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THE EFFECT
OF EXCHANGE RATE FLUCTUATIONS ON THE NIGERIA ECONOMY
CHAPTER ONE
INTRODUCTION
1.0 BACKGROUND OF THE STUDY
Foreign
exchange is the means of payment for international transaction. It is made up
of convertible currencies that are generally accepted for the settlement of
international trade and other external obligation. Just like every other
commodity, a market is established which works more like any other market
having a supply curve, a demand curve and an equilibrium price and quantity.
There are also conditions which are held constant (creteris paribus). When
these conditions change, the curve shift and there is a change in the
equilibrium price quantity. This market for currencies is known as the foreign
exchange market.
The foreign exchange market
according to the central bank of Nigeria is the medium of interaction between
the sellers and buyers of foreign exchange. The seller of foreign exchange
constitutes the supply while the buyers of foreign exchange constitutes its
demand. The supply of foreign exchange is derived from oil exports, non-oil
export, expenditure of foreign tourist in Nigeria, capital repatriation by
Nigerians resident abroad etc.
The demand for foreign exchange on
the other hand consist of payments for imports, financial commitments to
international organizations, external debt service obligations etc.
Before 1958, when the central bank
was established and the enactment of the exchange control act of 1962, foreign
exchange was earned by the private sectors and held in balances abroad by
commercial banks which acted as agents for local exporters. Another feature of
this period was that agriculture exports contributed the bulk of foreign
exchange receipts. The fact that the British pound sterling was at par with the
Nigerian pound sterling with easy convertibility delayed the establishment of
an active foreign exchange market.
However by 1958, when the central
bank was established and subsequent centralization of foreign exchange
authority. In banks, the need for a local foreign exchange market is paramount.
Other factors that led to the evolution of the foreign exchange market in
Nigeria include:
The changing
pattern of international trade institutional changes in the economy. structural
shift in production, etc.
By the early 1970’s, the official
exchange receipt was enhanced following the sharp rise in prices and demand for
crude oil exports which had by now displaced agricultural exports. The foreign
exchange market experienced a boom during this period and there became a need
for the management of foreign exchange resources. However, it was not until
1982 that comprehensive exchange controls were applied.
The exchange control system failed
to evolve an appropriate mechanism for foreign exchange allocation. This led to
the development of a dual exchange rate system, comprising of the first and
second tier foreign exchange market which was adopted in September 1986. The
first tier was managed while the second tier was subjected to market forces.
Not only has there been a metamorphosis of the institutional frame work from
second tier foreign exchange market (SFEM) to foreign exchange market (FEM) to
inter bank foreign exchange market (IFEM) to Autonomous Foreign Exchange market
(AFEM) etc, there have been frequent changes in operational guidelines and
procedures. Various pricing methods, marginal and weighted average exchange
rates determinations and the Dutch Auction System (DAS) among other have also
been adopted.
All those aimed at ensuring more
efficient allocation and utilization of scarce foreign exchange resources, to
enhance the flow of capital into the country, stimulates domestic industrial
production, promote export, increase revenue to the government, help reschedule
our foreign debt at more profitable terms etc.
When there are fluctuations in
foreign exchange rates, various economic activities are usually affected such
as the purchasing power, balance of payment, prices of goods and services,
import structure, export earning, government revenue, external reserves among
others.
These prevailing instability in
exchange rates and its effects on various economic variables, will be the areas
of concentration of the research work.
1.2. STATEMENT OF THE PROBLEM
Since
September 1986, when the market determined exchange rate system was introduced
via the second tier foreign exchange market, the naira exchange rate has
exhibited the features of continuous depreciation and instability.
This instability and continued
depreciation of the naira in the foreign exchange market has resulted in
declines in the standard of living of the populace, increased cost of
production which also leads to cost push inflation. It has also tended to
undermine the international competitiveness of non-oil exports and make
planning and projections difficult at both micro and macro levels of the
economy. A good number of small and medium scale enterprises have been
strangled out as a result of low dollar/ naira exchange rate and so many other
problems resulting from fluctuations in exchange rates can also be identified.
This movement of the exchange rate
along the path of depreciation since 1986 has raised a lot of questions on the
impact of exchange rate policies on the Nigerian economy.
