NAIRA EXCHANGE RATE DEPRECIATION AND DOMESTIC INFLATION IN NIGERIA

ABSTRACT

The research work critically examined the extent to which naira exchange rate depreciation had affected domestic inflationary rate in Nigeria between 1985 – 2000.

            Therefore, in this study, the researcher examined the trend of inflation and exchange and the relationship between the two variables.   A model was specified to show the relationship between both variables.  Also interest rate was included in the model as one of the variables that affect inflation.

The model was then estimated using multiple regression method and variable statistical tests where carried out on the regression equation.

The result was analyzed accordingly. Moreover, the result of the statistical test shows that exchange rate depreciation of Naira is significant in explaining variation in the rate of inflation.

Finally, the data for the project work was collected from most recent years in order to make finding, adequate in explaining the cause of inflation in recent times.

TABLE OF CONTENTS

CHAPTER ONE

Introduction                                                                           

1.1              Background to the study                                                       

1.2              Statement of problem                                    

1.3              Significance of study                                                 

1.4              Objective of the study                                                           

1.5              Research hypothesis                                                   

1.6              Scope of study                                                                                   

1.7              Definition of terms                                                                            

Reference                                                                   

CHAPTER TWO                                        

Literature review                                                                                            

2.1              The concept of exchange rate                                                

2.2              Exchange rate management in Nigeria                                              

2.3              Inflation – a concept                                                              

2.4              Theories of inflation                                                               

2.5              Inflation in Nigeria                                                                

2.6              Exchange rate depreciation and inflation in Nigeria             

2.7              Empirical evidence                                                                 

Reference                                                                               

CHAPTER THREE

Research methodology                                                                                  

3.1              Method of data collection and analysis                                 

3.2              Theoretical framework and model specification                    

Reference                                                                               

CHAPTER FOUR   

Analysis of result                                                                               

4.1              Presentation of result                                                 

4.2              Analysis of result                                                                               

CHAPTER FIVE

Summary, conclusion and recommendation              

5.1              Summary                                                                                

5.2              Conclusion                                                                                         

5.3              Recommendation                                                                               

                                    CHAPTER ONE

INTRODUCTION

1.1              BACKGROUND TO THE STUDY

The naira exchange rate depreciation coupled with persist increase in the inflationary rate has been a major bane on economy of Nigeria.  To a layman inflation is a phenomena to embrace as his income increases daily without knowing the harmful side of such an increase.  Whether there is anything like depreciation or an improvement in the exchange or whether is income is nominal or real the layman do not know.

But this complementary problems so to say of naira exchange rate depreciation and inflation has been a thought of obesity in the hearts of Nigerians past and present governments and many patriotic Nigerians.

The pegging of, inflation in Nigeria can be said to be a direct result of the policies of the country’s governments to stimulate a fast rate of economic growth and development, since 1951 when the ministerial government was introduced between 1984 and 1986, the naira was quoted against dollar and pounds as the only intervening currencies which was in line with the International Monetary Fund (I.M.F) demand.  I.M.F had earlier complained that naira exchange rate was rising above the stipulated 2% limit.  The naira was then devalued at 1.000 4 US dollar.  The inflation rate in Nigeria was not serious problem before her independence.  But immediately after the civil war i.e. from 1970’s, the inflation rate in Nigeria took another dimension.  The value of naira as against dollar and pounds sterling started to deteriorate, in 1970, it was a naira to 1.400 dollar and 0.584 pounds sterling.  In 1971, it was 1.44 dollar and 0.582 pounds sterling to a naira.  In 1973, it was 1.519 dollar and 0.614 pounds sterling to a naira.  In 1974 it was 1.589 and 0.675 pounds sterling to naira which increased to 1.623 dollars and 0.734 pounds sterling in 1975 as a result of Udoji salary award of 1974 increased wage extensively.  Higher wages increased the purchasing power of consumers thus, leading to increase in their prices.

