THE EFFECT OF EXCHANGE RATE DEREGULATION ON THE NIGERIA ECONOMY
ABSTRACT
The purpose of this work is to critically evaluate and apprise “the Effect of Exchange Rate Deregulation on the Nigeria economy”.
The methodology used is Ordinary Least Square (OLS) regression techniques as well as the Cochrane Orcutt method. Data used were annual time series data covering the period of 1970 – 2011. These data used were obtained from various secondary sources like the Annual Reports and Statistical Bulletin of Central Bank of Nigeria (CBN).
The findings of this research work reveals that the annual growth rate of exchange rate is positively related to balance of payment, inflation rate and interest rate, while it is inversely related to GDP and price level. The implication is that the GDP decreases when the exchange rate activities thrive.
TABLE OF CONTENTS
Title page …………………………………………………………i
Certification ………………………………………………………ii
Dedication……………………………………………………...…iii
Acknowledgement…………………………………….…………..iv
Table of Contents…………………………………………………v
Abstract……………………………………………………………ix
CHAPTER ONE: INTRODUCTION
1.1 Background of the Study………………………………………1
1.2 Statement of the Research Problem……………………………7
1.3 Research Question……………………………………………..10
1.4 Objectives of the Study…………………………………...……10
1.5 Hypothesis of the Study………………………………………..12
1.6 Scope of the Study……………………………………………..12
1.7 Significance of the Study………………………………………13
1.8 Limitation of the Study…………………….…………………..13
1.9 Definition of Terms……………………………………………14
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction……………………………………………………..16
2.1.1 The Models of Exchange Rate Determination………………..17
2.1.2 Assumptions under Monetary Model…………………………19
2.2 The Concept of Deregulation…………………………………...20
2.3 Theoretical Literature…………………………………………..21
2.3.1 Benefits Derived from the Deregulation of Exchange Rate in any Economy……….21
2.3.2 Drawbacks of Deregulation…………………………………22
2.3.3 Factors Affecting Exchange Rates………………………….22
2.3.4 Types of Exchange Rate System……………………………26
2.3.5 Problems of Economic Development………………………..28
2.4 Empirical Literature……………………………………………30
2.4.1 Pattern of Exchange Rate in Nigeria…………………………30
2.4.2 Exchange Rate Deregulation in China………………………33
2.4.3 Exchange Rate Deregulation in the Gulf Oil Countries……..36
2.4.4 Pattern of Exchange Rates in Kenya…………………………40
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Introduction……………………………………………………43
3.2 Model Specification…………………………………..……….43
3.3 A Priori Expectation…………………………………..……….44
3.4 Method of Data Analysis………………………………………45
3.5 Data for Regression…………………………………………….46
CHAPTER FOUR: EMPIRICAL ANALYSIS
4.1 Presentation of Regression Result………………………………48
4.2 Interpretation of Regression Result………………………………48
4.3 Policy Implication………………………………………………..51
CHAPTER FIVE: SUMMARY, RECOMMENDATION AND CONCLUSION
5.1 Summary……………………………………………………….55
5.2 Conclusion……………………………………………………..56
5.3 Recommendations………………………………………………57
Bibliography………………………………..………………………
CHAPTER ONE
Introduction
1.1 Background of the Study
How various individuals, groups, business persons and government have expressed concerns about attitudes of Nigerians towards the deregulation of exchange rate. Basically, the paper shows the relationship between the Nigeria economy and the government recent and past policies to increase the rate of converting Naira to Dollar.
Starting up with the current trends on the deregulation of the Nigeria currency in the foreign exchange market. On Wednesday, 20 January, 2016, an article was published in the Daily Sun Newspaper, as follows; Speaking during the opening of a one-day CBN/NEXIM Non-oil Simulation Conference in Abuja, CBN Governor Mr. Godwin Emefiele, attributed the decline (non-oil revenue by $6.14billion) to the low level of exports loan which he said, caused the decline in non-oil export revenue receipts from $10.53billion in 2014 to $4.39billion in 2015.
