Nigeria is a mono-product economy, where the main export commodity is crude oil, changes in oil prices has implications for the Nigerian economy and, in particular, exchange rate movements. The study examined the effects of oil price, external reserves and oil revenue on exchange rate volatility in Nigeria using yearly data from the year 1980 to 2016. The theoretical background of this study is based on the balance of payments theory and the purchasing power parity theory of exchange rate. Relevant descriptive and econometric analysis was employed. The econometrics tests used include unit root test or test for stationarity, using the augmented dickey fuller test which is suitable for large sample, Co integration test was conducted to show if there is a long run relationship between variables. The study made use of multiple regression method; thus exchange rate [EXR] as the dependent variable, oil price in the international market [OPR], oil revenue[ORV] and external reserves [EXRES] and the independent variables.
It was observed that a proportionate change in oil price leads to a more than proportionate change in exchange rate volatility in Nigeria. We therefore recommend that the Nigeria government should diversify from the Oil sector to other sectors of the economy so that Crude oil will no longer be the mainstay of the economy and frequent changes in crude oil price will not influence exchange rate volatility significantly in Nigeria.
1.1 Background to the Study
Crude oil is the largest source of energy in the world today, it powers the global economy and it’s industrialization process, fluctuation in the price of crude oil is expected to have significant impact n both importers and exporters of the product. Nigeria is an oil producing state, Nigeria is the largest oil producer in Africa and also 6th position in Organization of petroleum exporting countries (OPEC), Nigeria joined the OPEC cartel since 1971, the main responsibility of OPEC is to restrict the quantity of crude oil each country member will supply in the global oil market, the main aim is to protect the global price of crude oil. Nigeria is a net importer of finished products; Nigeria imports most of the petroleum products used for domestic consumption and other finished products. This signifies that a change in crude oil price in the international market is expected to cause change in the price of import and exchange rate in the economy. Nigeria discovered crude oil in 1956 and it became an export commodity in 1958. Prior to the discovery of crude oil, the export commodities were agricultural products. The production level of crude oil in the country has fluctuated over the years due to OPEC’S quota and socio-political instability. Following its discovery, crude oil has become a major source of income and foreign exchange for the country, thereby contributing to over 80% of the federal government revenue. Recently the global price of crude oil diminished in the international market; this led to a shock, on the foreign exchange rate of the country and thereby affected consumer prices, invariably, exchange rate is the price for which the currency of a country can be exchange for other country’s currency. According to Business Dictionary “exchange rate refers to the price for which the currency of a country can be exchanged for another country’s currency”. Exchange rate is also regarded as the value of one country’s currency in terms of another currency. Exchange rate is said to depreciate if the amount of domestic currency required to buy foreign currency increases, while the exchange rate appreciate if the amount of domestic currency required to buy foreign currency reduces.
There are various evidences, particularly over the post-bretton woods era, pointing to the vital role of oil price fluctuations in the determination of the path of the exchange rate. (Adeniyi et al, 2004). According to krugman (1983), exchange rate appreciates in response to rising oil prices and depreciates with response to falling oil; exporting countries, while the opposite is expected to be the case in oil exporting countries. Volatility is the fluctuation in the value of variables, especially price (Rout-ledge, 2002). According to Englama et al (2010), a volatile exchange rate makes international trade and investments more difficult because it increases the risk and uncertainty of external transaction and predisposes a country to exchange rate related risks (Jin, 2008).
According to OPEC’S statistical bulletin (2010-2011). Nigeria is a mono -product economy, the value of Nigeria’s total export revenue in 2010 was US$70,579 million and the revenue of petroleum exports from the total export revenue was US$61,804 million which is 87.6% 0f total export revenue. This means that Nigeria’s economy will be vulnerable to the movement of oil prices. During periods of favorable oil price shocks triggered by conflict in oil producing areas of the world, there is rise in the demand for the commodity by the consuming nations. Nigeria experienced favorable terms of trade evidenced by a large current account surplus and exchange rate appreciation. On the other hand when crude oil prices were low, occasioned by factors, such as low demand, Nigeria experienced unfavorable term of trade evidenced by budget deficit and slow economic growth (Englama, 2010). An example was a drop in the revenue from oil exports during the global financial crisis in 2009. According to OPEC statistical bulletin (2010-2011), oil export revenue dropped from US$74,033 million in 2008 to US$43,623 million in 2009 and the naira depreciated to N148.902 in 2009 from N118.546 in 2008. Oil price changes directly affects the inflow of foreign exchange into the country, therefore, for import dependent country like Nigeria, there is the need to understand the relationship between crude oil prices and exchange rate.
