EXCHANGE RATE MOVEMENTS AND ITS IMPLICATION ON THE VALUE OF THE NAIRA (1986 TO 2018)

EXCHANGE RATE MOVEMENTS AND ITS IMPLICATION ON THE VALUE OF THE NAIRA (1986 TO 2018)

This study aims to show the relationship between the various variables which include the exchange rate movements (such as the Dutch auction, the interbank, the official and the parallel) and the value of money which is measured using the consumer price index (CPI).

GET RELATED PROJECT TOPICS HERE

CHAPTER ONE

INTRODUCTION

1.1     Background to the Study

Foreign exchange is the means of payment for international transactions and it is made up of convertible currencies that are generally acceptable for the settlement of international trade and other external obligations.

The foreign exchange market is an arrangement or medium of interaction between the sellers and buyers of foreign exchange in a hid to negotiate a mutually acceptable price for the settlement of international transactions (Ile 1999: 325)

In finance, an exchange rate (also known as foreign exchange, forex exchange, FX rate, or Agio) between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency.

Afolabi (1999) defined the exchange rate as the price of one currency in terms of the other. In other words, it is the rate at which one currency will exchange for another.

Exchange rates are determined in the foreign exchange market which is open to a wide range of different types of buyers and sellers and where a currency trading is continuous: 24 hours a day except weekends. The SPOT exchange rate refers to the current exchange rate. The FORWARD exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.

In the pre-Babangida administration years, the Nigerian currency was above the dollar and on par with the pound. however, since 1986 to date, the value of the Naira has depreciated to a great extent which has had a negative effect/impact on Nigeria’s growing economy.

Exchange rates can be measured using the Dutch auction foreign exchange rate, interbank foreign exchange rate, official foreign exchange rate and the parallel foreign exchange rate.

Macroeconomic analysis relies on several different metrics to compare economic productivity and standards of living between countries and across time. One popular metric is purchasing power parity (PPP).

The concept of purchasing power parity allows one to estimate what the exchange rate between two currencies would have to be for the exchange to be at par with the purchasing power of the two countries’ currencies.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

The consumer price index (CPI) is the most widely used measure of price-level and is sometimes viewed as an indicator of the effectiveness of government economic policy. It provides information about price changes in the Nation’s economy to government, business, labour, and private citizens and is used by them as a guide to making economic decisions.

Traditionally, the consumer price index (CPI) was considered an upper bound on a cost-of-living index, in that the consumer price index (CPI) did not reflect the changes in buying or consumption patterns that consumers would make to adjust to relative price changes. The ability to substitute means that the increase in the cost to consumers of maintaining their level of well-being tends to be somewhat less than the increase in the cost of the mix of goods and services they previously purchased.

Consumer price index (CPI) values enormously impact the value of currencies (for instance the Naira) as well as the relationship of one currency to another. Currency traders always keep a close watch on not only monthly consumer price index (CPI) figures from a country but also estimates by experts about what the monthly consumer price index (CPI) will be. If the consumer price index (CPI) results don’t match experts’ estimates, there is usually a very volatile response from the currency of that country.

Naira value may be adjusted using the consumer price index (CPI) to adjust the federal income tax structure. These adjustments prevent inflation-induced increases in tax rates, an effect called bracket creep. An increase in the consumer price index (CPI) causes the Nigerian Naira to become weaker through the exchange rate (relative price-level changes).  The Consumer Price Index (CPI) is a broad measure of price-level changes in an economy to the cost of goods and services. That figure can have a significant impact on the value of a currency to the currencies of other nations.

1.2     Statement of the Problem

A review of the Nigerian economy shows a decline in the value of the naira to the constant upward movement of the foreign exchange rate in the years under study (1986-2018). One of the aims of the government is to have a stable exchange rate which helps to determine how the country’s currency is valued and how well it performs in the international market. The increase in foreign ER leads to cheaper domestic goods for foreign consumers, increasing exports, total demands and prices. The increase in the foreign exchange rate raises the inflation rate.

Also, the currency exchange rate has an indirect impact on unemployment because it affects the competitiveness of local firms and the cost of imported goods and raw materials. Changes in the currency exchange rate might cause job losses or increase the demand for employees. Currency appreciation tends to cause unemployment because the demand for imports become more and some local firms may fail to compete against the lower price of imports and go out of business.

This study was carried out to know the level of impact these changes in the ER have on the value of the Naira and also how the above set of problems that arises as a result of these changes can be solved.

1.3 Aim and Objective of the Study.

This study aims to show the relationship between the various variables which include the exchange rate (ER) movements (such as the Dutch auction, the interbank, the official and the parallel) and the value of money which is measured using the consumer price index (CPI).

The study has the following objectives:

1. To determine the effect of the changes in the Dutch auction foreign ER on the Consumer price index (CPI).
2. To determine the influence of the changes in the interbank foreign ER on the Consumer price index (CPI).
3. To determine the impact of the changes in the official foreign ER on the Consumer price index (CPI).
4. To determine the influence of the changes in the parallel foreign ER on the Consumer price index (CPI).

