that influence exchange rate in Nigeria.

1.2 Statement of Problem

Right from time immemorial, a country’s exchange rate and balance of payment is usually regarded as the sum of indices by which a nation’s strength can be measured especially its economic strength. They are also factors to look into when comparing a country’s relationship with other nations. These factors directly or indirectly affect a host of other factors

However, in recent times in Nigeria, these variables have experienced staggering difficulties. This cannot be argued considering the fact that Nigeria as a nation conduct their foreign transactions with the use of the united states dollar (USD) which is only gotten from the exports the country make to other nations.

Nigeria being a mono-product export country tends to export oil as it major exports after its discovery in 1970s while neglecting the agricultural sector which used to be its major exports. The price and quantity of the oil products been exported by Nigeria however is exogenously determined by the organization of petroleum exporting countries (OPEC) this means that the quantity been sold as well as the price are not determined by the Nigerian authorities. Moreover, the country is an import dependent country as they import 95% of the commodities consumed in the country. This implies that the forex generated from the export of oil cannot equate the forex spent on the importation of foreign commodities and this tends to move the exchange rate of the naira currency to that of other countries in a negative direction. Which directly affect the balance of payment of the country in negative forms.

          Also, the country resorts to borrowing in order to finance their annual budget deficit and afterwards spends a greater percentage of the countries inflows in financing the loans incurred. This also affects the balance of payment of the country terribly.

1.3 Research Questions

The extent to which exchange rate affects Balance of Payment in Nigeria remains unclear and therefore forms part of the problem which the research work intend to study considering the following questions:

1.     What is the impact of exchange rate on the Balance of Payment of Nigeria?

2.     What is the relationship exists between exchange rate and Balance of Payment of Nigeria?

3.     What is the causality relationship between exchange rate and balance of Payment of Nigeria?

1.4 Objective of the Study

Owing to the above listed research questions, the general objective of this study is to determine the impact of exchange rate on Nigeria’s Balance of payment. The specific objectives are to:

1.     Examine the impact of exchange rate on the Balance of Payment in Nigeria.

2.     Ascertain the relationship that exists between exchange rate and Balance of Payment in Nigeria.

3.     Obtain the causality relationship that exists between exchange rate and balance of Payment of Nigeria.

1.5 Hypothesis of the Study

Derived from the objective of this study, the following hypothesis will be evaluated.

1.     H0: Exchange rate has no significant impact on balance of payment in Nigeria.

2.     H0: Exchange rate has no relationship with balance of payment in Nigeria.

3.     H0: Exchange rate has no causality relationship with balance of payment in Nigeria

1.6 Significance of the Study

The result of this study will be beneficial to a wide range of audience, such as the following:

Policy Makers- This study will be of immense benefits to policy makers as it would assist them in the task of policy formulation by providing empirical evidence for their decision making concerning the roles of exchange rate in the balance of payment of Nigeria.

Government- The federal government will also find this study relevant as it will assist in making appropriate policies that will stabilize the exchange rate of the country or reduce the fluctuation to the barest minimum.

Subsequent Analysts- This investigation will also serve as a stepping stone for researchers who develop interest in carrying an empirical analysis on the impact of exchange on balance of payment.

Students- Students will find this piece highly relevant as it will undeniably increase their horizon and add to their existing stock of knowledge on the concept of exchange rate and its relationship with balance of payment.

1.7 Scope and Limitations of the Study

This study seeks to determine the impact of exchange rate on the balance of payment in Nigeria. The study is designed to cover a period of 36 years ranging from 1980 to 2016. The study is made up of five chapters, the chapter one which contains the introduction, chapter two concerned with literature reviews; chapter three covers the methodology of the study while chapter four focuses on the results and interpretations and chapter five on the summary and conclusion of the research work.

In the course of this work the researcher has been confronted with the difficulty in generating a valid time series data. In case where data is available, discrepancies between data on a variable from different sources still persist. The researcher was also confronted with technical problems such as lack of power supply to ensure a smooth running of the study.