THE EFFECT OF FLUCTUATING FOREIGN EXCHANGE RATE ON NIGERIA CURRENCY (A CASE STUDY OF CENTRAL BANK OF NIGERIA, ENUGU BRANCH)

CHAPTER ONE

INTRODUCTION

1.1   BACKGROUND OF THE STUDY

        The inter-bank market in foreign exchange is used for trading in foreign currencies – main vehicle for generating autonomous inflow of foreign exchange into the banking system.  La licensed banks, development banks and the central bank are active traders the market.  These banks intermediate for their corporate and individual customers that engage in international trade and investment.  The are always prepared to buy form or sell foreign currencies to their customers in both the spot and forward markets.  In addition, authorized dealers open and maintain foreign currency domiciliary accounts for their customers, especially the exporting customers.

        Exchange rates ruling in the inter-bank market fluctuate in response to the forces of supply and demand for foreign currencies, subject to a maximum spread of one percent between the buying and selling rates.  Al the authorized dealer banks are required by CBN to display their buying and selling rates for spot transactions, but are allowed to negotiate with customers in respect of forward transactions within the one per cent allowable spread or margin.  Authorized dealers are expected to make delivery of transactions of foreign currency to customers within three days from the day payment is made. The overall supervision of the market falls to the Central Bank of Nigeria which may, with the approval of the minister of Finance, intervene in the market from time to time to prescribe guidelines and give new directives.  The Central Bank of Nigeria intervenes at a biding session in order to minimize any large fluctuations in the niara exchange rates.

For example, in 1986, the Central Bank of Nigeria intervened at the 6th session and at the 12th session.

        In practice, the usual sources of foreign exchange to the market include the Central Bank of Nigeria auction, inflow to banks through autonomous sources, non-oil exports via dormiciliary foreign currency accounts, invisible trade items and other miscellaneous sources. For example in December 1986, the value of foreign exchange flowing in form these sources were: CBN auction $237.99 million, banks $28.99 and other miscellaneous sources $48.98million.

        It is interesting to note that the introduction of the Second-tier Foreign Exchange Market (SFEM) in September 1986, coupled with the dismantling of exchange controls have increased the inflow of foreign exchange from autonomous sources.  For exchange, the inflow of foreign exchange from private sources between October 1986 and May 1987 was put at $706 million (or about N2.6 billion).

1.2   STATEMENT OF THE PROBLEM

        Apart from the purely technical question of ensuring the steady appreciation of naira, one of the primary functions of determinants of exchange rate (CBN) is to sustain the value of the naira during fluctuation.

There are, however, other major problems falling our currency and it’s management. 

The persistent geometric progression in depreciation and arithmetic progression in appreciation of naira have discouraged foreign investors due to they cannot make it.  There appears to be no evidence more convincing about the need to central foreign exchange rate fluctuation, than the ever public outcry at the rate our money in falling and rising at the foreign market.

Many citizens going out of the country and public debts increasing.

Of utmost concern is the fact that as years roll by, the problem of the economy appears to be insurmountable.

        The problem of creating awareness to dealers on the impact of exchange rate fluctuation on their investment profits that the profit seeks to address.

        The general publics have little knowledge of financial implications associated with the unsteady exchange rate. Furthermore, there is the problem of dealers and citizen, not being aware of the impact or effect of the fluctuation of foreign exchange rate on naira’s value.

        Finally, the problem of knowing how possible it is for the determinants (both CBN and others) to control the issue to a considerable rate after the exercise.

1.3. NEED FOR THE STUDY

                There have been a lot of thought about the N.70: N138, appreciation and depreciation respectively to $1.00, in the foreign exchange market.  The research wants to carryout a research on what the government through the exchange rate determinants were doing and find out if the adept any exchange control measure in the currency management.  The researcher also wants to have an empirical base either to support all the poor impression people have o the naira exchange rate with dollar and to advice on how to improve the value by adopting exchange rate control measures.

         Therefore, the need for the study includes:

• To brought to light the effects of the fluctuation of foreign exchange rate on naira.
• To advice the nation on the necessity to check it.

1.4. PURPOSE OF STUDY

        From all that has been written above, it is the aim of this study to take a segment of the Central Bank of Nigeria, and study the approach of the bank towards the exchange rate fluctuation.

• Whether or not the CBN apply exchange controls as a bases for putting it to a considerable rate.
• If the measures introduced had done any thing over it and
• To formulate strategies and make recommendations that would be more effective in the foreign management.

1.5. SCOPE AND LIMITATION OF STUDY

        The scope of the study is very wide if it has to be carried out in all the branches of CBN, including the headquarter. The study is limited, based on the facts that there is no time and material resources to see tot he whole systems. This study is limited to (Enugu State) and the findings may not reflect the situation in the whole country.

These findings may not be valid for the whole branches of CBN, but by and large, what happens in Enugu branch can be said to apply to other breaches.

1.6. RESEARCH PROPORTION

        It is the objective of this study to know if:

1. The determinants of exchange rate mounts mish pressure    on its fluctuation effects on naira.
2.     CBN apply the foreign exchange rate control measures, it put the fluctuation to a considerable rate.

        3.     People have said reasonable things concerning it.

       4.     What had been done before yield any good results.

1.7. DEFINITION OF TERMS

The following terms used in this study should be taken to mean following.

FOREIGN EXCHANGE MARKET

This is an arrangement which exists to assist buyers and      sellers of foreign exchange to enter into contract of buying and selling.

FOERIGN EXCHANGE

This is a means of international payments.

It includes currencies of other countries that are freely acceptable in effecting international transactions.

EXCHANGE RATE

This is the price of one currency in terms of other.

TRADE WEIGHTED EXCHANGE RATE

        This is the value of a domestic currency expressed in terms of a weighted basket of currencies of the major trading partners. 

The weighted assigned to each currency reflects the volume of trade with the country of domicile.  The weights are reviewed regularly to take accounts of changing patterns of trade.

DUTCH AUCTION SYSTEM (DAS)

        This is a method of exchange rate determination through auction where the bidders pay according to their bid rates.  The ruling rate is arrived at with the last bid rate that clears the market.

DUAL EXCHANGE RATES REGIME

        This situation exists when two exchange rates are in existence in an economy.  This was the situation in Nigeria between September 1986 and July 1987 when two rates, the first and second-tier rates were in place.  Again in January 1995, a dual exchange rate system made up of the pegged, official exchange rate and floating, autonomous exchange rate, was introduced.

AVERAGE PRICING METHOD

        This is a method of exchange rate determination where the average of bid rates is applied as the ruling exchange rate.

MARGINAL PRICING METHOD

        This is the method in which bid rates are arranged in a descending order of magnitude and the rate at which available foreign exchange is exhausted is the marginal rate.

MODAL AVERAGE METHOD

        This is the method of determining the exchange rate by averaging the rates tending towards the mode.

ELIGIBLE TRANSACTIONS

        The authorized dealers in foreign exchange which comprise all licensed banks, that is to say, commercial and merchant banks and belatedly development banks and bureau de change.

CURRENCY CONVERTIBILITY

        Simply, convertibility may be defined as the ability to exchange one country’s currency for another’s, without any hindrance or restriction from the monetary authorities of either country.