EXCHANGE RATE VOLATILITY AND INFLATION IN NIGERIA

Table of content

Chapter one

1.1 General introduction

1.2 Statement of problem

1.3 Objective

1.4 Research question

1.5 Research hypothesis

1.6 Significant of the study

1.7 Scope and limitation for the study

1.8 Organization of the work.

Chapter two

2.1 Conceptual Literature

2.2 Empirical literature

2.3 Theoretical literature

 

Chapter three

3.1   Method of data collection

3.2   Population /Area of the study

3.3   Sample size

3.4   Data analysis

3.5   Technique of data analysis.

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS AND INTERPRETATION

4.1 Introductions

4.2 Data analysis

CHAPTER FIVE

5.1 Introduction

5.2 Summary

5.3 Conclusion

5.4 Recommendation

Appendix

 

Abstract

In recent times, the Nigerian economy has been experiencing significant exchange rate fluctuations, particularly depreciation in the foreign exchange market which has been accompanied with inflation. Thus, this study investigates the degree of pass through of the official and parallel exchange rates to inflation as well as the relationship between exchange rate volatility and inflation in Nigeria. This study examines the relationship between exchange rate volatility and inflation in Nigeria Specifically it sought to: explore the influence of exchange rate volatility on inflation in Nigeria; and to determine the nature and direction of causality between exchange rate and inflation in Nigeria.

 

 

 

 

 

 