1.2 Statement of Problem
Crude oil is a key source of energy in Nigeria and the world. Oil being an important part of the economy of Nigeria plays a strong role in influencing the economic and political fate of the country. Exchange rate on the other hand is the price of Nigerian currency against other countries currency, Nigeria since independence has different exchange rate policies before the establishment of Central Bank of Nigeria (CBN) in 1958 and the enactment of the exchange rate control Act of 1962. Foreign exchange was earned by the private sector and held in balances abroad by commercial Banks which acted as agents for local exporters. The oil boom experienced in the 1970s made it mandatory to manage foreign exchange resources in order to avoid shortage. However, shortage in the late 1970s and early 1980s compelled the government to introduce some ad hoc measures to control excessive demand for foreign exchange. But it was not until 1982 that comprehensive exchange control was applied. The increasing demand for foreign exchange at a time when the supply was shrinking encouraged the development of a flourishing parallel market for foreign exchange. Because the exchange control system was unable to evolve an appropriate mechanism for foreign exchange allocation in consonance with the goal of internal balance, it was discarded on September 26, 1986 while a new mechanism was evolved under the Structural Adjustment Program (SAP) introduced in 1986. The main objectives of exchange rate policy under the SAP were to preserve the value of the domestic currency, maintain a favorable external reserve portions and ensure external balance without compromising the need for internal balance and the overall goal of macroeconomic stability. A transitory dual exchange rate system (first and second-tier – SFEM) was adopted in September, 1986, but metamorphosed into the foreign exchange market (FEM) in 1987. Bureau de change was introduced in 1989 with a view to enlarging the scope of the FEM. In 1994, there was a policy reversal, occasioned by the non-relating pressure on the foreign exchange market. The former reforms such as the formal pegging of the naira exchange rate, the centralization of foreign exchange in the CBN, the restriction of bureau de change to buy foreign exchange as agent of the CBN, etc. were introduced in the foreign exchange market in 1994 as a result of volatility in exchange rates. There was another policy reversal in 1995 to that of “guided deregulation”. This necessitated the institution of the Autonomous Foreign Exchange Market (AFEM) which later metamorphosed into a daily, two-way quote inter-bank foreign exchange market (IFEM) in 1999. The Dutch Auction System (DAS) was reintroduced in 2002 as a result of intensification of the demand pressure in the foreign exchange market and the persistence in the depletion of the country’s external reserves. The DAS was conceived as a two-way auction system in which both the CBN and authorized dealers would participate in the foreign exchange market to buy and sell foreign exchange. The demand for exchange rate in Nigeria mostly comes from importers. A change in the price of crude oil is expected to cause a change in the price of import there by change the demand for foreign exchange in Nigeria. The supply of exchange rate on the other hand is determine by Central Bank of Nigeria which is mostly basely base on the demand pressure, current and future economic outlook, the central bank determine the quantity of foreign exchange to supply in the foreign exchange market. In essence the study will seek to answer the questions be what is the impact of oil price volatility on exchange rate in an oil producing nation (like Nigeria as a case study). And also answering the above question will help to see how and to what extent oil price influences exchange rate in Nigeria?
This study therefore seeks to analyze the basic appropriate view of the oil price and exchange rate relationship.
1.3 Research questions
The study attempts to give answers to the following questions
- Do oil price have a significant relationship with exchange rate
Volatility in Nigeria?
- What is the long run impact of oil price on exchange rate
Volatility in Nigeria?
1.4 Objectivesofthe Study
The major objective for this research is to determine if a long run relationship exists between oil
Price and exchange rate in Nigeria. The specific objectives include:
- To examine if there exists a significant relationship between oil price and exchange rate volatility in Nigeria.
- To assess the long run impact of oil price on exchange rate
Volatility in Nigeria.
1.5 Research Hypothesis
In effort to realize the objectives of the study, the following hypothesis will be tested:
H0: Oil price has no statistical significant effect on exchange rate volatility in Nigeria.
H1: Oil price has a statistical significant effect on exchange rate volatility in Nigeria.
H0: There is no long run relationship between oil price and exchange rate volatility in
H1: There is a long run relationship between oil price and exchange rate volatility Nigeria
1.6 Significance of the Study
The study of “nexus between oil price and exchange rate in Nigeria “ can be a learning paradigm to economist, and researchers; Researches conducted in this field of study have found out that oil price influence exchange rate to a great extent, especially oil producing countries.
Thus, this study is of great benefit to the government and policy makers. It reemphasizes the need to diversify and promote the growth of other sectors of the economy, in other to increase economic growth and improve the standard of living for Nigerians.
1.7 scope of the study
The study on” Nexus between oil price and exchange rate in Nigerian economy” was carried out in Nigeria for the period 1980 to 2016. The choice of the period was to capture periods of major changes in both oil price and exchange rate in Nigeria.
Lack of sufficient time, and unavailability of resources needed. The unavailability of some data and unreliability of some secondary were some of the limitations encountered in this research project.
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