AN EMPIRICAL STUDY OF EXCHANGE RATE FLUCTUATION AND EXPORT PERFORMANCE IN NIGERIA (1961-2011)

CHAPTER ONE

1. BACKGROUND OF THE STUDY

Exchange rate is a prominent determinant of world trade, receiving much attention in the context of global imbalances. The subject of exchange rate fluctuation came to be 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. As a consequence, 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.

1.1 STATEMENT OF THE PROBLEM

Despite the existence of literature on the influence of exchange rate fluctuations on exports 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 differ from the existing ones as it will carefully examine exchange rate fluctuations and export 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 and exports by adopting a popular econometric methodology for a measure of fluctuations which is Generalized Autoregressive Conditional Heteroscedasticity (GARCH) modeling technique, which was not used by some of the previous studies.

In view of the above problem, the following research questions are raised:

1. How does oil export respond to exchange rate fluctuation?

1. How does manufacturing export respond to exchange rate fluctuation?

1. How does agricultural export respond to exchange rate fluctuation

1.2 OBJECTIVES OF THE STUDY

The broad objective of the study is to determine impact of exchange rate fluctuations on export performance in Nigeria. Specifically, the study addresses the following objectives:

1. 1. To trace how oil export respond to exchange rate fluctuation.

1. 1. To trace how manufacturing export respond to exchange rate fluctuations.

1. 1. To trace how agricultural export respond to exchange rate fluctuation.

1. SIGNIFICANCE OF THE STUDY

This research will serve as a future guide to the 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.

1.4 SCOPE OR DELIMITATION OF THE STUDY

This study intends to look at the export performances and exchange rate fluctuations in Nigeria. Thus, it is restricted to tracing the responses of some export components to shock to the exchange rate over some periods; hence it omitted the test of hypothesis. The study covers a period of 51 years that is 1961-2011. This range is chosen to give room for enough degree of freedom that will ensure reliable estimates.