EXCHANGE RATE PASS-THROUGH TO CONSUMER PRICES IN NIGERIA

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EXCHANGE RATE PASS-THROUGH TO CONSUMER PRICES IN NIGERIA

Abstract

The increasing overdependence of Nigerian economy on imports has

necessitated the need to continually examine the effect of exchange rate shocks in consumer prices. The paper adopts a Structural Vector autoregressive to estimate the pass-through effect of exchange rate changes to consumer prices. Using the Variance Decomposition analyses, the study found a substantially large exchange rate pass-through to inflation in Nigeria. Finding shows that exchange rate has been more important in explaining Nigeria’s rising inflation phenomenon than the actual money supply. Therefore, it is recommended that Nigerian economy focuses on policies that ensure exchange rate stability and sound monetary surveillance.

Introduction

A consumer purchasing power largely depends upon wealth and prices of goods and services. Domestic purchasing power is mainly affected by the inflation rate of individual countries. High (low) inflation decreases (increases) the purchasing power of an individual (Jian, 2008). In season of high exchange rate, the value of country’s currency drops, the implication of this to Jian is that increase in the exchange rate has been passed to the consumer. The rate of exchange pass through to consumers depends among others on the quality of the imported good, price elasticity of demand, openness, and the monetary policy of the central bank and Stock market volatility (Charles, Simon & Daniel 2008).

Inflation is quite relevant in determining exchange rate pass through to consumer. Rising level of inflation induced from exchange rate increases raises price level of home and foreign goods (Paral Aaron, Ben and Alass, 1998). An understanding of the degree and timing of exchange rate pass-

through is very important in accessing its effect on different economies; pass-through could be complete where consumer/import prices respond absolutely to exchange rate movements, conversely a partial induce response of exchange rate on consumer prices is termed an incomplete pass-through (An, Akofio-sowah A.N 2009)

Furthermore, Olive (2002), and Campa and Goldbery (2005) maintained that when exchange rate changes, foreign firms can choose to pass-exchange rate changes fully to their selling prices in export markets i.e. complete pass- through to bear exchange rate changes to keep selling prices unchanged. Goldberg and Knetter (1997) discovered that only about 60 percent of exchange rate changes are passed on to import prices in the United States. One major reason responsible for incomplete pass-through is that most exporters and importers choose to hold their prices fixed and just decrease or increase the mark-up on prices, anytime there is a change in exchange rate. Dornbush (1987) discovered incomplete pass-through arises from firms that operate in a market characterized by imperfect competition and adjust their mark-up together with prices in response to exchange rate shock.

Like all other developing countries, the study of the exchange rate pass-though on consumers of consumable and capital goods cannot be over emphasized. Firstly, the Nigerian economy is external sector driven and shocks from global commodity market have several implications on consumers. For example, an increase in price of foreign raw materials or scarcity of key foreign import of the production sector will immediately reflect in the exchange rate pass-through to the manufacturer. Similarly, distortions in supply of consumer goods particularly stable food items or household items in the foreign market are a signal of high exchange rate pass-through to the country’s consumers.

Secondly, the need to stabilize Naira and make it formidable so as to compete with other currencies in the international markets is a pointer to the need for the study. Thirdly inflation in Nigerian is becoming endemic, there is need to look into the foreign exchange rate and see the extent of its contribution to the country’s high inflation rate.

In addition, there is need to make the external sector of the economy competitive through appropriate exchange rate adjustment and this can only be achieved with detailed study of effect of exchange rate pass-through on prices. The monetary authority needs guided policies on stabilization of exchange rate, both the producers for exporters, wholesale exporters, and importers need to constantly aware particularly in advance of the effect of exchange rate on their business. The consumer of foreign goods also needs to factor in the effect of foreign exchange rate in their choices and demand. Hence, the study on foreign exchange will continue to be relevant.

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