CHAPTER ONE

INTRODUCTION

• Background of the study

The degree of exchange rate volatility in the world market, particularly the Naira/Dollar exchange rate especially in the past few years is not only alarming but economically precarious. This has led to a number of questions and interest amongst economists as to the causes of this volatility especially under a floating exchange rate regime such as ours, hence necessitating the need for this research work at times like this. Exchange rate which refers to the price of one currency (usually the domestic currency) in terms of another currency is the quantity of another currency that could be purchased with a given unit of another currency. The role exchange rate plays in international economic transactions cannot be overemphasized because no nation can be economically self-sufficient due to varying factor endowment. Movements in the exchange rate have undulating effects on other macro-economic variables such as interest rate, inflation rate, unemployment, money supply, etc. This volatility can cause among other things balance of payment disequilibrium which have the tendency of bringing in inflation in case of depreciation or unemployment in case of appreciation within the economy. Apart from its inflationary tendencies, the fact that exchange rate fluctuation discourages trade and can create unemployment in the system is very certain. Take for instance, when contracts are signed to finance international trade in goods and services, the usual risks when considering whether such will result in profit being earned will be accessed. Under a floating exchange rate regime, an extra risk is added to the transaction so as to be able to account and cover any extra cost when there is a sudden fluctuation in the exchange rate. If this is not properly done, the sudden fluctuation might upset the calculated profits, hence wiping out the estimated profits. This also is highly inflationary and high inflation is generally harmful to the entire economy of any country. Exchange rate stability remains an important issue that usually dominates the policy-making agendas of governments both in the developed and developing countries. This is so because it has broad implications not only for international trade and balance of payments, but also for the general price level, for the conduct of monetary policy and for macroeconomic stability. Exchange rate refers to the rate at which one currency is exchanged for another(Jhingan,2005). It is the price of a country’s currency expressed in terms of another country’s currency. In Nigeria and indeed many developing countries, the price of foreign exchange plays a critical role in the ability of the economy to attain optimal levels in production activities(Danmola,2013). Furthermore, governments in many developing countries use exchange rate as an instrument for stabilization purposes. This is particularly so for imported commodities and those produced within an economy whose intermediate inputs and raw materials depend heavily on imports (Adelowokan, 2012). Macroeconomic performance is adjudged by three wide measures – inflation rate, output growth and unemployment rate of an economy (Ugwuanyi 2004). It is no wonder then that the issue of price stability, in addition to being the main aim of fiscal and monetary policy in both developed and developing countries, has also gained a huge amount of attention from economists and policy makers around the world. Inflation can be defined generally as the persistent rise in the prices of goods and services in an economy. It has positive as well as negative implications. Inflation might be emphatically corresponding with growth at some low levels, but at higher levels inflation is liable to be unfavorable for growth (Doguwa 2012). The Central Bank of Nigeria (CBN) targets about 2% rate of inflation which shows that inflation can be a serious advantage to the economy especially during periods of economic stagnation. Inflation helps in debt settlement, creates employment and boost growth. The negative effects of high inflation, on the other hand, cannot be overemphasised. Examining countries such as Germany in the early 1920s, Hungary in mid 1940s and Zimbabwe in late 2000s, further strengthens this fact (Lopez 2012). Rising level of Inflation reduces the value of a currency which further erodes the purchasing power of money. It is usually associated with higher interest rates which results in low savings and discourages investment and long-term growth. It also erodes export competitiveness and leads to balance of payment deficit. Inflation on the other hand, is also a topical macroeconomic problem that has been a priority over the years to all governments in the global economy. Inflation which refers to a sustained rise in the general level of prices- the price level (Blanchard, 2009), is one of the causes of economic retardation, and also it is a cause of both social and political unrest in many developing economies (Akinbobola, 2012). Inflation has beset the Nigerian economy over the years. Specifically, Nigeria’s inflation rate has been volatile and mostly double digit (Umo,2007). Whereas economic literature views inflation as being a monetary phenomenon, a wide range of empirical studies have identified exchange rate volatility as one of the key factors that accounts for the variations in the general price level. Specifically, in Nigeria, most studies such as Adelowokan(2012), Egwaikhide, Chete and Falokun(1994), Nwosa and Oseni (2012), Oriovwote and Eshenake(2012), Imimole and Enoma(2011) have identified the fluctuations in exchange rate as one of the proximate causes of inflation in Nigeria. Exchange rate volatility refers to the swings or fluctuations in the exchange rates over a period of time or the deviations from a benchmark or equilibrium exchange rate (Mordi, 2006). Also, it is seen as the risk associated with unexpected movements in the exchange rate. Economic fundamentals such as the inflation rate, interest rate and the balance of payments which have become more volatile in the 1980’s and early 1990’s, by themselves are sources of exchange rate volatility (Ozturk, 2006). Does the fluctuations in the exchange rate over the years have any implications for the general price level in Nigeria? Is there any linkage between inflation and exchange rate volatility in Nigeria? Does the Movements or swings in the exchange rate cause variations in the price level in Nigeria? These and more are the underlying issues which this study seeks to tackle. The fluctuation in the exchange rate can further be threatened if there is an already existing high level of inflation in the system coming from both the demand and the supply sides. In the words of Milton Friedman an American monetary Economist “Inflation is always and everywhere a monetary phenomenon”, (M. Friedman, 1968). A rise in money supply is always believed by the monetarists to cause a proportionate rise in price level and as the rise in the price level persists, the tendency is that the domestic goods and services produced within the country will become less competitive both within and outside the country when compared with other countries’ output, hence, loosing market both within and outside the country. As a result, import will increase and export will fall. This entails that purchasers of the country’s goods will demand less of their currency to settle account with them while consumers within the country will be supplying more of their local currency to settle account with the outside world. The fall in the demand and rise in the supply of the local currency will lead to depreciation of their exchange rate. However, a depreciating currency will mean that the price of the country’s export will fall while the price of imports will rise. Overtime, the volume of import will fall since import has become more expensive and the volume of export will rise since export has become relatively cheaper, hence, depreciation in the exchange rate can turn to appreciation in the country’s exchange rate. A vicious circle can emerge leading to more uncertainties in the foreign exchange market.

• STATEMENT OF THE PROBLEM

Since 1980, inflation in the developing countries has doubled that of developed countries (Bleaney and Fielding 1999). Average inflation rates in more advanced countries have taken various patterns in recent years, trending downwards after 2012 in developed countries, while remaining constant or expanding further in developing countries (Global Economic Prospects 2014). The trend of inflation in Nigeria has been characteristically positive ranging from creeping to running inflation. Doguwa (2012) finds that inflation is inimical to growth when it approaches 10.5 to 12% in Nigeria. According to CBN’s Statistical Bulletin (2005) high inflation was recorded in the early 1970’s from 13.8% in 1971 to 16.0% in 1972 which could be explained by the oil boom period and the economic controls and measures that were introduced after the Biafra (civil war) of 1967 to 1970. It is in view of this that the researcher intend to examine the effect of exchange rate volatility and inflation in Nigeria.

