AN INVESTIGATION INTO THE CAUSES AND EFFECT OF HIGH EXCHANGE RATE ON THE NIGERIA ECONOMY 2019-2023

CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Globally, government and citizens alike prioritize economic growth and development due to their significant influence on both the population and the nation as a whole. This focus is crucial for setting the nation in a favourable position within the global community. According to the research conducted by Vasani Selvam and Selva (2019), the attainment of macroeconomic objectives necessitates economic stability as a fundamental factor or requirement for growth in both established and emerging nations. The objectives encompassed in this framework may include the achievement of robust economic growth, a minimal inflation rate, a reduction in unemployment, a stable balance of payments, the maintenance of equitable development, and an enhancement of social welfare. As a result, economists worldwide have consistently advocated for the implementation of balanced monetary and fiscal policies.

Consequently, several developing countries used monetary and fiscal measures to regulate and modify their national economic activity with the aim of attaining certain objectives. This was done in an effort to achieve accelerated economic growth and sustainable development. The economic growth of a nation is indicative of its ability to enhance its services and expand its manufacturing capacity. Hence, the most basic conceptualization of economic development is the expansion of Gross Domestic Product (GDP). Consequently, nominal GDP is commonly subjected to adjustments to account for inflationary effects, with the objective of capturing the true value of real GDP.  However, the Nigerian economy has been plagued by the issue of instability in its foreign currency rate market, which is characterised by a significant amount of volatility (Osabuohien et al., 2018). The phenomenon of exchange rate fluctuation, characterised by the ongoing oscillation in the foreign exchange market of various nations, has garnered significant attention in contemporary international finance literature. This attention stems from the detrimental impact it poses on the economies of developing countries such as Nigeria (Alagidede and Ibrahim, 2017).

Coherently, the introduction of financial sector changes in Nigeria occurred through the creation and execution of the well-known Structural Adjustment Programme (SAP) in 1986. This programme was a key component of the broader Economic Recovery Programme (ERP). According to Kelikume & Nwani (2019), one aspect of the changes implemented in the late 1980s were the abandonment of fixed exchange rates in favour of a free-floating regime. The decision to move to flexible exchange rates was made in the idea that it would effectively mitigate the cyclical pattern of economic booms and busts, and ultimately steer the country towards a path of sustained economic prosperity.The anticipated effects of exchange rate channels on economic growth are seen in several aspects such as consumer price stability, trade volumes, investment levels, and terms of trade. In Nigeria, prior to the implementation of the structural adjustment plan (SAP), it seemed that the currency rate policy of the country intentionally promoted the overvaluation of the Naira. This was evident in 1981 when the exchange rate stood at ₦1 to 0.90 cents. This phenomenon inevitably promotes the inflow of imports and hampers the outflow of non-oil exports, leading to an excessive reliance of the Nigerian economy on imported resources rather than exported goods and services. It is indisputable that an economy characterised by a higher value of imports compared to exports would encounter an unfavourable balance of payments, resulting in the devaluation of its currency relative to the currencies of other countries engaged in trade. The currency of the aforementioned country exhibits a relatively low exchange rate as compared to other currencies. For instance, the Nigerian Naira is valued at ₦197.00 per US dollar, ₦281.29 per British pound sterling, and so forth (Omoregie, 2020).

Furthermore,  the Nigerian currency rate saw a significant negative effect due to the global economic and financial crisis. During the period of 2008 to 2009, there was a substantial increase in the Naira exchange rate against the dollar, with the value rising from about ₦120/$ to over ₦180/$. The decline in Nigeria's foreign profits and national income can be attributed to the persistent decrease in global crude oil prices.  Howbeit the advanced economies have placed a renewed focus on developing alternative sources of energy, such as wind, bio-energy, and solar power. This shift in emphasis has resulted in a decrease in the demand for crude oil, leading to a significant decline in prices. Specifically, the price per barrel has dropped from $110 to below $50 between mid-2018 and early 2019, and it currently stands at $38.77 per barrel in the last quarter of 2020. The aforementioned circumstances served to diminish Nigeria's foreign profits and revenues allocated towards the financing of key sectors aimed at job creation, economic stimulation, per capita income growth, and enhanced living standards.

 According to Oseni (2016), the liberalisation of capital flows in developing countries in recent decades, along with the substantial growth in cross-border financial transactions, has had a notable impact on the exchange rate in many of these nations characterised by underdeveloped capital markets and inconsistent economic policies.  As of August 2023, an unprecedented occurrence in the history of Nigeria, the official exchange rate of the Nigerian naira versus the United States dollar has reached N750 to a dollar on the official market. In the study conducted by Zakari (2017), it is argued that maintaining exchange rate stability plays a significant role in managing inflation. The author posits that a stable exchange rate is expected to mitigate domestic inflationary pressures through two mechanisms: the policy discipline effect, which limits the growth of money supply, and the credibility effect, which increases the demand for money and reduces the velocity of money. However, it is worth noting that the impossibility trilemma suggests that when a country has an open capital account, maintaining a stable exchange rate might result in a loss of control over monetary policy, potentially leading to increased inflation. It is widely accepted among economists that the value of a country's currency, in relation to other countries, is primarily determined by macroeconomic fundamentals. These fundamentals are reflected in the productivity and total production level of the economy. Although various theoretical models of exchange rate determination have extensively examined,  the underlying economic factors that influence exchange rates include the level of international trade and tourism, inflation outlook, interest rate differentials, and capital flows. These factors have been summarised in several classical concepts such as Purchasing Power Parity (PPP), Fischer's Interest Rate, and Market Fundamentals theories, among others.

