EFFECTS OF EXCHANGE RATE REGIMES ON AGRICULTURAL GROWTH IN NIGERIA (1970-2014)

ABSTRACT

Exchange rate policy in Nigeria has changed over time from fixed to flexible exchange rate regimes. There have been debates over which  type of exchange rate can best stimulate growth. Different regimes have been accompanied by instability and uncertainties, this necessitated this study to examine the relationship between exchange rate regimes and agricultural growth in Nigeria in different periods from 1970 to 2014. The objectives of this study were to describe the trend in exchange rate regime and agricultural growth; ascertain the effect of the fixed exchange rate regime on agricultural growth; assess the effect of flexible exchange rate regime on agricultural growth; and determine the causal relationship between  exchange rate  regime and  agricultural  growth.  The study  area is  Nigeria.  This research work covered a period of 45 years from 1970 to 2014.This was purposively chosen due to availability of data. Data were collected from Central Bank of Nigeria and Worldwide Governance Indicators (WGI). The data were grouped into three periods. The whole period (1970 -2014), the period of exchange rate fixed regime (1970-1985) and flexible regime (1986-2014) since exchange rate policy in Nigeria. This study tested the effect of the two basic exchange rate policies, namely, the fixed and flexible regimes on Agricultural growth in Nigeria, using the Ordinary Least Square Method. However, before the Ordinary Least Test was applied, the time series characteristics of the variables used in this study were tested, using Augmented Dickey-Fuller Unit Root Tests and Johanssen co integration Tests. The result showed that there exist a long run equilibrium relationship between the dependent and independent variables. Trend analysis showed increasing trend in agricultural GDP during the fixed exchange rate regime i.e. from 1970-1985 and also the agricultural gross domestic product during the flexible exchange rate regime i.e. from1986-2014. In addition, exchange rates remained stable during the fixed exchange rate  regime. Exchange rates during the flexible regime were not stable except from 1994 to 1998. Results of the regression analysis on the effect of exchange rate regimes on agricultural growth showed that inflation had positively and significantly affected agricultural growth during fixed exchange rate regime while results during the flexible exchange rate regime showed that macroeconomic instability index  was  found  to  have  positively  influenced  agricultural  growth  and  government expenditure on agriculture was found to have positively influenced agricultural growth. Political instability index in contrast was found to have negatively influenced agricultural growth. Results of the Regression analysis for the whole period showed that exchange rate, government expenditure on agriculture and macroeconomic instability were also found to have positively influence agricultural growth.  The results of the Granger Causality Test showed that exchange rate does granger cause Agricultural GDP. This study showed that no matter the exchange rate regime, whether fixed or flexible, what matters is the effectiveness of the management. Nigeria can substantially improve on its growth performance through improvements in the overall management of its exchange rate policy.

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CHAPTER ONE

INTRODUCTION

1.1       Background of the study

Growth in agricultural production and productivity are essential in achieving sustainable economic growth and reduction of poverty in Nigeria. One sector that has a critical role to play in poverty reduction in Nigeria is the agriculture sector as over 40% of the GDP comes from the sector and it employs about 60% of the working population (Nwafor, Ehor, Chukwu & Amuka, 2012). Economic growth in Nigeria has largely been accounted for by resilient agricultural growth associated with performance in four constituent sub-sectors: crops, livestock, fisheries and forestry (Eboh, Oduh & Ujah, 2012). One of the most effective ways to achieve rapid growth in the agricultural sector is via well managed exchange rate policy. The exchange rate thus, is an important economic measurement because it reflects the economic  strength  and  competitiveness  with  other  economies  (Akonji,  2013;  Asinya  & Takon, 2014).

Kenneth, Jonathan and Kenneth (2014) asserted that an exchange rate, as a price of one country’s money in terms of another’s, is among the most important prices in an open economy. It influences the flow of goods, services and capital in a country, and exerts strong pressure on the balance of payments, inflation and other macroeconomic variables such as: domestic price indicator, profitability of traded goods and services, allocation of resources and investment decisions, which explains why the monetary authorities and private sectors seek stability in these variables. Therefore, the choice and management of an exchange rate regime is an essential aspect of economic management to safeguard competitiveness, macroeconomic stability, and economic growth.

In Nigeria, exchange rate has changed within the time frame from fixed to flexible regimes. Ewa (2011) agreed that the exchange rate of the naira was relatively stable between

1973 and 1979 during the oil boom era and when agricultural products accounted for more than 70% of the nation’s gross domestic products (GDP). The main objectives of exchange rate policy in Nigeria are to preserve the value of the domestic currency, maintain a favorable external reserves position and ensure external balance without compromise the need for internal balance and the overall goal of macroeconomic stability. The use of the exchange rate as an instrument of control in the Nigerian economy has been rather limited (Gatawa & Mahmud, 2016). Despite the adoption of these policies at various stages to maintain a stable exchange rates which proved abortive, exchange rate fluctuates widely especially after the Structural Adjustment Programme (post-SAP era). Therefore, the downward trend of the country’s currency impacted greatly on agricultural product. Consequently, exchange rate fluctuations discourage firms from undertaking investment, innovation and trade, it may also deter firms from entering into export markets, thereby weakening investors’ confidence in the sector, and also raises the price of imported inputs such as seeds, fertilizers, pesticides, and capital equipment thereby reducing the agricultural commodities and income of farmers, and exchange rate risk which leads to capital reversal considered unfavorable for the economy at this trying times.

