EFFECTS OF EXCHANGE RATE FLUCTUATION ON ECONOMIC GROWTH IN NIGERIA

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EFFECTS OF EXCHANGE RATE FLUCTUATION ON ECONOMIC GROWTH IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 Background to the study

Exchange rate tends to be paramount to every country because it contributes to the economic development of nations by influencing the amount of foreign exchange reserves as well as the level of imports a country can afford. The subject of exchange rate fluctuation came to surface and became a topical issue in Nigeria because it is the goal of every economy to have a stable rate of exchange with its trading partners. In Nigeria, this goal was not realized in spite of the fact that they embarked on the devaluation of the naira and adopted the Structural Adjustment Program (SAP) in 1986. The failure to realize this goal subjected the Nigerian manufacturing sector to the challenge of a constantly fluctuating exchange rate. One objective of the SAP was the restructuring of the production base of the economy with a positive bias for the production of agricultural export. The foreign exchange reforms that facilitated a cumulative depreciation of the effective exchange rate were expected to increase the domestic prices of agricultural exports and hence boost domestic production. Empirically many researchers like Oyejide (1986), Ihimodu (1993) and World Bank (1994) analyzed the effects of cumulative depreciation of the effective exchange rate, as it resulted in the change in the structure and value of Nigeria’s exports. The depreciation increased the prices of agricultural exports and the result indicated a worked increase in the volume of agricultural exports over the years. However, very little achievements were made in stabilizing the rate exchange. Consequently, the problem of exchange rate fluctuations in Nigeria persists up till date.

Fluctuation is a major constraint on development of an economy, making planning more problematic and investment more risky. For instance, fluctuation in exchange rate may reduce the activities of potential investors in Nigeria because it increases uncertainty over the returns of a given investment. Potential investors will invest in a foreign location only if the expected returns are high enough to cover for the currency risk (Gerado, 2002). Risk in international commodity trade usually arises from two main sources; changes in world prices or fluctuation in exchange rate. Therefore, understanding the behavior of the exchange rate is very important for many reasons. First, the relationship between a country’s exchange rate and economic growth via trade is a crucial issue from both the descriptive and policy prescription perspective. As Edwards (1994; 61) asserts; “it is not an overstatement to say that the issue of real exchange rate behavior now occupies a central rate in policy evaluation and design”. A country’s exchange rate behavior is an important determinant of the growth rate of its exports and it serves as a measure of its international competitiveness (Bath and Amusa, 2003), Chukwu (2007)observed the instability exchange rate as a determinant of trade in Nigeria; having a positive influence on export trade and at other times a negative influence. This suggests an erratic change in its value having a long-run effect on export and economic growth. This research aims to determine the impact of fluctuations in the naira exchange rate on Nigerian’s export performance.

1.2 STATEMENT OF THE PROBLEM

Despite the existence of literature on the influence of exchange rate fluctuations on economic growth in Nigeria, theoretical and empirical works on the subject are yet to produce a consensus. The two major trends in the literature review indicate thus; the first argues that exchange rate fluctuations represent uncertainty and will impose costs on risk- adverse economic agents which as a result respond by favoring domestic- foreign trade just at the margin. In other words, it might hamper the growth of international trade (Chowdhury, 1993, Cushiman, 1983, 1988 Kenen and Rodrik, 1986). The second strand of literature argues that if the economic agents are sufficiently risk lovers, an increase in exchange rate raises the expected marginal utility of export revenue and thus induces them to increase their exports in order to maximize their revenue. Therefore, exchange rate fluctuations may actually catalyze trade flows (De Grauwe: 1988, IMF: 1984, Klein: 1990 and Chambers, R. G. and Just, R. E. (1991). Only few attempts have been made to examine them for developing countries, Nigeria inclusive because of the lack of reliable time –series data. The available instances include Vergil (2002) for turkey and Bah and AMUSA (2003) and Takendesa, (2005) for South Africa, Ajayi (1988), Adubi, A. A. and Okunmadewa, F. (1999), Osagie (1985) for Nigeria.

The research will carefully examine exchange rate fluctuation on economic growth for both the oil sector and non-oil sectors. Previous studies assessed only the influence of exchange rate fluctuation on either oil export, neglecting the non-oil export or on non-oil export alone excluding the oil export. They failed to ascertain its effect on both the oil and non-oil (like agricultural and manufacturing) sectors export. Analyzing only oil exports or non-oil exports exclusively may not really give a value judgment and conclusion on the effect of exchange rate fluctuations and export performances in Nigeria. Furthermore, the study will provide deep insight into the relationship existing between exchange rate fluctuations on economic growth in Nigeria. In view of the above problem, the following research questions are raised:

1. How does the Nigerian economy respond to exchange rate fluctuation?

2. How does manufacturing companies respond to exchange rate fluctuation?

3. How does agricultural export respond to exchange rate fluctuation?

1.3 OBJECTIVES OF THE STUDY

The main objective of this study is to examine the impact of exchange rate fluctuations on economic growth in Nigeria. Specifically, the study is meant to addresses the following sub objectives:

i) To trace how the Nigerian economy respond to exchange rate fluctuation.

ii) To trace how manufacturing companies respond to exchange rate fluctuations.

iii) To trace how agricultural export respond to exchange rate fluctuation.

iv) To ascertain if there is any significant relationship between exchange rate and the Nigerian economy.

