IMPACT OF EXCHANGE RATE VOLATILITY AND EXPORT IN NIGERIA (1986 -2016)

ABSTRACT

The study examined the impact of exchange rate volatility on export in Nigeria between 1985 and 2016. The study specifically sought the influence of exchange rate volatility (proxy by official naira/dollar rate), real gross domestic product and interest rate (proxy by lending rate) on export (proxy by net export) in Nigeria between 1985 and 2016. The study adopted the econometric techniques of Augmented-Dickey Fuller unit root test, Johansen Cointegration test, Error Correction Mechanism and Granger Causality test. The result reviewed that: Exchange rate and lending rate were stationary at level, net export was stationary at first- order difference and real gross domestic product was stationary at second-order difference; The Trace and Maximum Eigen statistic indicated the one cointegrating equation between net export, exchange rate, real GDP and lending rate; The ECM results revealed that the speed of adjustment from short-run equilibrium to long-run equilibrium is approximately 68% per annum; Exchange rate and lending rate had negative impact on net export in Nigeria between 1985 and 2016; The Granger Causality test showed the presence of unidirectional causality from: net export to exchange rate; net export to lending rate; exchange rate to lending rate and real GDP to lending rate. The study concluded that exchange rate volatility negatively affect export performance in Nigeria. The study suggested that; Government should adopt selective credit control in order to direct funds to the productive sectors of the economy, which will enhance production for local consumption and exportation; The country’s resources should be domesticated through an inward-looking policy that will encourage the local utilization of the country’s enormous resources and also diversify the country’s export base; Monetary authorities are encouraged to ensure stability in exchange rate in order to stem inflationary tendencies in Nigeria, which have negative effect on export in Nigeria; A friendly business environment should be created. Policy development should prioritize on promoting exports in more business-friendly environment with adequate security and infrastructural facilities.

CHAPTER ONE

INTRODUCTION

1.1.  Background of the Study

It is imperative to note that exchange rate, whether fixed or floating, affects macroeconomic performances such as import, export, national price level, agricultural output, interest rate etc. as well as economic units such as individuals’ purchasing power, firms’ performance etc. which in the long-run could affect the economic growth (Chong and Tan, 2008). Chong and Tan (2008) empirical analysis revealed that the exchange rate volatility is responsible for changes in macroeconomic fundamentals for the developing economies. The volatility and unpredictability of exchange rate is due to the confluence of the factors that affect it (Hanias and Curtis, 2008). As such, the issue of exchange rate sensitivity and determinacy is controversial and has been a subject of much debate. A large number of studies and articles addressed the issue both theoretically and empirically and found different results, which have fuelled the debate. The traditional view is that fluctuations in exchange rates affect relative domestic prices, causing expenditures to shift between domestic and foreign goods (Khan et al, 2010; Betts and Kehoe, 2005). The new view is that relative prices are not much affected by exchange rate fluctuations in the short-run (Cheong, 2004).

Exchange rate fluctuations influence domestic prices through their effects on aggregate supply and demand for products. In general, when a currency depreciates it will result in higher import prices if the country is an international price taker, while lower import prices result from appreciation (Benita and Lauterbach, 2007). The potentially higher cost of imported inputs associated with an exchange rate depreciation increases marginal costs and leads to higher prices of domestically produced goods (Kandil, 2004). Further, import-competing firms might increase prices in response to foreign competitor price increases, to improve profit margins. The extent of such price adjustment depends on a variety of factors such as market structure, the relative number of domestic and foreign firms in the market, the nature of government exchange rate policy and product substitutability (Fouquin et al, 2001; Sekkat and Mansour, 2000). Most Nigerian real sectors and companies depend on imported inputs in the form of equipment, plant and machinery and other materials and given the fact that the bulk of the country’s foreign earnings is from oil earnings which accounts for over 80.0 per cent of the foreign exchange earnings (CBN, 2008a), thus revealing the extent of the vulnerability of these companies to swings in the exchange rate which is greatly affected by fluctuations in the oil price in the international market. Mohammad (2010) noted that the risks associated with volatile exchange rates are major impediments for countries such as Nigeria that attempt to develop through export expansion strategy and financial liberalization.

