Format: MS-WORD Chapters: 1-5
Pages: 65 Attributes: COMPREHENSIVE RESEARCH
1.1 Background to the Study
Since its establishment in 1959, the Central Bank of Nigeria (CBN) has continued to play the traditional role expected of a central bank, which is the regulation of stock of money in such a way as to promote social welfare. This role is anchored on the use of monetary policy that is usually targeted towards the achievement of full-employment equilibrium, rapid economic growth, price stability, and external balance (Adesoye et al., 2012). Over the years, the major goals of monetary policy have often been to manipulate the exchange rate and interest rate. Later objectives were extended Thus, inflation targeting and exchange rate policy have dominated CBN’s monetary policy focus based on assumption that these are essential tools of achieving macroeconomic stability (Aliyu and Englarna, 2009).
The economic environment that guided monetary policy before 1986 was characterized by the dominance of the oil sector, the expanding role of the public sector in the economic and over-dependence on the external sector. In order to maintain price stability and a healthy balance of payments position, monetary management depended on the use of direct monetary instruments such as credit ceilings selective credit controls, administered interest and exchange rates, as well as the prescription of cash reserve requirements and special deposits. The uses of market based-instruments were not feasible at the mid-70s because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rates (Adesoye et al., 2012).
The effect of exchange rate volatility has been increasingly recognized globally as one of the most important macro-economic variables that is responsible for the performance of an economy in both developed and developing countries of the world. Against this backdrop, the economic performance experienced in Latin America, Asia and Africa in the twentieth century was attributed to sound exchange rate policy in such countries. Therefore, it could be argued that appropriate exchange rate system is crucial conditions for improving the economic performance and ensuring price stability in an economy. Volatile real exchange rates are associated with unpredictable movements in the relative prices in the economy and it creates a high degree of uncertainty that affect both domestic and foreign investment decisions.( Obaseki,1991),
Therefore, it could be argued that appropriate exchange rate system is a crucial condition for improving the economic performance of a country and attracting foreign direct investment. This is largely because the exchange rate is not only an important relative price of a nation currency in term of others that connects domestic and world market for goods and assets but also a signal of the competitiveness of a country’s exchange power with the rest of the world in a global market (Hossain, 2002).
The CBN introduced Dutch Auction System (DAS) which replaced the IFEM in 2006 and the official parallel market rates in Nigeria merged. The introduction DAS as a method of exchange rate determination, through auction, where the bidders pay according to their bid rates. The exchange rate however continued to appreciate throughout 2006 owing to the high revenues from high crude oil prices internationally. However, despite various efforts by government to maintain exchange rate stability in 2007, the Naira continued to depreciate against the US dollar. For instance, the monthly average official exchange rate of Naira per US dollar depreciated from Ni 18.5 to 157.5 between 2008 and 2012 (CBN, 2013).
In early 2012, the Central Bank of Nigeria (CBN) employed the Wholesale Dutch Auction System (WDAS) as a mechanism for exchange rate management, until the first quarter of 2013 when it was replaced with the Retail Dutch Auction System (RDAS). The reintroduction of the RDAS was to curb unwholesome practices by authorized dealers, stem exchange rate volatility and demand pressure in the foreign exchange market. Similarly, the CBN also directed that the payment of remittances through money transfer organizations should only be collectable in Naira. The forward segment of the foreign exchange market remained open, but witnessed low patronage during the 2013 and 2014 in Nigeria (Azeez et al., 2012).
The important point to note about all these changes since the introduction of SAP in 1986 is that the authorities want exchange rate be determined through the market forces of demand and supply, and how the system could stabilized the stock market prices. The exchange rates policy allowed floating and the relative values between the Naira and the US Dollar to be determined by the market forces. The US dollar is the intervention currency in the market while the exchange rates of other currencies are based on cross reference to the Naira-dollar exchange rates.( Aliyu, 2011).
Despite these changes, The NSE markets continue to face challenges around liquidity and depth over decades. The Nigerian economy has suffered from economic crises over the years. Firms operating in the stock market are affected by unstable stock prices and volatile exchange rate which exposed them to high business risk and foreign exchange risk. Volatility in exchange rate for example, creates macroeconomic uncertainty t].at adversely affects the investors’ confidence and growth of the market. Such volatility can be traced to the rapid expansion in international trade after the 1970’s (Akpan, 2008).
However, a lot of empirical literature investigated by the study showed that that there are mixed view on the link between the exchange rate volatility and stock prices in Nigeria. Interesting to note is that some studies like that of Alam and Tafiques (2007) admit that there is need for continuous research in the area of exchange rates and stock markets. Moreover, studies in other countries also provided room for further research. Morales (2008) admitted that further research along these lines is required in order to establish more comprehensively the true nature of spillovers from exchange rates to equity markets. Thus, this study is imperative to make contribution to the existing literature or previous studies, given that most previous studies do not always provide a convergence conclusion on the issue raised earlier about the relative effect of the exchange rate volatility on stock prices in Nigeria.
1.2 Statements of the Research Problem
Over the past decades, the fundamental objective of monetary policy in Nigeria includes; the maintenance of price stability, stable exchange rate and control of inflation that supports the financial market and economic growth. The failure of the monetary policy instrument in stabilizing the economy results in instability in the Nigerian Stock Exchange (NSE) market.