1.3 OBJECTIVES OF THE
STUDY
Objectives
of the study
i. To find out the impact of
exchange rate fluctuation on economic growth of Nigeria.
ii. To examine the nature of the
relationship between exchange rate fluctuations and economic growth in Nigeria.
iii. To offer some recommendations
based on the findings of the study.
1.4 FORMULATION OF
HYPOTHESES
For
meaningful findings, conclusions and recommendations, a set of testable
hypothesis based on available data will be necessary. In the course of this
research work, the following hypothesis would be tested.
Hi: Exchange
rate fluctuations has no significant impact on Nigeria Economy.
Hi: Exchange
rate fluctuations has significant impact on Nigeria Economy.
1.5 SIGNIFICANCE OF THE
STUDY
The study
would identify the strengths and weakness of exchange rate policy and
management, identify those economic variables that are mostly affected by
instability in exchange rate and provide the general public with the awareness
on the foreign exchange transaction and its impact on the economy.
The various
findings of this would enable the government and financial authorizes to
device, modify and adopt a better foreign exchange transaction for the economy.
1.6 DEFINITION OF TERMS :
1. Foreign Exchange
Foreign
exchange is a means of payment for international transactions. It is made up of
currencies of other countries that are freely acceptable in settling
international transactions.
2. Foreign exchange market :
This is a
medium of interaction among buyers and sellers of foreign- exchange with
a view of negotiating acceptable prices for settling international transaction.
3. Exchange rate – This is the price of one
currency in terms of another
4. SEMI- Second tier foreign exchange
market. Under this system the exchange rate is largely determined by market
forces.
5. AFEM – Autonomous foreign exchange
market. This exchange rate under this system
are being determined essentially through market forces.
6. IFEM – Inter bank foreign exchange
market.
7. Dutch auction system (DAS) – this is a
method of exchange rate determination through action where the bidders pay last
bid rate that clears the market.
8. Dual exchange rate regime- This situation
exist when two exchange rates are in existence in an economy.
9. Marginal pricing method: This is the
method in which bid rates are arranged in a descending order of magnitude. The
last bid rate at which available foreign exchange is exhausted (marginal rate)
is the applicable exchange rate.
10. Exchange control – This is a foreign exchange
arrangement in which the government purchase all incoming foreign exchange and
is the only source from which foreign exchange can be purchased legally.
CHAPTER
ONE
INTRODUCTION
2.0 BACKGROUND OF THE STUDY
Foreign
exchange is the means of payment for international transaction. It is made up
of convertible currencies that are generally accepted for the settlement of
international trade and other external obligation. Just like every other
commodity, a market is established which works more like any other market
having a supply curve, a demand curve and an equilibrium price and quantity.
There are also conditions which are held constant (creteris paribus). When
these conditions change, the curve shift and there is a change in the
equilibrium price quantity. This market for currencies is known as the foreign
exchange market.
The foreign exchange market
according to the central bank of Nigeria is the medium of interaction between
the sellers and buyers of foreign exchange. The seller of foreign exchange
constitutes the supply while the buyers of foreign exchange constitutes its
demand. The supply of foreign exchange is derived from oil exports, non-oil
export, expenditure of foreign tourist in Nigeria, capital repatriation by
Nigerians resident abroad etc.
The demand for foreign exchange on
the other hand consist of payments for imports, financial commitments to
international organizations, external debt service obligations etc.
Before 1958, when the central bank
was established and the enactment of the exchange control act of 1962, foreign
exchange was earned by the private sectors and held in balances abroad by
commercial banks which acted as agents for local exporters. Another feature of
this period was that agriculture exports contributed the bulk of foreign
exchange receipts. The fact that the British pound sterling was at par with the
Nigerian pound sterling with easy convertibility delayed the establishment of
an active foreign exchange market.
However by 1958, when the central
bank was established and subsequent centralization of foreign exchange
authority. In banks, the need for a local foreign exchange market is paramount.
Other factors that led to the evolution of the foreign exchange market in
Nigeria include:
The changing
pattern of international trade institutional changes in the economy. structural
shift in production, etc.
By the early 1970’s, the official
exchange receipt was enhanced following the sharp rise in prices and demand for
crude oil exports which had by now displaced agricultural exports. The foreign
exchange market experienced a boom during this period and there became a need
for the management of foreign exchange resources. However, it was not until
1982 that comprehensive exchange controls were applied.