• OBJECTIVE OF THE STUDY

The main objective of this study is to investigate the nemesis of exchange rate volatility and inflation in Nigeria, but to aid the completion of the study, the researcher intend to achieve the following specific objectives;

1. To ascertain if there is any significant relationship between exchange rate volatility and inflation in Nigeria
2. To ascertain the impact of exchange rate volatility on foreign direct investment in Nigeria

• To examine the effect of inflation on Nigeria economic growth

1. To examine the role of central bank of Nigeria in curbing the menace of exchange rate volatility in Nigeria
   • RESEARCH QUESTION

The following research questions were formulated to aid the completion of the study;

1. Is there any significant relationship between exchange rate volatility and inflation in Nigeria?
2. Does exchange rate volatility has any impact on foreign direct investment in Nigeria?

• Does inflation has any effect on Nigeria economic growth?

1. Does central bank of Nigeria effectively play her role in curbing the menace of exchange rate volatility in Nigeria?
   • RESEARCH HYPOTHESIS

The following research hypothesis were formulated by the researcher to aid the completion of the study

H₀: there is no significant relationship between exchange rate volatility and inflation in Nigeria

H₁: there is a significant relationship between exchange rate volatility and inflation in Nigeria

H₀: exchange rate volatility does not have any significant impact on foreign direct investment in Nigeria

H₂: exchange rate volatility does have a significant impact on foreign direct investment in Nigeria

• SIGNIFICANCE OF THE STUDY

It is believed that at the completion of the study the findings will be beneficial to the policy makers as the findings will assist in the planning of government unit through the provision of more efficient feedback information on the effectiveness of their anti-inflationary policies.  It will help individuals and corporations in the planning of their marketing mix for their products.   It will help the IMF on how to advice the Nigerians to overcome the effects of exchange rate volatility and inflation. The study will also be beneficial to financial institution (CBN) central bank of Nigeria as the study will help them regulate the volume of money in circulation

• SCOPE AND LIMITATION OF THE STUDY

The scope of the study covers the exchange rate volatility and inflation in Nigeria. In the cause of the study, there were some factors which militate against the scope of the study which were beyond the control of the researcher;

1. a) AVAILABILITY OF RESEARCH MATERIAL: The research material available to the researcher is insufficient, thereby limiting the study
2. b) TIME: The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.
3. c) Organizational privacy: Limited Access staff and personnel of central bank make it difficult to get all the necessary and required information concerning the activities.

1.8 OPERATIONAL DEFINITION OF TERMS

Inflation

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time

Open And Suppressed Inflation: Open inflation is the result of the uninterrupted operation of the market mechanism

Stag inflation: This is a situation whereby recession is accompanied by a high rate of inflation also called inflationary recessing

Exchange rate

Exchange rate is the price of one currency in terms of another. More accurately an exchange rate is the number of units of foreign currency and vice versa.

Exchange rate volatility

Volatility represents the degree to which a variable changes over time. Volatile exchange rates make international trade and investment decisions more difficult because volatility increases exchange rate risk

Nominal Exchange Rate

The nominal exchange rate is defined as units of domestic currency per unit of foreign exchange.

Trade Tables

These are goods what could be exchange for in the international market.

Non Trade Table

These are the outputs of an economy that can be consumed domestically and therefore for exportation e.g. electricity.

Misalignment

This is the deviation of the actual real exchange rate from its equilibrium value.

1.9 ORGANIZATION OF THE STUDY

This research work is organized in five chapters, for easy understanding, as follows Chapter one is concern with the introduction, which consist of the (overview, of the study), statement of problem, objectives of the study, research question, significance or the study, research methodology, definition of terms and historical background of the study. Chapter two highlight the theoretical framework on which the study is based, thus the review of related literature. Chapter three deals on the research design and methodology adopted in the study. Chapter four concentrate on the data collection and analysis and presentation of finding.  Chapter five gives summary, conclusion, and recommendations made of the study.

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