Klein and Shambaugh (2010) reported that the choice of regime may influence growth through its indirect effect on investment, productivity, and international trade. A pegged exchange rate regime may increase confidence and reduce uncertainty and transaction costs, thus boosting investment, productivity, and trade, while uncertainty about exchange rates, under floating regimes, may create a damper to investment. However, if a peg is not credible or leads to overvaluation and black market premiums, as was observed in Nigeria, then it may lead to lower investment, productivity, and trade, and hence weaker growth and competitiveness. Countries with more developed financial markets may be better able to contain exchange rate volatility associated with a flexible exchange rate, and thus are able to

achieve the benefits of flexible rates in terms of enhancing the ability to adjust to real shocks without sacrificing the stability that a credible peg may entail (Ghosh, Gulde, & Wolf, 2014).

1.2       Problem Statement.

It has been a challenge to identify a direct correlation between exchange rate regimes and economic growth. One of the most important issues left unanswered in international finance is the debates over which type of exchange rate can best stimulate economic growth. Stable exchange rate systems are an important component to stable and prosperous economic growth. Stability is the main advantage of a fixed exchange rate, because the exchange rate between the currency and its peg does not fluctuate based on market conditions. Therefore, it can create a steady business climate favourable for trade and investments. On the other hand, floating  exchange  rate  allows  the  central  banks  to  exercise  more  independent  monetary policy, which is crucial to control the economy.

There has been a controversy as regards output of goods and services under the flexible exchange rate system and under the fixed exchange rate system. While Eme and Johnson (2012) insist that flexibility in exchange rates does not have any relationship either directly or indirectly on the growth of output in Nigeria, Edwards and Levy-Yeyati (2003) and Rano-Aliyu (2009) contend that countries with more flexible exchange rate systems grow faster than countries with fixed exchange rate regimes. Available studies in Nigeria where exchange rate regime and growth were captured include that of Eze and Okpala (2014) and (Oleka & Okolie, 2016). These studies, however, focused on the general economy. The relevance of agricultural sector, a leading sector in the Nigerian economy, in terms of its contributions to income, employment, foreign exchange earnings and domestic food supply (Omojimite, 2012), therefore necessitated   the assessment of the effects of exchange rate regimes on agricultural growth.

Kenneth,  Jonathan  and  Kenneth  (2014)  in  their  study  examined  the  impact  of exchange rate regime on  economic growth  in  Nigeria,  but  did  not  assess  the effect  on agricultural growth. This study seeks to identify how various exchange rate regimes influence agricultural growth.

Thus, the following questions necessarily arose as guide for the study:

i.      What effect does the fixed exchange rate regime have on the Nigerian economy especially on agricultural growth?

ii.      What effect does the flexible exchange rate regime have on the Nigerian economy in general especially on agricultural growth?

iii.       Is  there  any  causal  relationship  between  exchange  rate  regimes  and  agricultural growth?

1.3       Objectives of the study

The main objective of this study was to assess the effect of exchange rate regimes on agricultural growth in Nigeria. The specific objectives of the study are to:

i.      describe the trend in exchange rate regime and agricultural growth;

ii.      ascertain the effect of the fixed exchange rate regime on agricultural growth;

iii.     assess the effect of flexible exchange rate regime on agricultural growth; and

iv.      determine  the  causal  relationship  between  exchange  rate  regime  and  agricultural growth.

1.4       Hypothesis of the Study

HO1:  Fixed exchange rate regime does not have any significant effect on agricultural growth. HO2: Flexible exchange rate regime does not have any significant effect on agricultural growth.

HO3: There is no causal relationship between exchange rate and agricultural growth.

1.5       Justification of the Study

Exchange rate is the price of one country’s currency expressed in terms of some other currency. It determines the relative prices of domestic and foreign goods, as well as the strength of external sector participation in the international trade. In Nigeria, exchange rate has changed within the time frame from fixed to flexible regimes. The fact that exchange rate policies vary across countries and time suggests that the causes and effects of exchange rate regimes can be understood both empirically and the theoretically.

Exchange rate policies in developing countries are often sensitive and controversial, mainly because of the kind of structural transformation required, such as reducing imports or expanding non-oil exports, which invariably imply a depreciation of the nominal exchange rate. Such domestic adjustments, due to their short-run impact on prices and demand, are perceived as damaging to the economy. Ironically, the distortions inherent in an overvalued exchange rate regime are hardly a subject of debate in developing economies that are dependent on imports for production and consumption.

The study is of relevance to the Nigerian economy in the following ways: It serves 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 is of immense help to the general economy, as it provides possible measures that monetary authority could adopt in order to maintain stability in exchange rate so that, it can influence importantly agricultural growth, consumption, resource allocation, employment and private and foreign investments as research has shown. Above all, it adds to the existing literature thus, provides relevant information that could guide further researchers on the subject.

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