The exchange control system failed
to evolve an appropriate mechanism for foreign exchange allocation. This led to
the development of a dual exchange rate system, comprising of the first and
second tier foreign exchange market which was adopted in September 1986. The
first tier was managed while the second tier was subjected to market forces.
Not only has there been a metamorphosis of the institutional frame work from
second tier foreign exchange market (SFEM) to foreign exchange market (FEM) to
inter bank foreign exchange market (IFEM) to Autonomous Foreign Exchange market
(AFEM) etc, there have been frequent changes in operational guidelines and
procedures. Various pricing methods, marginal and weighted average exchange
rates determinations and the Dutch Auction System (DAS) among other have also
been adopted.
All those aimed at ensuring more
efficient allocation and utilization of scarce foreign exchange resources, to
enhance the flow of capital into the country, stimulates domestic industrial
production, promote export, increase revenue to the government, help reschedule
our foreign debt at more profitable terms etc.
When there are fluctuations in
foreign exchange rates, various economic activities are usually affected such
as the purchasing power, balance of payment, prices of goods and services,
import structure, export earning, government revenue, external reserves among
others.
These prevailing instability in
exchange rates and its effects on various economic variables, will be the areas
of concentration of the research work.
1.3. STATEMENT
OF THE PROBLEM
Since
September 1986, when the market determined exchange rate system was introduced
via the second tier foreign exchange market, the naira exchange rate has
exhibited the features of continuous depreciation and instability.
This instability and continued
depreciation of the naira in the foreign exchange market has resulted in
declines in the standard of living of the populace, increased cost of
production which also leads to cost push inflation. It has also tended to
undermine the international competitiveness of non-oil exports and make
planning and projections difficult at both micro and macro levels of the
economy. A good number of small and medium scale enterprises have been
strangled out as a result of low dollar/ naira exchange rate and so many other
problems resulting from fluctuations in exchange rates can also be identified.
This movement of the exchange rate
along the path of depreciation since 1986 has raised a lot of questions on the
impact of exchange rate policies on the Nigerian economy.
1.7 OBJECTIVES OF THE
STUDY
Objectives
of the study
iv. To find out the impact of exchange rate
fluctuation on economic growth of Nigeria.
v. To examine the nature of the
relationship between exchange rate fluctuations and economic growth in Nigeria.
vi. To offer some recommendations
based on the findings of the study.
1.8 FORMULATION OF
HYPOTHESES
For
meaningful findings, conclusions and recommendations, a set of testable
hypothesis based on available data will be necessary. In the course of this
research work, the following hypothesis would be tested.
Hi: Exchange
rate fluctuations has no significant impact on Nigeria Economy.
Hi: Exchange
rate fluctuations has significant impact on Nigeria Economy.
1.9 SIGNIFICANCE OF THE
STUDY
The study
would identify the strengths and weakness of exchange rate policy and
management, identify those economic variables that are mostly affected by
instability in exchange rate and provide the general public with the awareness
on the foreign exchange transaction and its impact on the economy.
The various
findings of this would enable the government and financial authorizes to
device, modify and adopt a better foreign exchange transaction for the economy.
1.10 DEFINITION OF TERMS :
11. Foreign Exchange
Foreign
exchange is a means of payment for international transactions. It is made up of
currencies of other countries that are freely acceptable in settling
international transactions.
12. Foreign exchange market :
This is a
medium of interaction among buyers and sellers of foreign- exchange with
a view of negotiating acceptable prices for settling international transaction.
13. Exchange rate – This is the price of one
currency in terms of another
14. SEMI- Second tier foreign exchange market.
Under this system the exchange rate is largely determined by market forces.
15. AFEM – Autonomous foreign exchange market.
This exchange rate under this system are
being determined essentially through market forces.
16. IFEM – Inter bank foreign exchange market.
17. Dutch auction system (DAS) – this is a method
of exchange rate determination through action where the bidders pay last bid
rate that clears the market.
18. Dual exchange rate regime- This situation
exist when two exchange rates are in existence in an economy.
19. Marginal pricing method: This is the method
in which bid rates are arranged in a descending order of magnitude. The last
bid rate at which available foreign exchange is exhausted (marginal rate) is
the applicable exchange rate.
20. Exchange control – This is a foreign exchange
arrangement in which the government purchase all incoming foreign exchange and
is the only source from which foreign exchange can be purchased legally.
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