THE IMPACT OF EXCHANGE RATE, VARIATION ON BALANCE OF PAYMENT

CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF STUDY

          Exchange rate arrangements in Nigeria have undergone significant changes over the last four decades. It shifted from a find regime in the 1960s and the mid 1980s, and finally to the various types of the floating regime since 1986 following the adoption of the structural adjustment programme (SAP).

          The most serous problem is the disequilibrium in the balance of payment. The disequilibrium has lead to Nigeria being unable to meet the debt obligation and as a result her trading partners become so skeptical about extending further credit to her. The search over the years by the government for economic policies portion viable, so they handled and enforced exchange earnings in a pool under government control.

          In the view of the apparent unbalance in the economy and consequent undesirable development, the government adopted fundamental economic restricting strategies, which had the implication of breaking with the past policies that have intended to be more protective in character.

          One main area of the structural reforms included that of checking inflation is a long term and making the price of foreign goods reflect their relative domestic prices to expand the internal industrial based? And to mercies internal supply capacity. The introduction of the structural adjustment programme (SAP) affected the actual exchange rate of the naira and other trading currencies of the world.

          The second tier foreign exchange market (SFEM) was established on the 28thSeptember, 1987 as a mechanism of achieving a realistic exchange rate for the naira and ensuring a more efficient allocation of scare foreign exchange resources.

          All public and private transaction supported by appropriate documents were expected to be financial through the market with the exception of certain transactions such as debt serving, contributions by governments to international organizations and executed prior to the commencement of second tier foreign market (SFEM) and for which approval had to be received. Such exceptions, however, to be executed through the official first tier market were both merged on 2nd July 1987 to firm the foreign exchange market (FEM).

          A country’s eternal balance position is among the primary factors identified in literature that seeks to determine a long-run fundamental value of us real exchange rate.

          The real exchange rate is the rate at which one country’s currency is exchanged for another. Alternatively exchange rate maybe defined as the price of one unit of the foreign currency in term of the domestic currency. Exchange rate players a crucial role in international economic transactions. Thrilwall (2003) argues that gains from trade are unequally disturbed between developing countries that specialize in primary product and developed countries as they are likely to experience unemployment, decline in terms of trade and slower economic growth. However he doesn’t deny the necessity for developing countries to trade. Also due to its varying effect on the volume of trade, the exchange rate exerts a strong influence on a country’s balance of payment position.

          The underlying intuition is straight forward. A positive steady state net international investments position may allow a country to run persistent trade deficits. In turn all things being equal the capacity to substain a negative net export balance allows the maintenance of a “strong” real exchange rate. Conversely a debtor country that must run a trade surplus may require a surplus in its balance of payment when total receipts from exports and foreign investment exceeds total payment.

          The relation between external balance and the real exchange rate to policy makers and currency speculators. The two broad methods of determination usually applied in exchange rate regimes. It could also be a mixture of two regimes. Examples are the crawling peg and the managed float several factors influences the major consideration is the internal economic condition or essentials, the eternal economic environment and the effect of various random shocks on the domestic economy.

          Over the past decades exchange rate management in Nigeria has undergone significant changes. It shifted from a fixed exchange regime in 1960s to a pegged regime between 1970 and the mid 1980, these changes are not pearlier to the naira alone as the US dollars was fixed in gold terms until 1971 when it was debunked and has since been floated.

          The fixed exchange rate regime induced an over valuation of the naira of finished goods with payment position, domestic production and the nations external reserves.

          The autonomous foreign exchange market was introduced in 1995, but due to its failure to achieve the objective of the CBN, an inter bank foreign exchange market was introduced on the 25th of October 1999. It was designed as a two-way quotation system within the economy by encouraging the finding of inter-bank operations from priority earned foreign exchange. As a result of the persistent expansionary fiscal operations of the government and excess liquidity in the system the IFEM was unable to proffer any solution.

          In July 2002, The Central Bank of Nigeria (CBN) introduced the Dutch Auction System (DAS) (It is an improvement over the previous mechanisms trends) to replace IFEM as demand premises on the exchange rate intensified and a depletion in the external reserves level persisted. This was because the foreign exchange earnings from oil contained to general output and employment goals in their countries from which Nigeria’s import originated.

          The major objective of the CBN has been the need to maintain a realistic exchange rate, which would result in simultaneous achievement of internal and external balances and facilitate the achievement of sustainable economic growth and development.

1.2     STATEMENT OF RESEARCH PROBLEM

Nigeria, like other developing countries has been expediency balance of payment disequilibrium. There has been a persistent inflection, high rate of unemployment, increase in imports and a fall in export commodities also a general decline in the gross domestic product (GDP).

          The federal government has tried to correct this imbalances by borrowing from both aboard have added to the Nigeria balance of payment disequilibria.

          Every economy aims at achieving a favourable external balance of payment position in its international relations. The attainment and maintenance of external balances depends on accurate understanding of the effects of the real exchange rate movement on the balance of payment position.

          Economists and policy analyst are yet to reach an agreement on the best exchange rate policy. The history of less developed countries and Nigeria in particular, is best with the incidence of political unrest and social disorder ernanating arguably from high rate of foreign exchange, balance of payment disequilibria and unemployment.

          This study intends to analyses the effect of exchange rate and other macro economic variables on the balances of payment position in Nigeria.

1.3     OBJECTIVE OF THE STUDY

The main objective of this research work is to investigate and determine the impact of exchange rate variation on Nigerian’s internal balance position and to also determine the relationship between the exchange rate and the Nigeria. More specifically the study intends to achieve the following.

i.        To determine the effect of foreign exchange rate changes on the BOP 

ii.       To determine the impact of exchanges rate on foreign reserves in Nigeria.

iii.      To determine the impact of foreign reserves on economic growth in Nigeria.

1.4     STATEMENT OF HYPOTHESIS                                                        

          The hypothesis tested in this research includes:

i.        There is no significant relationship between exchange rate and (BOP).

ii.       Exchange rate has no significant impact on foreign reserves

iii.      Foreign reserves has no significance impact on economic growth in Nigeria.

1.5     SIGNIFICANCE OF THE STUDY

  The research work will help identify the actual impact of exchange rate variation on balance of payment. It will also examine the exchange rate management policy, because the exchange rate management policy is an evolving process and a challenge before the balance of payment.

          The significant of this study is that the result would help policy makers to adopt exchange rate policies that would not be detrimental to the balance of the payment position, which is one of the macroeconomic goals.