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AN EMPIRICAL ANALYSIS
OF THE EFFECT OF CURRENCY DEPRECATION ON THE NIGERIA ECONOMY (1986-2010)
CHAPTER ONE
INTRODUCTION
1.1BACKGROUND OF THE
STUDY
The currency of a nation would normally
serve as a medium of exchange, a standard of value and a store of value.
A close perusals of these functions
would show that in a complex economy, money is usually the only accepted medium
through which a buyer pays a seller. The currency of a nation functions
also as a store of value. Money is a convenient way to store wealth for
use whenever it is needed. If however, the value of a currency is not stable,
the value of that wealth will diminished daily. The Nigerian currency has
continued to lose value over a long period of time and as years go by.
This does have severe consequences on the economy.
Before 1986, the Nigerian currency “Naira” in terms of other currencies was
over values, but after 1986 till date, Nigerian currency has been
depreciating. Nigeria adopted the Second Tier Exchange Market (SFEM) in
September 1986. The SFEM was a foreign exchange policy. The main
objectives of SFEM were to achieve:
a. A realistic
exchange rate for the Naira through the inter play of market forces.
b. The
deregulation and liberalization of exchange and trade controls among
others. Government adopted the Second Tier Foreign Exchange Market (SFEM)
as a Foreign Exchange policy for many reasons.
One of the reasons
why government adopted the Second – Tier Foreign Exchange Policy (SFEM) was
because of the state of the economy. In the Nigeria economy there was a
problem of persistence and deterioration of balance of payments, External debt
crisis, the erosion of international credit worthiness, as witnessed by the
inability of most holders of import licenses in 1985 and 1986 to effectively
utilize them owing to the dearth of confirming lines and the acute shortage of
raw materials and consumer goods. These problems had its origin from the
“oil boom” of 1970s. After the boom there were substantial imbalances and
distortions in the economy. This was also the era of sudden increase in
the number of public sector institutions and enterprises and private sector
institutions and enterprises and private sector firms, which were largely
dependent on imported inputs. It was also the era of ‘white elephant projects”
huge and expensive projects of doubtful utility or viability. There was
heavy dependence on oil and imported inputs. This rendered the economy
vulnerable to economic shocks with the collapse of the world oil market.
In the mid 1981, there was economic crisis in the economy because most of our
revenue came from oil sector of the economy and other sectors have been
neglected.
Another
major reason adopting the Second –Tier Foreign Exchange Market Policy (SFEM)
was due to the varying degree of decline in external reserves. After the
oil boom in the 1970s the country official Foreign External Reserves stood at
about US $ 10billion at the end of December 1980. These external reserves
depleted to a 1010 level of about US $ 3.81billion at the end of 1981.
The external reserves as at December 1982 amounted to US $1.5billion. The
external reserves as at December 1983 totaled to US $ 1.2billion and the
exchange rate was N0.7486 to 1 US dollar while the exchange rate as at that
time was N0.8083 to 1 US dollar. The reserve of December 1985 did not
show any improvement when compared to 1981 figure. The exchange rate did
not reflect the precipitous down turn in the economy, though there was a
serious depletion of external reserves and a gradual and persistence
depreciation of the Naira during the period. The ailing economy could not
support the relatively strong currency. The problem of Nigeria state of
economy was blamed on the overvalued currency. A less valued currency
will help encourage export and improve the economy. This above problem
led the government to adopt Second-Tier Foreign Market Policy. This
involves a devaluation of Nigeria Naira.
The
Second – Tier Foreign Exchange Market Policy (SFEM) started with the first
bidding session (auction) on 26th September, 1986 in the Central
Bank Nigeria. The government operated a “Dual Exchange rate system
policy” This policy allowed for two different rates. In the market, these
were the first and Second Tier Exchange Market rate. On the date, the
exchange rate in the first tier Foreign Exchange Market, which was being
administratively determined as N1.5691 to 1 US dollar while the rate in SFEM
was N4.0177, thus showing depreciation of 66% when compared with the First
–Tier Foreign Exchange Market. Due to problems like multiplicity of
rates, which results in the further depreciation of the Naira, the dual
exchange rate system policy was replaced by unified exchange rate system.
Under
the policy of the unified exchange rate system, the first and second-tier rates
were merged in July 1987 into a unified exchange rate and the market was called
Foreign Exchange Market (FEM). This method subjected all transactions to
market process. There was still persistence in depreciation of Naira
exchange rate through an Auction System. Specially the major sectors was the
achievement of balance of payment stability. This objective was to be
achieved through the adoption of realistic exchange rate policy coupled with
the liberalization of the external trade and payment system (CBN 1993).
The
Central Bank of Nigeria in its monetary credit policy, foreign trade and
exchange policy guiltiness for 2000 abolished AFEM and replaced it with (IFEM)
inter Bank Foreign Exchange Market. In July 2002, the government adopted
the Dutch Auction System. This is a system of where by each bank is
allowed to buy foreign exchange from Central Bank at its own exchange
rate. Central Bank sales foreign exchange to banks at different exchange
rate twice weekly. It is against this background that this study is being
centered.