He further by saying, it has been observed that while credit to non-oil export is declining and currently at an average of 0.6 per cent of total domestic loans to the private sector in the past five years, domestic credit to the economy has been on the rise.
Managing Director of Nigeria Export Import Bank (NEXIM) Mr. Robert Orya, said the gathering at the seminar underscored the recurring problem of the volatility in the international oil market which has challenged the Nigeria economy over the years.
He said the recent rebasing of Nigeria’s economy revealed that production base had become much more diversified with the service sectors accounting for about 52 per cent of the Gross Domestic Product in 2014. Orya regetted that the revenue profile has remained skewed, with oil and gas sector contributing over 70 per cent and over 90 per cent of government and export earnings respectively, noting that the current episode of the global oil price collapse is expected to be quiet protracted and had manifested in Nigeria in significant revenue decline at all tiers of government with the attendant macroeconomic and external sector challenges. “Non-oil Revenues Decline by $6.14bn say CBN”, (2016).
On page 42 of the same newspaper, has it that Nigeria has comparative advantages over China and most developed countries in the production of tomatoes and many other farm produce, a status attributable to national endowment of the country with better soil types. Exploring this potential, according to Chief Eric Odinaka Umeofia, the President/CEO of Erisco Foods Limited, an indigenous manufacturing company with over 18 high quality food brands, all produced locally, is sine qua non to the success of President Muhammadu Buhari administration’s economic diversification policy “New Forex Policy ‘ll Lift Manufacturing Sector”, (2016).
Readers may ask, what relationship exist between the topic and the sited scenarios above? One of the major purpose of deregulating currency is diversification. More so, encouraging investment in local production rather than consumable import. The policy looks impressive so far in certain sector and also failed miserably in other sector. The failure is traced to other economic mechanism that ought to be in place before now. According to the CBN Governor Mr. Godwin Emefiele, attributed the decline (non-oil revenue by $6.14billion) to the low level of exports loan.
As it is popularly said that only those that comply with regulations become regulators. The outcome of regulating an economy efficiently and effectively often results to outstanding achievement of that economy. Nigeria is a country that has always involved in different regulation strategies. Implementation of a new regulation which usually considers changes of previous regulation as a result of failed policies. The economic stabilization measures involving strict exchange and trade controls, introduced in 1983 and 1984 and retained in 1985 accomplished very little, in an instance. When there exists a regulatory failure, this could be due to excessive regulation and or ineffective implementation of regulatory measures. Tola, (2006).
Till date, the introduction of foreign exchange markets in Nigeria was propelled by a number of factors which include the changing pattern of international trade, structural shift in output and institutional changes. Before the advent of central bank and the exchange control act of 1962 was put into law, the private sector earned the foreign exchange and commercial banks abroad held in balance, acted as the agents for local exporters. Agricultural exports contributed a large part of the foreign exporters at this period. The need to develop a foreign exchange market distinct from those in the major international centres became paramount. Ikpefan, (n.d.).
The Nigeria currency (Pounds) was tied to the British currency (Pounds) with ease of conversion, hindered the development of an effective foreign exchange authority in the bank, it became necessary to develop a foreign exchange market unique from the international market.
In the early 1970's the agricultural exporters were displaced by crude oil exports as the country's major foreign exchange revenue. Foreign exchange receipts was enhanced as a result of the sharp rise in petroleum prices. Thus, very significant number of economic agents had to patronize the CBN for foreign exchange market experienced a boom during the period, and to avoid lapses, the management came under more effective focus. In the Pre-SFEM period (1962-1986) the CBN was the only custodian of foreign exchange (Forex). All receipts of forex meant for the country was channeled through the CBN, and remittance of foreign exchanges were made by the CBN in respect of authorised dealers who carried out the instruction of their customers in respect of all transactions from abroad and invisible trade transactions was vested on the monetary authorities by the exchange control act. The exchange control act 1962 vested in the monetary authorities the power to approve all applications for foreign exchange in respect of all import transactions and invisible trade transactions. Ikpefan, (n.d).
