CHAPTER ONE
1.0 1.1 BACKGROUND TO STUDY INTRODUCTION
There is scarcely any country that lives in absolute autarky in this globalised world. The economies of all the countries of the world are linked directly or indirectly through asset or/and goods markets. This linkage is made possible through trade and foreign exchange. The price of foreign currencies in terms of a local currency (i.e. foreign exchange) is therefore important to the understanding of the growth trajectory of all countries of the world.
An appropriate exchange rate regime provides the anchor for low and sustainable inflation and macroeconomic stability which is crucial for a well functioning economy. Low inflation is of course, not an end in itself, but simply a means to an end. The ultimate end being the advancement of the economic well-being of all Nigerians. Against this background, the commitment of the Central Bank of Nigeria (CBN) is to contribute to the economic well-being of Nigerians, through the conduct and implementation of sound monetary policy. Typically, one of the key instruments of monetary management in Nigeria is the exchange rates. Of course, the achievement of an optimal exchange rate regime by itself may not be an adequate guarantee for the best macroeconomic outcome for Nigeria. Experience has shown that good fiscal and structural policies are also essential for the sustenance of a well functioning economy (Soludo, 2005).
The economic performance of Sub-Saharan Africa over the past two decades has been rather poor compared with other developing regions (Kandil and Mirzaie, 2003). Real per capita income has raised little and has even declined in some countries, while inflation has proved difficult to control. A closer examination of individual country
results reveals, however, significant variations over time and between different countries Kamin (1997).
The empirical work which has been undertaken to explore possible links between exchange rates and macroeconomic variables is based on the analytical framework developed by Kamin (1997), which provides evidence on the existence of an empirical relationship between the rate of inflation and the level of the real exchange rate in selected Latin American and Asian countries and advanced industrialized economies. As a follow to the analytical framework provided by Kamin (1997), this study is designed to examine the foreign exchange market in Nigeria with the view of investigating the relationship between the exchange rates and some macroeconomic variables.
Nigeria, like many other low income open economies of the world, has adopted the two main exchange rate regimes for the purpose of gaining internal and external balance. The augments and conditions for and against each of the regime is clear given that they are all aimed at maintaining stability in exchange rates. Direct administrative control exchange rate policy was used to manage Nigerias foreign exchange from independence in 1960. The country changed to a market regulated regime in 1986 for obvious reasons.
1.2
STATEMENT OF PROBLEM
There has been an ongoing debate on the appropriate exchange rate policy in developing countries. The debate focuses on the degree of fluctuations in the exchange rate in the face of internal and external shocks. Exchange rate fluctuations are likely, in turn, to determine economic performance.
In judging the desirability of exchange rate fluctuations, it becomes, therefore, necessary to evaluate their effects on output growth, pattern of domestic prices and some other macroeconomic variables.
1.3
RESEARCH OBJECTIVES
The aim of this research is to assess the impact of foreign exchange rate and management on Nigeria economy. For this aim to be achieved the following specific objectives were pursued:
(i) (ii)
To identify the determinants of the foreign exchange rates; To examine the impact of foreign exchange rates on Nigerias economic growth;
(iii) (iv)
To examine the impact of foreign exchange rates on external reserve; To examine the impact of foreign exchange rates on general price level.
1.4
SIGNIFICANCE OF STUDY
The significance of this study is as follows: (i) It would provide an empirical effect of exchange rate on the economic growth; (ii) It would contribute to existing literature by identifying the major factors that are responsible for the spread between the official and parallel foreign exchange market rates in Nigeria; (iii) Lastly, it would provide policy recommendations to policy-makers on ways to resuscitate the foreign exchange market in Nigeria. 1.5 The (i) RESEARCH QUESTION research What questions, are the which would guide of this study, are as follows: rates?
determinants
foreign
exchange
(ii) What has been the impact of foreign exchange rate on the growth of Nigerian economy? (iii) What is the relationship between foreign exchange rate and external reserve? (iv) How does the exchange rate affects the general price level in Nigeria?
1.6
RESEARCH HYPOTHESIS
The research hypotheses to be tested in the course of this study are stated below as HYPOTHESIS I Ho: That there is no relationship between exchange rate and the economic growth of Nigeria. H1: That there is relationship between exchange rate and the economic growth of Nigeria. HYPOTHESIS II Ho: That there is no relationship between exchange rate and general price level in Nigeria. H1: That there is relationship between exchange rate and general price level in Nigeria.
1.7
RESEARCH METHODOLOGY
The Econometric approach that would be adopted to examine the relevance of the exchange rate in the official foreign exchange market to the economic growth of Nigeria shall be the Chi Square (CHS) method. This econometric method would be used because it is very reliable and widely used in researches. The independent variable is the exchange rate while the dependent variables are: gross domestic product, external reserve and consumer price index. The test of the hypotheses earlier stated would be done with the data spanning between 1980 and 2005 at 5% level of significance and as such, the generalization of the study findings would be limited to this extent. Secondary data would be used in this study. The relevant data to be used would be sourced from the Central Bank of Nigerias statistical reports, annual reports and statement of accounts.
1.8
SCOPE AND LIMITATION OF THE STUDY
This study would focus extensively on the foreign exchange policies of Nigerian government and how they impacted on the structure of the foreign exchange market. The spread between the parallel and official foreign exchange market shall also be examined with the view of identifying the factors responsible for the differences.
In the bid to identify the strategies for resuscitating the foreign exchange market in Nigeria, the importance of the official exchange rate in the economic growth process of Nigeria shall be empirically investigated. The influence of the external reserve shall also be given due consideration. Besides, major issues in the foreign exchange policy and current development in the Nigerian foreign exchange market shall be examined. These would enhance the suggestion of the ways to resuscitate the foreign exchange market in Nigeria.