1.4 RESEARCH HYPOTHESES

Based on the research questions and the objectives, the following null and alternate hypotheses were formulated by the researcher;

Ho: Exchange rate has no positive significant impact on economic growth of Nigeria.

H1: Exchange rate has a positive significant impact on economic growth of Nigeria.

Ho: there is no causal relationship between exchange rate and export growth in Nigeria.

H2: there is a causal relationship between exchange rate and export growth in Nigeria.

1.5 SIGNIFICANCE OF THE STUDY

It is believed that at the end of this study, the findings will serve as a future guide to policy makers in the formulation of better and efficient policy options for managing exchange rate fluctuations in Nigeria. Also, the research will be of immense help to the general economy, as it will provide possible measures the monetary authority could adopt in order to maintain exchange rate stability so that exchange rate can influence importantly export growth, consumption, resource allocation, employment and private and foreign investments as research has shown. Above all, it will add to the existing literature thus, providing relevant information that could guide further researchers on this subject.

1.6 SCOPE AND LIMITATION OF THE STUDY

This study intends to look at the export performances and exchange rate fluctuations in Nigeria. The study covers the period from 1982 -2015. This range is chosen to give room for enough degree of freedom that will ensure reliable estimates. The researcher encountered some constraint in the course of the study; Little time and inadequate funds limited the researcher’s ability to generate complete and concrete research material, this is because of time and money constraints at the disposal of the researchers, on the other hand, the unwillingness and the busy schedule of the bank officials delayed the study, in order to provide us with more appeal cases and their valued opinions. However, we had to convince the respondents by giving gentlemen word that the names would not be disclosed in our study and the materials would be used for this study purpose only. Finally, there was no enough previous research work been carried out on this study, thus creating a lump sum of work for the researcher, and extending the duration initially budgeted for the completion of the research study.

1.7 Definition of Terms

Exchange rate: In finance, an exchange rate of two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.

Fluctuation: Price fluctuations are upward or downward swings in the prices of products in an economy. Fluctuations in prices are a common phenomenon in the economic world, particularly among producers of agricultural products.

Economic growth: Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product or real GDP, usually in per capita terms.

Nigerian Capital Market: The Nigerian Stock Exchange (NSE) was established in 1960 as the Lagos Stock Exchange. In 1977, its name was changed from the Lagos Stock Exchange to the Nigerian Stock Exchange. As at March 7, 2017, it has 176 listed companies with a total market capitalization of about N8.5 trillion. All listings are included in the Nigerian Stock Exchange All Shares index. In terms of market capitalization, the Nigerian Stock Exchange is the third largest stock exchange in Africa.

Stock Price Index: A stock index or stock market index is a measurement of the value of a section of the stock market. It is computed from the prices of selected stocks (typically a weighted average). It is a tool used by investors and financial managers to describe the market, and to compare the return on specific investments.

Market Capitalization: This refers to the total market value of the equity in publicity traded entity. It also refers to the value of all listed securities based on their market prices.

1.8 JUSTIFICATION OF THE STUDY

Impact of exchange rate on economic growth and development in Nigeria is not a strange topic as quite a number of researches have been carried out in relation to this issue. Unfortunately, many of the studies earlier conducted in have not utilized extended period and modern estimation methods as employed in this study. For instance, Udegbunam (2002) in his study has examined the effect of openness, stock market development and industrial growth in Nigeria, utilizing annual time series data covering the period from 1970 to 1997 and employing Ordinary Least squares (OLS) as estimation technique. In another study, Oke (2012) has examined the effect of capital market activities on the development of the Nigerian oil industries, utilizing annual time series data covering the period from 1999 to 2009 under the framework of cointegration technique and error correction mechanism. Meanwhile, Victor, Kenechukwu and Richard (2013) have undertook analysis into the effect of capital market on Nigeria’s industrial sector development, using data from 1980 to 2008 employing descriptive statistic methods. This study contributes to the current debate but differs from the previous scopes and studies by using a fairly large period of time as well as using current data in analyzing the effects of exchange rate fluctuation on economic growth in Nigeria.

1.9 Plan of the Study

The study is divided into 5 chapters. Chapter one consist of introduction to the study and it is sub-divided into 9 headings which are background of the study, statement of problem, research hypotheses etc. Chapter two is the literature review which comprise of the conceptual, empirical and theoretical framework. Chapter three is the research methodology which mainly concerns itself about the design of the study, the method of data collection, sample size, sampling technique, method of data analysis and the decision rule. The second to the last chapter, chapter four comprise of the research data presentation and analysis and the last chapter, chapter five is the summary, conclusion and recommendation of the research.

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