Project-THE EFFECT OF FOREIGN EXCHANGE MANAGEMENT AND NIGERIA ECONOMY

THE EFFECT OF FOREIGN EXCHANGE MANAGEMENT AND NIGERIA ECONOMY

(A STUDY OF CENTRAL BANK OF NIGERIA {CBN}, LAGOS)

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CHAPTER ONE

INTRODUCTION

 1.1 Background to the Study

Exchange rate refers to the price of one currency (the domestic currency) in terms of another (the foreign currency). Exchange rate plays a key role in international economic transactions because no nation can remain in autarky due to varying factor endowment. Movements in the exchange rate have ripple effects on other economic variables such as interest rate, inflation rate, unemployment, money supply, etc. These facts underscore the importance of exchange rate to the economic well-being of every country that opens its doors to international trade in goods and services. The importance of exchange rate derives from the fact that it connects the price systems of two different countries making it possible for international trade to make direct comparison of traded goods. In other words, it links domestic prices with international prices (Ojo, 1990).

Exchange rate is the price of one currency in terms of another. It is the amount of foreign currency that may be bought for one unit of the domestic currency or the cost in domestic currency of purchasing one unit of the foreign currency (Soderstine, 1998). It is the rate at which one currency exchanges for the other, and it is used to characterize the international monetary system (Iyoha, 1996).

Anifowose (1994) describes foreign exchange as a monetary asset used on a daily basis to settle international transactions and to finance deficits in a country’s balance of payments. He emphasizes that it is an important component of a country’s stock of external reserve. Other components include holding of monetary gold and special drawing rights (SDRs). He considers foreign exchange management as a conscious effort to control and use available foreign resources optimally while ensuring to build up external reserves in other to avoid external shocks attributable to dwindling of foreign exchange receipts.

Obaseki (1991) observes that foreign exchange can be acquired by a country through exports of goods and services, direct investment inflow or external loans, aids and grants which can be used in settling international obligations.

Foreign exchange is essential to coordinate global business. Foreign exchange management is associated with currency transactions designed to meet and receive overseas payments. Beyond these transactions, foreign exchange management requires you to understand the relevant factors that influence currency values. From that point, you may execute the proper strategy to manage risks and improve potential earnings.

Foreign exchange management begins with trading currencies to exchange goods and services overseas. International businesses convert overseas profits back into their domestic currency to spend at home. Meanwhile, consumers exchange domestic currency for foreign banknotes to buy overseas goods. These transactions occur within the foreign exchange markets, where networks of private individuals, banks and organized financial exchanges provide the infrastructure to trade international banknotes (Mussa, 1986).

Effective foreign exchange management requires you to preserve purchasing power by staying current on any events affecting rates and operating accordingly. You will exploit the buying power of high exchange rates to acquire overseas goods. Alternatively, low exchange rates are an opportunity to boost overseas sales, as your wares become relatively cheaper overseas.

Foreign exchange occurs at rates that are associated with currency valuations. Foreign exchange rates describe the amount of one currency that must be given up to receive one unit of another currency. Foreign exchange rates parallel the political and economic environment of a particular country. For example, domestic foreign exchange rates appreciate when the economy is strong and the currency is in high demand to buy the nation’s stocks and real estate. Conversely, currency values fall amidst political and social instability. Foreigners generally liquidate business assets in war-torn nations that struggle with development.

1.2 Statement of the Problem

The central bank of Nigeria for some time now has been operating under serious constraints in the management of foreign exchange market for economy Nigeria. These constraints include loss of foreign exchange supply, lapse in the policy coordination, various malpractices of operators in the foreign exchange market (such as round. Tripling in banks) e.t.c. This problem has to a great extent undermined the economy of Nigeria in foreign exchange management process, culminating to persistent deterioration in the value of Nigeria and the increase in exchange rate.

The exchange rate between naira and other currencies of the world especially dollar is now very volatile. It fluctuates on weekly, daily and even on hourly basis and there is no limit to its variability. This fluctuation has made naira to be very unstable and its value reduced to the barest minimum. This problem of exchange rate variability became too disturbing after the emergence of the generalized floating system in the early 1970’s. It was not however surprising that six different systems were tried between 1986 and 2008. Between 1986 and 1989, the average pricing system, marginal pricing system and the Dutch Auction System were used while the Interbank.

Foreign Exchange Market (IFEM) system was in place between 1989 and 1990. This was replaced by the re-introduction of the Dutch auction system which was tested till March 1992 when a new  system based on the interbank foreign exchange market was instituted. Finally, the wholesales Dutch Auction System (W-DAS) was introduced in February 20, 2006. The introduction of the W-DAS was also to deepen foreign exchange market in order to evolve a realistic exchange rate for the naira.

Although the naira firmed up at the end of 1986 relative to its position at the beginning of the second-tier market, the fluctuation from one bidding session to another was large. The Central Bank of Nigeria actually had to intervene on two occasions in order to moderate the amplitude of fluctuation in the exchange rate.