1.2 Statement of Problem

In recent time the effects of high exchange rate on the economy are generally considered to be harmful.  For an open economy as Nigeria, Alagidede & Ibrahim, (2017) averred that high exchange rate comes from both domestic factors (internal pressures) and overseas factors (external pressures). The external factors results from increase in the world prices of commodities or fluctuations in the real exchange rate. However the influence of exchange rate on an economy is a function of the exchange rate regime as practiced in Nigeria. Alagidede and Ibrahim (2017) mentioned that  Fluctuation in the real exchange rate has a major impact on output and prices through the aggregate demand and supply channels. On the supply side, depreciation or devaluation of domestic currency affects the price level and output directly through the importation of goods in which case the country is an international price taker. Indirect effect of depreciation or devaluation is transmitted through the price of capital goods imported by manufacturers as inputs in the production process.           

 Akinlo and Onatunji, (2020) stated that concerns about the consequences of exchange rate fluctuations in both developed and developing economies like Nigeria have evolved in an astonishing manner owing to its impact on exports (Usman and Elsalih, 2018), trade (; Rashid and Waqar, 2017), inflation investment ( Zakari, 2017), and more general economic activity (, and growth .   While anecdotally, the exchange rate volatility has been linked to macroeconomic instability, a minimal attempt has been made to investigate the factors behind it and its impact on internal and external stability. Moreover, discussions surrounding Nigeria’s exchange rate fluctuations are only gleaned from public discourses on the economy with very little empirical and theoretical content. As such, to bridge the theoretical and empirical gaps and improve on the weaknesses of the previous studies from the Nigerian context, this study on an investigation into the causes and effect of high exchange rate on the nigeria economy 2019-2023

1.3 Objective of the study

The study is focused on  an investigation into the causes and effect of high exchange rate on the Nigeria economy 2019-2023. Other specific objectives includes:

i.          To examine the extent of exchange rate fluctuation between 2019-2023.

ii.        To find out the causes of persistent high exchange rate in Nigeria.

iii.      To ascertain the effects of high exchange rate on Nigeria’s economic performance.

1.4  Research Question

i.          What is  the extent of exchange rate fluctuation in Nigeria between 2019-2023 ?

ii.        What are the causes of persistent high exchange rate in Nigeria?

iii.      What are the effects of high exchange rate on Nigeria’s economy?

1.5 Research  Hypothesis

Ho1: The extent  of  exchange rate fluctuation in Nigeria between 2019-2023 is low.

Ho2: There isno significant effect of high exchange rate on Nigeria economy.

1.6  Significance of the Study

The significance of this research work lies in the fact that if the causes of the unstable exchange rate of the naira is identified and corrected, the economy will rapidly grow and develop into an advanced one. This is so because if the unstable exchange rate of the naira is proved to be affecting badly the macro-economic major variables, including real exchange rate, real interest rate, inflation rate, gross domestic product and trade openness of the country, attempts should be made to stabilize the exchange rate. This is because these variables are gauge for the importantly measurement of growth and development of any economy. Importantly, this study would help the government and the central bank of Nigeria (CBN) to identify the strength and weakness of each foreign exchange system and hence adopts the policy that suits the economy best this will definitely enhance growth and development of the economy, the study will also serve as a guide to future researchers on this subject.

1.7 Scope of the Study

This research work is designed to cover the period 2019-2023, a period of thirty one years. The general overview of the profile of Nigerians exchange rate over the years shall be discussed. The scope consist of the regulatory and deregulatory exchange rate period that is the fixed exchange rate and the floating exchange rate period. The study is based on core macro-economic performance of Nigeria between 2019-2023.

1.8 Limitation  of the study

The study is structured to evaluate the Nigeria exchange rate as the pilot of economic growth and development. The study is therefore limited to the core economic growth variables such as GDP,net foreign direct investment, inflation rate, and interest rate. Nigeria and not the socio- political factors of the foreign exchange rate.

1.9 Definition Of Terms

Exchange Rate: An exchange rate is a rate at which one currency will be exchanged for another currency and affects trade and the movement of money between countries. Exchange rates are impacted by both the domestic currency value and the foreign currency value. In the case of Nigeria’s naira to Dollar

Market Volatility: Volatility is an investment term that describes when a market or security experiences periods of unpredictable, and sometimes sharp, price movements

Economic Growth: Economic growth can be defined as the increase or improvement in the inflation-adjusted market value of the goods and services produced by an economy in a financial year. Statisticians conventionally measure such growth as the percent rate of increase in the real and nominal gross domestic product.

Get this material NGN 5,000

Message Us on WhatsApp  »