Background to the Study
The exchange rate is perhaps one of the most widely discussed topics in Nigeria today. This is not surprising given its macro-economic importance especially in a highly import dependent economy as Nigeria (Olisadebe, 1995) Exchange rate is the price of one country’s currency expressed in terms of some other currency. It determines the relative prices of domestic and foreign goods, as well as the strength of external sector participation in international trade. Exchange rate regime and interest rate remain important issues of discourse in International finance as well as in developing nations, with more economies embracing trade liberalization as a requisite for economic growth (Obansa, Okoroafor, Aluko and Millicent, 2013).
Perhaps one of the greatest development challenges that have confronted Nigeria since 1986 was when the fixed exchange rate system was abolished and replaced with the flexible exchange rate system as the designing of policy measures to enhance exchange rate appreciation in Nigeria. This particularly is the case after the abysmal failure of the Structural Adjustment Program me (SAP) devaluation policy package designed to aggressively promote export in Nigeria. Nigeria being an import dependent nation particularly for her capital goods and considering the centrality of the rate of exchange of such a country’s currency to her trading partner’s currency, a good number of writers have expressed their interest and position on this important subject. Interest rate in this area has significantly increased over the years as being generated by the fluctuations and the depreciating nature of such an important economic variable as well as its effect on other sectors of the economy. Data provided by (Ekanem 1997) shows that manufacturing companies are operating below 40% capacity and they are import dependent. For several years, the manufacturing sector has concentrated basically on the import of raw materials. This seems to be attributable to the overcrowding of this important sector of the Nigerian economy by multinational corporations. As a result, this sector has been deviled by high interest rates, raising inflation, naira depreciation, foreign earning shortages and consumer’s strong resistance to local products.
Olisadebe (1991) expressed that the naira exchange rate given its macroeconomic impact especially in Nigeria is perhaps one of the most widely discussed topic today. According to him one of the worrisome development in the naira exchange rate in recent years, especially since the introduction of the Structural Adjustment Program me (SAP) in 1986 is that it has continued to depreciate as a result of which some people have called for fixing of the exchange rate even at par with United States dollar. On the equilibrium of exchange rate, the author remarked that such rates ensures the simultaneous attainment of internal and external balance. Exchange rate policy involves choosing where foreign transaction will take place(Obadan,1996). Exchange rate policy is therefore a component of macroeconomic management policies the monetary authorities in any given economy uses to achieve internal balance in medium run. Specifically internal balance means the level of economic activity that is consistent with the satisfactory control of inflation. On the contrary, external or sustainable current account deficit financed on lasting basis expected capital inflow.
In Nigeria, exchange rate has changed within the time frame from regulated to deregulated regimes. Ewa, (2011) agreed that the exchange rate of the naira was relatively stable between 1973 and 1979 during the oil boom era and when agricultural products accounted for more than 70% of the nation’s gross domestic products (GDP). In 1986 when Federal government adopted Structural Adjustment Policy (SAP) the country moved from a peg regime to a flexible exchange rate regime where exchange rate is left completely to be determined by market forces but rather the prevailing system is the managed float whereby monetary authorities intervene periodically in the foreign exchange market in order to attain some strategic objectives (Mordi, 2006). This inconsistency in policies and lack of continuity in the exchange rate policies aggravated unstable nature of the naira rate (Gbosi, 2005).
It is important to know that economic objectives are usually the main consideration in determining the exchange control. For instance from 1982 – 1983, the Nigerian currency was pegged to the British pound sterling on a 1.1 ratio. Before then, the Nigerian naira has been devalued by 10%. Apart from these policy measures discussed above, the Central Bank of Nigeria (CBN) applied the basket of currencies approach from 1979 as a guide in determining the exchange rate which was determined by the relative strength of the currencies of the country’s trading partner and the volume of trade with such countries. Specifically weights were attached to these countries with the American dollars and British pound sterling on the exchange rate mechanism (CBN, 1994). One of the objectives of the various macroeconomic policies adopted under the structural adjustment program me (SPA) in July, 1986 was to establish a realistic and sustainable exchange rate for the naira, this policy was recommended in 1986 by the International Monetary Fund (IMF). On exchange mechanism and was adopted in 1986.
The key element of structural adjustment program me (SAP) was the free market determination of the naira exchange rate through an auction system. This was the beginning of the unstable exchange rate; the government had to establish the foreign exchange market (FEM) to stabilize the exchange rate depending on the state of balance of payments, the rate of inflation, Domestic liquidity and employment. Between 1986 and 2003, the federal Government experimented with different exchange rate policies without allowing any of them to make a remarkable impact in the economy before it was changed. This inconsistency in policies and lack of continuity in exchange rate policies aggravated unstable nature of the naira rate (Gbosi, 1994).
Benson and Victor, (2012) and Aliyu, (2011) noted that despite various efforts by the government to maintain a stable exchange rate, the naira has depreciated throughout the 80’s to date. Against this background, this research study intends to investigate the impact of exchange rate fluctuation on economic growth in Nigeria over a period of 33 years (1981 – 2014).