AN EMPIRICAL ANALYSIS OF THE EFFECT OF CURRENCY DEPRECATION ON THE NIGERIA ECONOMY (1986-2010)


AN EMPIRICAL ANALYSIS OF THE EFFECT OF CURRENCY DEPRECATION ON THE NIGERIA ECONOMY (1986-2010)

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CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND 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.Currency Deprecation

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 realistic exchange rate for the Naira through the inter play of market forces.
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.Currency Deprecation

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.Currency Deprecation

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).Currency Deprecation

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.Currency Deprecation

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.Currency Deprecation

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.Currency Deprecation

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.Currency Deprecation

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.Currency Deprecation

It is against the above problem that this study intends to find out!

If the persistent currency depreciation has effect on the Nigerian economy and
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:

To critically find out how a depreciating currency affect Gross Domestic Products (GDP) in Nigeria.
To find out the impact of depreciating currency on export trades in Nigeria.
To make reasonable recommendation on the problems.Currency Deprecation

1.4 Research Questions

Whether depreciation currency affect Gross Domestic Products (GDP) in Nigeria.
Do you think that currency depreciation has impact on export trade in Nigeria?
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.

H0: Currency depreciation has no effect on the Nigeria Economy.

Hi: Currency depreciation has effect on the Nigeria Economy.

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.Currency Deprecation

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.Currency Deprecation

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.Currency Deprecation

 

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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