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CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

The exchange rate is perhaps one of the most widely discussed topics in Nigeria today. This is not surprising given the macro-economic importance, especially in a highly import dependent economy as Nigeria. However, following the fluctuations of the Naira in 1986, a policy was induced by the structural adjustment programme (SAP).This made the subject of exchange rate, a topical issue in Nigeria. The goal of every economy is to be stable, and to have a balanced balance of payment. As result of using the floating foreign exchange determination system, the country achieved that. The country also embarked on devaluation to promote export and stabilise the rate of exchange.

Prior to 1986, Nigeria was on a fixed exchange rate determination system. At that time, Naira was very strong in reference to dollar. The exchange rate was one naira to one U.S dollar that is; #1 =$1.The increasing demand for foreign exchange and the inability of the exchange control system to evolve, an appropriate mechanism for foreign exchange allocation in consonance with the goal of internal balance, made the fixed exchange rate determination system to be discarded in September, 26 1986 while the structural adjustment programme (SAP) came in.

The main objective of the new exchange rate policy (SAP), was to pressure the value of the domestic currency, maintain a favourable external balance alongside the overall goal of macroeconomic stability and to determine a realistic exchange rate for the Naira. It was between 1973 and 1979,that the new SAP policy contributed for more than 70% of the nation’s GDP and played a vital role, in the increase of its balance of payment (BOP).

Nzolta (2004) defines Foreign Exchange as the value of foreign nation’s currency in terms of the home nation currency. In finance, exchange rate between two currencies specify how much one currency is worth in terms of the other.

Devaluation is the fall in fixed exchange rate which reduces the value of a currency in terms of other currencies. What is being discussed in this study however, is determining how the reduction in the value of a currency, with respect to the currency of another country can lead to the fluctuation of exchange rate. It also discusses how this reduction, affect the record of all monetary transactions, between a country and another, whether it is visible or invisible in a period of time. Nigeria is currently facing serious problems regarding foreign exchange ratio (which is very low in comparison to other countries) as well as balance of payment, which is clearly in disequilibrium and in deficit. As a result of this, the Economy is retrogressing and the citizens are clearly suffering.

It is important to know that economic objectives are usually the main considerations in determining the Exchange control. From 1982 – 1983, when Nigeria’s naira has been devalued by 10%, the British pound sterling and the naira was 1:1 ratio. The Central Bank of Nigeria applied a Basket of currency approach from 1979, as the guide in determining the exchange rate which is usually determined by the relative strength of the currencies, of the country’s trading partners and the volume of trade with such countries. Specifically, weights were attached to these countries with the American dollars, and the British Pound Sterling on the exchange rate mechanism. After the structural adjustment programme, the Government established the foreign exchange market (FEM), to stabilize the exchange rate depending on the state of the balance of payments, the rate of inflation, domestic liquidity and employment.

Between 1986 and 2003, the Federal Government, experimented with different exchange rate policies. None of them made a remarkable impact in the growth of the economy’s balance of payment, before it was changed. The inconsistency in policies, and lack of continuity in exchange rate policies, aggregated an unstable nature for the Naira’s rate.

Therefore, the Nigeria’s external sector was overheated and fragile and was characterized by over-valuation of the Naira’s exchange rate. It was also characterized by accumulation of trade arrears, continuous decline in foreign exchange earnings and increasing debt service obligations that resulted from excessive debt burden.

1.2    STATEMENT OF THE PROBLEM

The foreign exchange and balance of payment are some of the key factors of a nation’s Life. They are factors that look into comparing a country’s relationship with other nations. The exchange rate and balance of payment of a country, such as the inflation rate of a country, foreign direct investment , inflation rate and interest rate which will directly and indirectly affect the balance of payment and the Nigerian economy at large.

In 1973 and 1979, the exchange rate was relatively stable as a result of the oil boom. Nigeria however, started recording huge balance of payment deficits and very low foreign reserve in the 1980’s.

It was felt that a depreciation of naira would relieve pressures on the balance of payment. Consequently the Naira was devalued and the irony of this policy instrument is that, Nigeria’s foreign trade structure did not satisfy the conditions for a successful balance of payment policy. The country’s foreign structure is characterized by export of crude petroleum and agricultural produce, whose prices are predetermined in the world market with low imports and export price elasticity in demand.

Currently, the nation’s exchange rate has fallen and has since been fluctuating. This so far has been due to unfavourable nature of the competing powers of the nation’s currencies and the currencies of the world. The economy for a long time has been struggling to resolve the problems of external and internal imbalances. This has manifested in the disequilibrium, in her balance of payment while causing a balance of payment deficit.