The structural changes as a result of policies pursed, left the Nigeria economy with fluctuating prices and even more exposed to external shocks. The system became heavily dependent on crude oil. In the early 1980s, crude oil export accounted for 22% of the GDP, 81% of the government revenue and 96% of export earnings before oil boom was worn down by the effect of appreciating local currency, inadequate pricing policy, and rural urban migration. Nigerians became major food importer overtime.
This development had a negative effect on manufacturing output. Manufacturing output helped immensely by the reformed foreign exchange allocation system moved up quite rapidly from the low levels before 1986. The range of import duties was recorded to be between the range of 10 and 60 per cent, which can be described as irrational tariff structure designed to logically put local industries out of business or cause manufacturers to be unproductive. Ikpefan, (n.d.).
This project work now tends to analysis previous statistical data and project materials to predict what could be the result of the proposed deregulation policy if efficiently executed by the ministries. More so, tends to examine the effect of exchange rate deregulation on foreign and local industrial produce in the past years. This paper becomes essential in the light of the need to examine the impact of exchange rate policy reversal in the real sector of the economy whether it attracts foreign investment, more job opportunities, and professionalism in delivery of financial services, providing money for economic growth and development and if it thereby create inter-boundaries ties between countries and inter-governmental relationship.
1.2 Statement of the Research Problem
The fundamental problems that will be dealt with in this project work are:
⦁ The significance of exchange rate deregulation on the international market from the Nigeria perspective,
⦁ The snail speed situation of the development of the manufacturing sector,
⦁ Unprecedented fall in capacity utilization rate in industry,
⦁ Neglect of non-oil sector.
The exchange rate has become so volatile, since the adoption of exchange rate deregulation policy in Nigeria. The awareness of the fluctuating exchange rate was between 1962 and 1973 when the Dollar was devalued by 10% and in order to maintain the existing conversion rate to the Dollar, the Naira too was devalued by the same 10%. Changes in money supply did not constitute major macro-economic problem and the stability of the exchange rate was guaranteed before then. This was so because the rate was fixed but was being varied by CBN as stated in control act enacted on central bank 1962. The centralization of foreign exchange, rational allocation of foreign exchange and adequate internal and external balances were some of the rationale behind the act.
In 1986 when the Naira was floated on the 2nd tier foreign exchange market (SFEM) during the Structural Adjustment Programme (SAP), the trend in exchange rate rose sharply. Further fluctuation of the exchange rate continued in 1993 until when the Naira eventually stabilized at 21 Naira per US Dollar. The exchange rate under the pro-rata basis was officially pegged at N21.996 to cushion the effects of high demand and the instability in the market. The major element of the deregulation was the re-introduction of Autonomous Market for Foreign Exchange (AFEM) for transactions in privately sourced foreign exchange at market-determined rates. In the AFEM, the banks were made the principal dealers. A subsidized and pegged official exchange rate of $1.00=N22.00 was reserved for public sector transactions of non-commercial agencies, including debt service payment and National Priority Projects. In 2007, the official exchange rate of Naira to the Dollar as at April is $1=N127.00. Ikpefan, (n.d.)
Ever since the Naira has been fluctuating due to the demand and supply of Dollar. In order to divert the economy from mainly oil sector, to reduce unemployment, to reduce the level of importation and encourage local production, to bring in foreign direct investment and foreign portfolio among others. The federal government of Nigeria and the central bank of Nigeria proposed to devalue the exchange rate. The official exchange rate to Dollar now float between N300-N310 as of January 2016.
1.3 Research Questions
⦁ Why do Nigeria government have to deregulate the exchange rate to discourage importation and encourage exportation?
⦁ What could have been the rationale behind the snail speed situation of the development of the manufacturing sector?
⦁ What is the logic behind the unprecedented fall in capacity utilization rate in industry?