In Nigeria, exchange rate volatility was identified by the monetary authorities as one of the constraints on stability in Nigeria Stock Exchange (NSF) market over the recent decades. Since, the adoption of flexible exchange rate regime during the structural adjustment programme (SAP) in I 986. The sources of exchange rate instability or volatility are exogenous. In effect, fundamental shifts in the dynamics of the global capital market, together with marginally high domestic interest rates, inflation rate, high money supply lead to sustained strength and volatility of the currency (Hale and Hughes, 2011). The instability or volatility of the exchange rate has, also been caused by large fluctuations in financial flows especially stock market and this has made the achievement of the stability of the Naira to be nearly impossible.
The overall idea for flexible exchange rates policy is to remove what investors have argued to be over valuation of the Naira. The issue of exchange rate instability become a re-occurrence decimal in the macroeconomic challenges such as - high inflation, unstable exchange rate, frequent change of interest rate, and high money supply, among others confronting Nigerian government thereby affecting the trend in the movement of Nigerian Stock Exchange (NSE) market, (Taylor, 2005). The persistent fall in the value of Nigerian’s domestic currency correspond with the period of high stock prices volatility has resulted to high degree of exchange risk and uncertainty in the Nigerian stock market which impedes international trade and capital movements (Mbutor, 2010). However, the stock exchange market has displayed a relatively high degree of volatility in response to the flexible exchange rate regime that followed the SAP era in 1986. The Nigerian Naira, which is the most dominating currency in the Nigerian Stock Exchange NSE) market, has shown high currency volatility which makes it difficult for businesses to plan and budget thereby has negative effect On price stability and consequently on firms profitability. The existence of such volatility creates serious problems that involving changes, uncertainties and risks has created fear among the stock brokers and other investors about the future certainty of the stock market in country.
Another problem inherent in the operation of the Nigerian Stock Exchange (NSF) market is that of chal1enge of “olaliii1y clustering”, that is, the periods in which stock market prices show wide swings for an extended time period followed by periods in which there is relative calm as a result of exchange rates fluctuation. Gujarati (2008) opined that, measuring volatility in financial time series, such as, exchange rates, inflation rates, interest rates, is often exhibit the phenomenon of volatility clustering, Therefore, the use of ARCH and GARCH is appropriate.
In an attempt to model the relationship among the stock market variables, plethora of similar studies have been conducted in the past to examine and re-examine the nature of the relationship between exchange rates and the stock market prices, using different econometrics models with varying results.
1.3 Research Questions
The following research questions are raised by the study:
i. What are the effects of exchange rates volatility on economic growth in Nigeria?
ii. What are the trends in the movements of the exchange rate and economic growth in Nigeria?
1.4 Research Objectives
i. Evaluate the effects of exchange rate volatility on economic growth in Nigeria.
ii. Examine the significant relationship between exchange rate and economic growth in Nigeria.
1.5 Research Hypothesis
In line with the objectives of the study, the following null hypotheses shall be tested.
H01: The Exchange rate volatility has no significant effects on economic growth in
Ho2: There is no long run relationship between exchange rate volatility and economic growth in Nigeria.
H03: There are no significant trends in the movements of exchange rate volatility and economic growth in Nigeria.
1.6 Justification of the Study
The study is in response to the view point that foreign exchange has both social and opportunity costs that could produce mixed effects on the economy of a nation. This study has made an addition to the existing body of knowledge in a related topic. Findings have thus emitted the existing literature and provided empirical evidence that ensure the robustness of the conclusion drawn and suggestions on how best to mitigate cost and adverse effects on the stock market.
In Nigeria, as the relationship between exchange rate and stock market prices is considered critical, obtaining reliable estimates of the response of the stock price to exchange rate signals would be a critical step on the side of monetary policy maker to formulate an effective policy decision. The study also revealed the strength and weaknesses of the various exchange rate policy regimes that have been adopted by the Central Bank of Nigeria (CBN) over the years, to address the issues of exchange rate volatility that could stabilize stock market prices in the economy.
Players in the stock market are likely to equally benefit from the output of the study. This is largely because having an accurate estimate on the action and reaction of the stock market prices to changes in exchange rate form an important component of formulating effective investment and risk management decisions.
1.7 Scope of the Study
In assessing the effects of exchange rate volatility on economic growth in Nigeria, the scope of the study was restricted to the period of twenty nine years from 1986 to 2017. During this period a tremendous changes that occurred in the foreign exchange dealings within the Nigerian economy, particularly with the introduction of Structural Adjustment Program (SAP) in 1986 and Second Tier Security Market (SSM) in 1986. These periods served as a major factor that shaping the dynamics of exchange rate and stock exchange market in Nigeria. The study is based on monthly time series data that obtained from Central Bank of Nigeria (CBN) statistical bulletin, Nigerian Stock Exchange (NSE) and National Bureau Statistics (NBS) publications. Meanwhile, the variable indicators on which data were examined and collected are Real exchange rates (EXR), NSE- AW Share Index as proxy to Stock prices (ASI), broad Money supply (MS2), and Real Interest rates (INTR) and Inflation rates (INF)
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