Exchange rate depreciation of naira to dollar will make importation of goods to be expensive and therefore promote locally made goods to be patronised by the people while foreign made goods will become expensive and therefore, if export grows faster than import, the net export will increase and thus it will promote favourable balance of trade and favourable balance of payment. Net export is the difference between export and import, if export is greater than import, the net export will be positive and favourable but if the import is greater than export, the next export will be negative and unfavourable. Therefore, exchange rate depreciation can determine the volume of net export of a country.  Besides, Chong and Tan (2008) hinted that the impact of exchange rate volatility on economic fundamentals is substantially great if an economy does not provide possible tools in hedging currency risk in its market place which unfortunately, is the case in Nigeria. Furthermore, Chong and Tan (2008) argued that exchange rate volatility has a catalytic effect to various sectors of the economy especially in developing countries where exchange rate volatility poses a threat to their local trade.

Exchange rate management can predict how the real sectors of the economy will contribute to the growth of the net export of the economy. This because there is a linkage between exchange rate and the capital market since most corporations are listed on the floor of the Nigerian Stock Exchange and whatsoever affect the trading of the Nigerian Stock Exchange will also affect the productivity of the real sectors of the economy with resultant effect on the reduction in locally made goods and thus will reduce export and consequently result to decrease in unfavourable net export. It is imperative to note that a depreciation of the local currency makes exporting goods attractive and leads to an increase in foreign demand and hence revenue for the firm and its value would appreciate and hence the stock prices. On the other hand, an appreciation of the local currency decreases profits for an exporting firm because it leads to a decrease in foreign demand of its products. However, the sensitivity of the value of an importing firm to exchange rate changes is just the opposite to that of an exporting firm. In addition, variations in exchange rates affect a firm’s transaction exposure. Therefore, this study examines the impact of exchange rate volatility on export in Nigeria.

1.2.  Statement of the Problem

The year 2009 was overcast by the global financial and economic crisis, which was precipitated in August 2007 by the collapse of the sub-prime lending market in the United States. The crisis led to the crash of most other sectors and markets across Europe with consequent effect on developing economies especially oil-export dependent countries like Nigeria. The impact was aggravated by the reduction in crude oil production due to the persistent restiveness in the Niger Delta region. The spiral effect of the global economic crisis on Nigerian economy continued in 2009 with the exorbitant lending rate mounting pressure on the stock market as a result of massive borrowed fund in the market. The rush by stock investors to liquidate their investment to repay their loans in order to avoid the excessive lending rate caused the Nigerian stock market to crash. This decline was also driven by concerns over unrealistically high valuations in practically all sectors. Regulatory intervention in the equities market only served to erode investor confidence further, especially among institutional investors, as the measures failed to address the fundamental issues. The effect of the global economic meltdown on Nigerian exchange rate was phenomenon as the Naira exchange rate vis-a-vis the Dollar rose astronomically from about N120/$ to more than N 150/$ (about 50% increase) between 2008 and 2011 and it also increased to more than N 380/$ between January to September, 2016. This is attributable to the sharp drop in foreign earnings of Nigeria as a result of the persistent fall of crude oil price.

It is evident from the foregoing that the recent economic recession has further revealed that Nigerian economy is excessively exposed to external shocks. Although various factors have been adduced to Nigeria’s poor economic performance, the major problem has been the economy’s continued excessive reliance on the fortunes of the ever unstable oil market for foreign exchange thereby causing frequent volatility in the country’s exchange rate. The renewed emphasis on the production of alternatives to fossil-fuel energy, such as solar, wind and bio-energy in the advanced economies, would reduce oil demand and further weaken Nigerian foreign earnings. Thus, in the absence of concerted efforts to shore-up and widen the revenue base, there will be reduction in crude oil revenue, excess crude oil receipts savings and foreign exchange earnings in the coming years. This will spell doom for the real sectors in the country with reduction in local production and this will lead to decrease in export in relation to import, consequently result to unfavourable net export. This raises the question of the relative impact of foreign exchange volatility on export in Nigeria? Thus, this study is motivated to provide an empirical answer to the pressing issues in the study.