The frequency with which new exchange rates were introduced and changed and the intermittent intervention of the Central Bank is informed by the determined effort of the monetary authorities to un-relentlessly combat the un-abating depreciation and instability of the naira exchange rate. In addition to the generalized floating exchange rate system, a number of other factors have contributed to the dwindling fortune of Naira. These includes weak production base and undiversified nature of the economy; import dependent production structure; sluggish foreign capital inflows; unguided trade liberalization policy; over reliance on the imperfect market system, weak balance of payment position, loss of monetary policy and more importantly, poor foreign  exchange management system (Obadan, 2001).

This undesirable phenomenon has sparked off the emergence of serious theoretical and empirical studies on the exchange rate determination that dominated the literature of recent. The research community has however, casted  doubts both on the validity and adequacy of these various exchange rate determination systems ever tried in history. Some of the authors that have researched this area found that the floating exchange rate system alone cannot determine the realistic value of naira.

The exchange rate between naira and other currencies of the world especially dollar is now very volatile. It fluctuates on weekly, daily and even on hourly basis and there is no limit to its variability. This fluctuation has made naira to be very unstable and its value reduced to the barest minimum.

1.3 Purpose of the Study

The study examines foreign exchange management and Nigeria economy. The specific objectives of the study are to:

1. Measure the positive effect of foreign exchange management in Nigeria Economy.
2. Examine the effect of currency fluctuation on the development of Nigerian economy.
3.  Examine the effect of foreign exchange management on balance of payment
4. Find out the effect of foreign exchange management on interest rate.

 1.4 Relevant Research Questions

1. How effective is foreign exchange management on Nigeria Economy?
2. What are the effects of currency fluctuation on the development of Nigerian economy?
3.  What are the effects of foreign exchange management on balance of payment?
4. What are the effects of foreign exchange management on interest rate?

1.5 Research Hypotheses

The following hypotheses were developed for the study:

In carrying out this research work these hypothetical statements are made to serve as a direction on which the work will be premised.

H_o: There is no positive relationship between foreign exchange management and Nigeria Economy.

H₁: There is positive relationship between foreign exchange management and Nigeria Economy.

1.6 Scope of the Study

The research work seeks to evaluate the effect of foreign exchange management and Nigeria economy with a view to explore Central Bank of Nigeria, Lagos.

The study as perceived might face some logistic challenges in term of the time and the costs involved in carrying out the research, but nevertheless, it would strive to accomplish its aims and purpose.

 

1.7 Significance of the Study

The findings and recommendations of this study will be of great benefit through the following ways:

• The study will equip students on the relevance of foreign exchange management and its contribution to the economy of the nation. The application of the knowledge derived from the study can serve as a guide on how students can understand operation of foreign exchange management.
• The study will give the general public an insight into how a well-managed foreign exchange management can be of great benefit to the society as whole and its contribution to the economy.
• Furthermore, the study will serve as added advantage to the government, revealing ways in which effective management of foreign management can aid the development of Nigerian economy.

 

• Definition Of Terms

Exchange Rate: This is the price of one currency in terms of another or the price at which a currency will exchange for another. It is also the number of Foreign Exchange that a unit of domestic currency will buy.

Foreign Exchange: This is described as the means of international payments, which includes currencies of other countries that are freely acceptable in affecting international transactions.

Management: Management is said to be the act of getting things done through people involving planning, organizing, co-coordinating and control.

Foreign Exchange Management: In its broadcast sense, refers to the efficient holding and optimal development of all the countries foreign exchange expenditure and other monetary policy target through a body or group of people (Central Bank of Nigeria).

Second-tier Foreign Exchange Market: This was introduced in September 1986 under the flexible exchange rate with the floatation of the Naira under this system; the exchange rate was largely determined by market forces.

Autonomous Foreign Exchange Market: Purchase or sale of foreign exchange by authorized dealers mostly banks at rates determined by the market but subject to intervention of the Central Bank of Nigeria.

Balance of Payment: Records of economic transactions between a country and the rest of the world.

Bureau De Change: Non-bank financial institution licensed to buy and sell foreign exchange to small users.

REFERENCES

Anifowose, O. K. (1994).  Allocation and Management of foreign exchange, The Nigerian Experience The CBN Bulletin, Vol. 18, No 4.

Obadan, M. I (1996). Impact of External sector policies on Nigeria’s Economic Development Central Bank of Nigeria Economic and Financial Review, Vol. 34, No 4, December.

Obaseki. P. J. (1991). Foreign exchange management in Nigeria: past, present and Future CBN Economic and financial Review. Vol. 29 No 1 Lagos. Central Bank of Nigeria.

Iyoha, M. A. (1996). Macroeconomic Policy management of Nigeria’s External Sector in the post SAP period. Nigeria Journal of Economic and Social Studies. Vol. 38, No 1.

Sodestine, B. O. (1998).  International Finance, London: Macmillian Educ.  Ltd., 2nd ed.

Mussa, M. L. (1986). Nominal Exchange Rate Regimes and the Behavior of Real Exchange Rates: Evidence and Implications. Carnegie-Rochester Conference Series on Public Policy 25: 117-224.

Ojo, M. O. (1990). The management of foreign exchange under Nigeria’s SAP CBN Economic and Financial Review, Vol. 28, No 2.

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