⦁ What relationship exist between the exchange rate and the neglecting of non-oil sector?
1.4 Objectives of the Study
Nigeria government has imposed heavy regulation on foreign exchange which resulted to an unfavourable economy indirectly. Also, the country has so much depended on crude oil for too long and has displaced other gifts of nature endowed on us. Nigeria do not refine crude oil for usage in different products, which shows how the growth rate of the industries has really fallen to. The local industries are no longer encourage to prepare themselves for the international setting. This local industries are no longer encourage to prepare themselves for the international setting. This research work now seeks to analyze the main threats and challenges of regulating and deregulating the foreign exchange market which in turn could have effect on the local industries either positively or negatively.
⦁ To find out the strengths and problems and what development and growth has the exchange rate deregulation impacted on the economy?
⦁ To find out the factors hindering the success or the snail speed situation in the manufacturing sector.
⦁ The cause for the inefficiency in the industrial sector looks wantingly.
⦁ Crude oil is one in a hundred factors for neglecting the non-oil sector, other factors would be addressed.
1.5 Hypothesis of the Study
⦁ H1: The deregulation of exchange rate made Nigeria products cheaper relatively to foreign products.
Ho: The deregulation of exchange rate did not make Nigeria products cheaper relatively to foreign products.
⦁ H1: Importation of certain goods sent Nigeria manufacturers out of the system.
Ho: Importation of certain goods did not send Nigeria manufacturers out of the system.
⦁ H1: The industry see the deregulation as an opportunity not to produce the best quality products.
Ho:The industry did not see the deregulation as an opportunity not to produce the best quality products.
⦁ H1:Low exchange rate made the non-oil sector worsen.
Ho:Low exchange rate did not make the non-oil sector worsen.
1.6 Scope of the Study
This research work is concerned about the Nigeria economy. However, we shall give regards to other economies as part of reference. The data to be conducted are to be the annual published time series data on the selected variables from CBN statistical bulletin. The period covered will be from 1970 to 2014. This is with respect to ready information at hand. More so, in this period/era we have numerous regulation and deregulation actions.
1.7 Significance of the Study
This work is relevant to the citizenry of Nigeria, foreign investors, other researchers and beneficiaries of this study, importers, exporters and even the academia, manufacturers to focus on the aspect of the exchange rate regulation as it greatly determine the performance in terms of output of industries.
1.8 Limitation of the Study
⦁ Inability to obtain data from the primary source as a result of finance, influence to government ministries and knowledge on how to go about it.
⦁ Lack of availability of some up-to-date data necessary for the study.
1.9Definition of Terms
Devaluation / Revaluation:
A reduction in a fixed exchange rate is a devaluation. An increase in a fixed exchange rate is a revaluation. In 1949 there was a devaluation of several currencies, including the British pound, reflecting the fact that those currencies had been overvalued against the dollar. Hubbard & O’Brien, (2010).
Exchange Rate is the price of one currency in terms of another. It is the amount of foreign currency that may be bought for one unit of the domestic currency or the cost in domestic currency of purchasing one unit of the foreign currency. Soderstine, (1998).
Diversification means not putting all your eggs in one basket. If you put your eggs in one basket, buying say 2 oil shares for your £2, you have a 50 per cent chance of earning £8 and a 50 per cent chance of earning £4. It depends whether the oil industry has good or bad times. The average return is £6, but the actual return will either be £4 or £8. Begg, Fischer & Dornbusch, (2008).
Non-oil sector is a sector of the Nigeria economy that do not involve in the exploitation, refining and marketing of crude oil or it later products like petroleum, kerosene, diesel etc. Non-oil sector includes agricultural, banking, mining sectors among others.
Macro Economy is the branch of Economic theory which deals with the study of national economy in aggregative terms. It complements micro economics, the other branch of Economic theory, which involves the study of the economy “in the small” and in particular, analyzes the consumer behavior of households and the production decisions of business firms. Iyoha, (2007).
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