1.4 Research Questions

To guide this study, the following questions were formulated.

1. To what extent does the changes in the Dutch auction foreign exchange rate affect the consumer price index (CPI).
2. What is the degree at which the changes in the interbank foreign exchange rate affect the consumer price index (CPI)?
3. How much effect does the changes in the official foreign exchange rate have on the consumer price index (CPI)?
4. To what extent do the changes in the parallel foreign exchange rate affect the consumer price index (CPI).

1.5 Statement of Hypothesis

The following hypotheses have been stated in their null form which was formulated and shall be tested in this study for the achievement of the stated objectives;

H₁: The Dutch auction foreign exchange rate has no significant effect on the consumer price index (CPI).

H₂: The interbank foreign exchange rate has no significant effect on the consumer price index (CPI).

H₃: The official foreign exchange rate has no significant effect on the consumer price index (CPI).

H₄: The Parallel foreign exchange rate has no significant effect on the consumer price index (CPI).

1.6 Significance of the Study

This research work will be of immense benefit to the following groups of people:

1. Policy Makers – This research work will be of help to policymakers in the various governmental organization in Nigeria who formulate and issue the regulatory economic guidelines.
2. Financial Analyst– This work will also benefit financial analysts who engage in certain investment activities
3. Government – This work will aid the government to adopt the best foreign exchange rate to improve the value of the naira.
4. Students and researchers – This work will be of immense benefit to students and researchers who may desire to research further on the topic or related topics in the future.

1.7 Scope of the Study

(A) Content scope

This study centers on the exchange rate movements and its implication on the value of the Naira. The variables used to discuss the changes or measures of ER include the Dutch auction foreign exchange rate, the interbank foreign exchange rate, the official foreign exchange rate, and the parallel foreign exchange rate.

The consumer price index (CPI) is used to measure or determine the value of the Naira to the above variables. The years’ understudy is between 1986 to 2018.

(B) Geographical scope

The geographical scope of this research work is limited to Nigeria. This is so because the work aims to look at the exchange rate movement and the value of the Naira which is the unit of currency in Nigeria.

1.8 Limitation of the Study

Some problems were encountered in the course of the study:

1. Limitation of Data: The data used were limited to the use of certain variables and reports which is not the only way to get the result for this work.
2. Reliability of Data: To some extent, the data received for the sake of this research work may not be completely accurate as it may have one or two errors.
3. Self-reported data: This is a limitation to the study as pre-existing data is used and as such the data were rarely independently verified.

1.9 Definition of Terms

1. Autonomous Foreign Exchange Market (AFEM): this is the market where banks are allowed to source their foreign exchange and sale and use at market-determined rates.
2. Current factor cost: This is used to measure the rate of Gross domestic product (GDP).
3. Dual exchange rate: This situation exists where two exchange rates are in existence in an economy.
4. Dutch Auction System (DAS): This is a method of determining the exchange rate through auction.
5. First — Tier Foreign Exchange Market: This was the market where the government and its agencies buy foreign currency at an officially determined rate of exchange.
6. Inter-Bank foreign Exchange market (IFEM): This was conceived to deepen the foreign exchange market through active participation of other players e.g. bank, oil companies, non- bank financial institutions. It is the market where banks can sale foreign exchange to one another and other users at their rates.
7. Parallel market: This is also known as the blank market’. It is the unofficial market where foreign currencies are bought and sold.
8. Second-tier foreign exchange market (SFEM): This was the market where non-governmental bodies buy and sell foreign exchange at a market-determined exchange rate.
9. Purchasing power parity (PPP): Purchasing Power Parity (PPP) is an economic theory that compares different countries’ currencies through a market “basket of goods” approach. According to this concept, two currencies are in equilibrium or at par when a market basket of goods (taking into account the exchange rate) is priced the same in both countries.
10. Consumer price index (CPI): The consumer price index (CPI) is used to measure or determine the value of the money or currency (for instance the naira) to the rate at which it exchanges with another currency. That figure can have a significant impact on the value of a currency to the currencies of other nations.

1.10 Organization of the Study

The Chapter 1 of this study covers the introduction which describes the background of the study, statement of the problem, aims and the objectives of the study, the research questions, statement of hypothesis, significance of the study, the scope of the study (geographical and content), limitations of the study and the definition of terms.

Chapter 2 takes a look at the literature review which covers the theories, the conceptual framework of currency value, , the empirical review and that gap analysis. Chapter 3 is the research methodology which includes the research design, the population of the study, the sample size, the data collection method, the operational measure of variables, the model specification and the data analysis technique.

Chapter 4 captures the data presentation and analysis. The data sourced is analyzed, indicating the level at which each variable influences the other after which a t-test is conducted to check for accuracy of the result.

Chapter 5 captures the summary, conclusion, and recommendations.  The summary of the analysis is given, a conclusion is drawn from the result of the analysis and certain recommendations are stated to improve the level of the outcome.