Relevant literatures and opinions on this issue are of the view that exchange rate policy plays an important role, of maintaining internal and external balances. On the other hand, other writers argue that devaluation is not the best policy for the less developed country, because of many diverse results. Some economists, disputed the ability of the change in real exchange rate. This other to improve the trade balance of developing countries, because of elasticity of low exports other writers said that structural policies could however, change the long term trends in the terms of trade, and the prospects of export-led growth.

The impact of the combination of inflation and exchange rate volatility on balance of payment alongside stock returns is a problem having known that the exchange rate provides evidence, for the impact of international market on the overall health of the economy. This is particularly so, in a developing economy like Nigeria, with high inflation rate and very strong dependence of its economy, on foreign trade. This therefore focuses on the examination of the predictive power of inflation and Naira / US dollar exchange rate. It also focuses on how it affects growth and balance of payment.

The major problem however, which the study was designed to solve is whether the exchange rate fluctuations has any bearing on Nigeria’s balance of payment.

1.3    RESEARCH QUESTIONS

This work is guided by the following research questions:

1.        i.            What is the effect of exchange rate fluctuations on the balance of payment in Nigeria?
2.      ii.            Does interest rate have any impact on the balance of payment in Nigeria?
3.   iii.            How does inflation affect the balance of payment in Nigeria?
4.   iv.            Is there any impact of foreign direct investment on the balance of payment in Nigeria?

1.4    OBJECTIVES OF THE STUDY

The main objective of this study is to examine / the effect of exchange Rate fluctuations on Nigeria’s balance of payment.

The specific objective however include;

1.        i.            Evaluating and determining the impact of interest rate on the balance of payment of Nigeria
2.      ii.            To examine the effect of inflation on Nigeria’s balance of payment
3.   iii.            Inquiring into the impact of foreign direct investment on the balance of payment of Nigeria.

1.5    RESEARCH HYPOTHESIS

The hypothesis tested in the Null form includes:-

1.        i.            There is no significant relationship between exchange rate fluctuations and the balance of payment of Nigeria.
2.      ii.            There is no impact of interest rate on the balance of payment of Nigeria.
3.   iii.            There is no impact of inflation on the balance of payment of Nigeria.
4.   iv.            There is no effect of foreign direct investment on Nigeria’s balance of payment.

1.6    SIGNIFICANCE OF THE STUDY

The exchange rate and balance of payment are the heart and foundation of Economic development. There have been fluctuations in exchange rates over the years, alongside other controversial factors that lead to adverse conditions in Nigeria. Inflation happens to be one of these factors resulting from fluctuating exchange rates. Increased interest rate is also a case, alongside decreased foreign investments,this is as a result of foreign investors avoiding debts burden of a Nation being laid on them. All these however, affect the economy adversely. It is therefore significant that this study analyses exchange rate fluctuations and make known it’s effect on growth and balance of payment. It will also bring to lime light, its implications on policies and make recommendations which will be of immense help to policy makers and the government

Academicians, students and lecturers will find the information provided in this work useful. It will serve as an enrichment or addition to the knowledge base of the study / subject.

Another significance lies in the fact that if the cause of the unstable exchange rate of the naira is identified and corrected, the economy will rapidly grow and develop into an advanced one. This implies that, if the unstable exchange rate of naira is proved to be affecting macro-economic areas (such as real exchange rate, inflation rate, the openness of the Economy, etc.) badly, attempts will be made to stabilize it.

Importantly, aside the government, the Central Bank of Nigeria will find this study helpful. It will be useful in identifying the strengths and weaknesses of each foreign exchange system, and hence adopt policies that suit the economy best. This will be for the overall development of the economy.

This study will also assist future researchers who intend to indulge in this same topic or other related ones.

1.7    SCOPE OF THE STUDY

This study is limited to the analysis of exchange rate, and its effect on the Nigeria’s balance of payments, with reference to the Nigeria economy. This study covers the period of 30years i.e from the period of 1983 – 2013. Data will be extracted from the Central Bank Statistical bulletin, The Nigerian Bureau of Statistics, the internet and other necessary sources.

1.8    LIMITATION OF THE STUDY

The study was faced with a number of limitation .One of such limitation however, is unreliable statistical information especially in the Nigerian economy.

Another of such limitation is the financial constraint of the researcher, alongside other factors. These limitations however are not sufficient to undermine the reliability of the information provided. The study anticipates such challenges and took steps to minimize the effect of such disturbances on the validity of the project.