Naira Exchange Rate Depreciation And Domestic Inflation
The depreciation of the Naira exchange rate has significantly impacted domestic inflation, creating a complex economic scenario. The continuous decline in the value of the Naira against major currencies has led to an increase in the cost of imported goods and services. This, in turn, exerts upward pressure on overall price levels within the country. The government’s efforts to address this challenge have been met with various obstacles, including external factors such as global economic trends and internal issues like fiscal policies. As a result, consumers grapple with rising prices for essential commodities, affecting purchasing power and potentially contributing to a cycle of inflationary pressures. Policymakers face the intricate task of finding comprehensive solutions to stabilize the exchange rate and mitigate the adverse effects of inflation on the domestic economy.
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.
Title page
Approval page
Dedication
Certification
Acknowledgement
Abstract
Table of contents
CHAPTER ONE
Introduction 1
1.1 Background to the study 1
1.2 Statement of problem 3
1.3 Significance of study 5
1.4 Objective of the study 5
1.5 Research hypothesis 6
1.6 Scope of study 7
1.7 Definition of terms 7
Reference 8
CHAPTER TWO
Literature review 9
2.1 The concept of exchange rate 9
2.2 Exchange rate management in Nigeria 19
2.3 Inflation – a concept 28
2.4 Theories of inflation 32
2.5 Inflation in Nigeria 37
2.6 Exchange rate depreciation and inflation in Nigeria 41
2.7 Empirical evidence 43
Reference 46
CHAPTER THREE
Research methodology 48
3.1 Method of data collection and analysis 48
3.2 Theoretical framework and model specification 48
Reference 53
CHAPTER FOUR
Analysis of result 54
4.1 Presentation of result 54
4.2 Analysis of result 55
CHAPTER FIVE
Summary, conclusion and recommendation 57
5.1 Summary 57
5.2 Conclusion 58
5.3 Recommendation 58
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 SCOPE AND LIMITATION OF THE STUDY
The study covers the period from 1985 to 2000. It concentrates on the trend of exchange rate depreciation and inflation in Nigeria. The study is limited to the period because of the problems associated with the availability and collection of secondary data needed for the research work due partly to the level of development of the Nigeria economy.
1.7 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.
The exchange rate of a country’s currency, such as the Naira in the case of Nigeria, can have a significant impact on domestic inflation. Exchange rate depreciation and domestic inflation are closely linked, and changes in one can influence the other in several ways. Here’s how they are interconnected:
- Imported Inflation: When the exchange rate of a currency like the Naira depreciates, it means that the Naira has weakened relative to other currencies. This makes imported goods and services more expensive. Since many countries rely on imports for various products, an exchange rate depreciation can lead to higher prices for these imported goods. As a result, the cost of living for consumers can increase, contributing to domestic inflation.
- Cost-Push Inflation: Exchange rate depreciation can also affect the cost of production for domestic industries that rely on imported inputs. If businesses need to pay more for imported raw materials or components, they may pass on these increased costs to consumers in the form of higher prices for their goods and services. This is known as cost-push inflation.
- Monetary Policy Response: Central banks, like the Central Bank of Nigeria (CBN), often respond to exchange rate depreciation by adjusting their monetary policy. They may raise interest rates to stabilize the currency or reduce the money supply to combat inflation. These policy measures can have a direct impact on domestic inflation rates.
- Inflation Expectations: Exchange rate depreciation can influence people’s expectations about future inflation. If the public expects prices to rise due to a depreciating currency, they may adjust their behavior accordingly. For example, workers may demand higher wages, and businesses may anticipate higher costs and raise prices proactively, contributing to inflation.
- External Debt Burden: A depreciating currency can also affect a country’s external debt burden. If a significant portion of a country’s debt is denominated in foreign currencies, a weaker domestic currency can make it more expensive to service and repay that debt. To cover these higher debt servicing costs, governments may resort to printing more money, which can contribute to inflation.
It’s important to note that the relationship between exchange rate depreciation and domestic inflation is not always straightforward. Several factors, including the overall economic situation, the central bank’s response, and the country’s trade balance, can influence the extent to which exchange rate changes impact inflation.
In the case of Nigeria, managing the exchange rate of the Naira and controlling inflation has been a significant challenge for policymakers. The country has experienced periods of exchange rate depreciation and high inflation, and the Central Bank of Nigeria has implemented various policies to address these issues, including adjusting interest rates and foreign exchange controls.
Overall, exchange rate depreciation can be one of the drivers of domestic inflation, but it is just one of many factors that can influence inflation in an economy. Policymakers must consider a holistic approach to managing inflation that takes into account various economic factors and employs appropriate policy measures.