1.3.  Objectives of the Study

The broad objective of the study is to examine the Impact of Exchange Rate Volatility on Export in Nigeria. Other specific objectives include:

i. To examine the trend of exchange rate fluctuation in Nigeria over the years in Nigeria.

ii. To investigate the relationship that exists between exchange rate fluctuation and the macroeconomic variables whose transmission mechanism could affect net export

iii. To investigate the existence of long-run relationship between exchange rate management and net export

1.4      Research Questions

The following research questions are answered in the course of this study:

Does exchange rate fluctuation have a significant impact on net export in Nigeria?

Would exchange rate volatility affect other macroeconomic variables which are capable of affecting net export in Nigeria?

Is there a long-run relationship between exchange rate management and net export in Nigeria?

1.5       Research Hypothesis

The following hypotheses are stated in null (Ho) and alternative (H1) forms and are tested in the course of the study:

Hypothesis One

Ho:  There is no significant impact of exchange rate on net export in Nigeria.

H1:  There is significant impact of exchange rate on net export in Nigeria.

Hypothesis Two

Ho: Exchange rate volatility does not affect other macroeconomic variables which are capable of affecting net export in Nigeria

H1: Exchange rate volatility affects other macroeconomic variables which are capable of affecting net export in Nigeria

Hypothesis Three

Ho:  There is no long run relationship between exchange rate and net export in Nigeria.

Hi:   There is a long run relationship between exchange rate and net export in Nigeria.

1.6     Justification of the Study

Exchange rate is an important economic variable as its appreciation or depreciation affects the performance of the economy. Its value can be used to assess the overall performance of an economy and so it is a very important variable in the policy decision-making of a country. Any government at any point in time seeks the stability of the exchange rate because it provides economic agents the opportunity to plan ahead without fear of varying costs and prices of goods and services. On the other hand, instability of exchange rate can cause a negative distortion in any economy, resulting to unfavourable net export, unfavourable balance of payment and trade. This study would therefore provide an empirical justification on the link between exchange rate depreciation on net export. Study of this nature will enable policy makers to know how exchange rate affects net export and also the extent to which growth is affected; this will also inform participants in the real sector of the need to formulate strategies to hedge against exchange rate volatility risk.

The rationale for this study lies on the desire to make an important contribution to the work of previous researchers. Many researchers, like Schnabl, 2007, Aliyu (2009), Razazadehkarsalari et al, 2011) have investigated exchange rate volatility and gross domestic product but their studies have not specifically captured export. This present study, therefore, aims to fill this research gap as well as contribute to the body of knowledge by considering specifically the impact of foreign exchange volatility on export. This study covers pre-SAP, post-SAP and democratic era in Nigeria. Recommendations are made at the end of this study that can improve the performance of Nigerian economic growth. This study will also serve as a reference point for potential students/researchers who would be interested in conducting similar studies on this research topic.

1.7.   Scope and Limitation of the Study

This work provides elaborate studies on the impact of exchange rate volatility on export in Nigeria spanning the period of 1985-2016. It relies on secondary data obtained from the latest CBN Bulletin.

1.8.   Plan of the Study

This study is organized into five chapters; following chapter one is chapter two which covers the literature review, theoretical review and empirical studies. Chapter three covers research methodology and data presentation. Chapter four contains the test of research hypothesis, data analyses and the interpretation of result while chapter five contains summary, recommendation, conclusion and suggestion for further studies.

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