The introduction of Structural Adjustment Programme (SAP), and second-Tier Foreign Exchange (SFEM) in 1986 on one of government’s major policy packages, was aimed at making the over, valued naira exchange rate more realistic and responsive to market forces.  Regrettably, C. Anyanwu (1989) observed, the SAP/SEFEM was a disaster that was fast destroying the foundation of Nigeria economy.  There was consequent persistence of exchange rate depreciation of the naira (from 1.5691 naira to 1.0 dollar at the end of September 1986, 7.8950 naira to 1.0 dollar by mid February 1990).  Also by August 1998, the dollar was sold for 21.9960 naira at the Foreign Exchange Market (FEM) while at parallel market it was sold for 45 naira.  The value of naira continued to depreciate to the extent that the exchange rate was less than one dollar to a naira before 1990.  It was 0.119 US dollar to a naira in 1990.  This depreciated to 115.7 to a dollar by the 12 April, 2001 (CBN) 1994.  By 2003, it has risen N130 to the US dollar.

1.2              STATEMENT OF PROBLEM

The depreciation of naira persistently, has various inflationary effects on the economy of Nigeria.  The effects of this macro-economic problem can be highlighted in different stages.  In the first place, when a currency is depreciated, it is designed to reduced or discourage the excessive dependence on a particular foreign or some foreign commodities.

This will make domestic prices of such imports may be intermediate goods and as a result tends to push the cost of production of final goods up.

In another way, deteriorating exchange rate of naira could bring about inflation of increase in wage rate or demand, when the naira is devalued, the price of important raw materials increases domestic firms may be willing to increase production reduction on their competition as a result of like in prices of raw materials.

Consequently, the output of the firms will attract high prices, therefore for consumers to meet their provisions level of consumption or maintain their real income, calls for wages increase which according to Sotersten (1994) will worsen the whole situation.

Nigerians as one of the developing nations that heavily depend on imported inputs, implements and machinery, the cost of these are usually very high due to poor exchange rate of naira.

This will discourage potential investors, how investment will lead to reduced national product, which is an indicator of stagnancy or retrogression of the economy.

For this reason, Obasanjo (1999) noted that any thing could happen of regulatory authorities did not take steps to tidy up the situation, so the researcher wants to find out the problems and suggest ways of remedying the situation.

1.3              SIGNIFICANT OF THE STUDY

For the purpose of this study, the researcher took a step further to determine the possible significances.

(i)                 To give other researchers who which to write on this topic the process to follow

(ii)               To check the inflationary of deflationary gap

(iii)             To determine the cumulative impact of broad money growth and the sizeable devaluation of the naira

(iv)             To determine the fate of naira with other internal currencies.

(v)               To determine government policies.

1.4              OBJECTIVE OF THE STUDY

The objectives of this study include the following

(i)                 To identify the causes of inflation and exchange rate depreciation.

(ii)               Examine the extent to which naira exchange rate depreciation heed affected domestic inflationary rate in Nation.

(iii)             Assess the effectiveness of government earlier introduced policies.

(iv)             Give suggestion and recommendation on appropriate policies for the future.

1.5              RESEARCH HYPOTHESIS

Since the research data was mainly from secondary sources, the hypothesis used will be in two forms to determine result.

The null hypothesis and the alternative hypothesis.  The null hypothesis (Ho) will be tested against the alternative hypothesis (Hi)

(a)        Ho:      There is no positive or significant relationship

between exchange rate depreciation and domestic inflation in Nigeria.

(b)        Hi:       There is significant or positive relationship between

exchange rate depreciation and domestic inflation in Nigeria.

1.6              DEFINITION OF TERMS

Exchange rate:            This is the price at which one country exchanges its currency for other currencies.

Depreciation:  This is when exchange rate changes so that a unit of its currency can buy fewer units of foreign currency.

Devaluation:    This is an intentional act put forward by the government of a country with the aim of sustaining equilibrium.

Inflation:          This is substantial, sustained increase in general level of prices.