1.2 Statement
of Problem
Since the introduction of Market
determined exchange rate through the Second –Tier Foreign Market (SFEM) in
1986, the Naira exchange rate has exhibited the features of continuous
depreciation and instability in both the official rate of Naira to Dollar has
moved from N1.55 per dollar in 1986 to N44 in 1993, N133.5 in 2002 and
N152 in 2010. The depreciation of the currency is more in 90s and 2000s
than in the 80s. the causes of depreciation includes; excess demand for
foreign exchange inflow, inadequate funding of foreign exchange market,
instability in the crude oil market, speculative activities, sharp practices of
authorized dealers, expansionary monetary and fiscal policies which fueled
demand pressure in the market, fragile export base and built import dependence
of the economic system, industrial sector and employment rate contribution to
gross domestic product is not impressive. There is low manufacturing, low
productivity and neglect of agricultural sector.
This instability and continued depreciation of the naira has done a lot of
damage to the economy of the nation. The effects of the economy include;
decline standard of living of the populace, increased cost of production,
cost-push inflation etc. Bureau de change was established in 1989 to
challenge the parallel market but this was not effective because the parallel
market is waxing stronger everyday to the detriment of the official market and
the economy in general. This lead to problem of widening gap between the
rates in the official market on one hand and those in the bureau de change and
parallel market on the hand. At the end of December, 2003 Inter-Bank
Foreign Exchange Market (IFEM) rate stood at N113.5 while the parallel and
bureau de change market rates was N135 leaving the gap at N0.5K.
One of the major causes of currency depreciation is the balance of payment
disequilibrium, which stood at 774.3 between 1975-1979. It improved in 1985 to
349 and in 1993, it has a higher strong negative – 13615.9 and improved in
2009.
The Scenario depicted above shows that our imports are more than our exports
and this affects our currency because our external reserves decreases. Fiscal
deficit has also been a major cause of currency depreciation. This has
resulted in excess liquidity in the economy. In 1999, this fiscal deficit
went up to 300billion. This was very high compared to 1997, which was
4.7billion. This excess liquidity also lead to high inflation rate was
10.5. It fell in 1985 to 5.5 but in 1993. It was 57.2 and in 2005, it was
76.1.
The Central Bank has attributed the major cause of currency deprecation to
excess liquidity and it is blamed on the Federal Government for not yielding to
its advise on spending especially the disbursement the N198billion oil wind
fall to the State and Local Government. This was the cause of currency
depreciation in 2001, 2002 and to 2005.
It
is against the above problem that this study intends to find out!
1.
If the persistent currency depreciation has effect on the Nigerian economy and
2.
The impact of the persistent currency depreciation on the export trade.
1.3 Objectives
of the Study
The objectives of the study are as follows:
1.
To critically find out how a depreciating currency affect Gross Domestic
Products (GDP) in Nigeria.
2.
To find out the impact of depreciating currency on export trades in Nigeria.
3.
To make reasonable recommendation on the problems.
1.4 Research
Questions
1.
Whether depreciation currency affect Gross Domestic Products (GDP) in Nigeria.
2.
Do you think that currency depreciation has impact on export trade in Nigeria?
3.
What do you recommends for depreciating currency on export trade?
1.5 Research
Hypotheses
The following
hypothesis have been formulated based on the objectives of the study.
1.
H0: Currency depreciation
has no effect on the Nigeria Economy.
Hi:
Currency
depreciation has effect on the Nigeria Economy.
2.
H0: Currency depreciation
does not effect export trade negatively
H2:
Currency
depreciation effects export trade negatively.
1.5
Significance of the Study
The value of a nations currency is not just an economic indicator. It is also a
status symbol of a nation and a measure of its dignity. No wonder the
British of the economic benefits of a single European currency was unwilling to
give up the pround for ERUO.
Exchange rate is a strong economic indicator for assessing the overall
performance of an economy. It is one of the micro-economic variables that
reflects the strength or weakness of an economy. A persistently strong
currency is a reflection of a weak and vulnerable economy while conversely a
persistently weak currency is a reflection of a weak and vulnerable
economy.
A
country’s currency is its symbol of strength. The underlying strength in
its currency is the gross national product, which includes agriculture, mining,
manufacturing, drilling and tourism etc. The sum total of what the
economy produces and exports show out in a strong currency. If the Government
and the privates sector properly manage the Nigeria Foreign exchange market, it
will generate a reliable and stable naira rate of exchange that will encourage
manufactures and agriculturist to invest which will lead to economic
development and growth, enhance bring about a strong currency. A country’s
worth is dependent on its currency because of international worth in the
Foreign Exchange Market (FEM). This shows that the currency of a nation
is its symbol of personality. A strong currency will attract investors and this
will boost the country economy.
Therefore, this research study will
provide a clear cut definition of Nigeria Foreign Exchange Market problem,
causes of the persistent depreciation of the naira and their solution, which
will be of help to the generality of the masses and all sort of enterprises.
The study will provide the reader with an opportunity of understanding the
intricate of the Foreign Exchange Management and methods of managing foreign
exchange policies.
1.6 Scope of
the Study
The research work covers what happens to Nigerian currency between
1986-2010. Therefore, this research study covers the causes of the
persistent depreciation of the naira. This study will show how deficit
financing, inflation, low capacity utilization, balance of payment
disequilibrium has contribution to the instability and depreciation of exchange
rate. This research study will show the role of Central Bank in managing
the foreign exchange and its drive towards making the exchange rate a strong
one. This research will show the historical background of the currency
depreciation in the Nigeria economy. This period our currency started
depreciation and factors that have contributed to the persistent depreciation.
The research study will show the effects of depreciation of currency on Nigeria
economy. It will show how the depreciation of currency affects investors,
business, and the economy as a whole.
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