IMPACT OF EXCHANGE RATE VOLATILITY ON THE NIGERIAN ECONOMY 1987-2015

ABSTRACT

This study examined the impact of exchange rate volatility on the Nigerian economy using five (5) key macroeconomic indicators. To achieve these objectives, which are to; ascertain the impact of exchange rate volatility on economic growth, determine the impact of exchange rate volatility on foreign portfolio investment, establish the impact of exchange rate volatility on foreign direct investment, examine the impact of exchange rate volatility on international trade volume and evaluate the impact of exchange rate volatility on foreign reserve management. The study employed Bollerslev (1986) Generalized Autoregressive Heteroscedasticity which is a modification of Engel (1982) Autoregressive Heteroscedasticity Model. Exchange rate volatility entered the models as the independent variables, while the dependent variables were economic growth, foreign portfolio investment, foreign direct investment, trade flows and external foreign reserves. Variables such as degree of economic openness, inflation rate, interest rates, government revenue, market size, and monetary policy and interbank lending rates entered the models as controlled variables. The findings of the study revealed that exchange rate volatility is harmful to the Nigerian economy, with relatively high welfare cost. The implication is that exchange rate volatility increases the risk of factor of domestic firms trading internationally, which lead to increased prices to hedge against additional risk premium. Based on the findings, the study made recommendations that could stablise the foreign exchange rate and reduce welfare cost. Some of the recommendations are; the need to stabilise exchange rate policies, build countercyclical fiscal buffers during economic boom, diversifying the Nigeria economy to reduce vulnerability to external shocks, tax all foreign exchange transactions to reduce the volatility of foreign exchange, restructure the economy to eliminate all structural rigidities that hinders the ease of doing business, among others.

CHAPTER ONE

INTRODUCTION

1.1  Background to the study

Exchange rate management has remained topical for researchers and policy makers because of its importance in ensuring price stability, favourablebalance of payment, reserve management, capital flows, among others. This evinced interest in exchange rate has resulted in a plethora of studies along this line. Some features associated with these studies are controversies on the definition, measurement and appropriate regimes of exchange rate. Danson, GaneshandPundo(2012) simply define exchange rate as the rate at which a currency may be converted into another currency.That is, it determines how much the residents of a country pay for  imported  goods  and  services,  and  how  much  they  receive  for  exported  goods  and services(also see Dickson, 2012). Marrewijk (2005) sees it as the price of one currency relative to another currency, or equivalently the price of foreign money expressed in domestic money.Thus, exchange rate is a conversion factor, a multiplier or a ratio, depending on the direction of conversion. This has influenced scholars to argue that if exchange rates can freely move, it may turn out to be the fastest moving price in the economy.

These definitions could  be  classified  into  two  broad categories,  exchange rate  pricing  and exchange rate regimes or markets. On exchange rate pricing, real exchange rate is the weighted average of a country’s currency relative to an index or basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country’s currency, with each other country within the index. This is used to determine an individual country’s currency value relative to the other major currencies in the index, as adjusted for the effects of inflation (Frankel and Goldstein, 2005). However, the nominal exchange rate is the unadjusted weighted average value of a country’s currency relative to all major currencies being traded within an index or pool of currencies. The weights are determined by the importance a home country places on all other currencies traded within the pool, as measured by the balance of trade. This is determined by fiat in a fixed rate regime and by demand and supply for the two currencies in the foreign exchange rate market in a floating rate regime (Mckinnon and Ohno, 1997).

Exchange rate quotationor market is classified into official, Dutch auction and parallel markets. The official exchange rate refers to the exchange rate determined by national authorities or the rate determined in the legally sanctioned exchange market, and used in fixed exchange rate management. This  is  calculated as an annual average  based on  monthly averages of local currency units relative to other currencies (Manuelli and Peck, 1990). A Dutch auction is a type of auction in which the auctioneer begins with a high asking price which is lowered until some participants are willing to accept the auctioneer’s price, or a predetermined reserve price (the seller’s minimum acceptable price) is reached. The winning participant pays the last announced price. This is used for managed and flexible  float regimes (Marrewijk, 2005). The parallel market  transactions  usually  occur  outside  government  price  controls  or  taxes,  and  very prominent in the Nigerian foreign exchange market (Obadan, 2005).

The disagreement on the robust definition of exchange rate also manifestedits measurement. For instance, Iqbal, Major, and Habib(2011) definethe real exchange rate as a common measure of international competitiveness, while postulating that the real exchange is an index of competitiveness of currency of any country, andan inverse relationship between theindex and competitiveness. They argued therefore, that if exchange rate of a country is properly valued, it would not affect the macroeconomic variables and the macroeconomic performance of that country.Rodrik (1993) measure the real exchange rate as the effective prices of exports relative to domestic price level. In his opinion, real exchange rate is a relative price and not under the direct  control of authorities,  though,  it  could  be  influenced  by  policy.  The  importance  of measuring exchange rate has also received serious attention among scholars. Exchange rate measurement is generally seen as a measure of international competitiveness thathelps to identify inflation and currency effects, and represents the relative cost or price expressed in common currency. Thus, the lower the index the more competitive is the country (Azid et.al, 2005; Dansonet al. 2012).

In Nigeria, foreign exchange management can be traced to the establishment of Central Bank of Nigeria. For instance, between 1960s and mid-1980s, the monetary authority operated a fixed exchange rate system, which was to achieve a stable exchange rate and preserve the value of external reserves (Obadan, 2006). The policy led to stable but unsustainable exchange rate,as it

encouraged cheap importation of goods and services, created a problem of balance of payments, depletion of external reserves and capital flight.

The introduction of Structural Adjustment Programme in 1986 led toderegulating the foreign exchange market with the introduction of First-tier and Second-tier Foreign Exchange Market (SFEM) in September, 1986, and the adoption of flexible exchange rate regime. The two markets were later merged in 1987 to form Foreign Exchange Market (FEM). To achieve stable exchange rate, the weighted average, marginal and the Dutch system were adopted respectively. In spite of these policies, exchange rate volatility was still persistent, which also necessitated Central Bank of Nigeria to frequently intervene in the foreign exchange market.

By 1989, the Interbank Foreign Exchange Market was introduced and abandoned in1990 but reintroduced in 1999.   In like  manner, the Dutch Auction System (DAS), which was first introduced in 1987, was reintroduced in 1990 and again in 2002 as a retail DAS. Meanwhile, to further  deregulate the  Forex  market,  a  wholesale  DAS  was  introduced  in  February,  2006. However, following the depletion of the external reserves from US$62.08 billion in September,

2008 to US$50.10 billion in January, 2009, the retail DAS was reintroduced in January, 2009. This was later abandoned and wholesale DAS was reintroduced in July, 2009 following the improvement in oil revenue. To reduce the demand pressure in the market, retail DAS was reintroduced in January, 2013.

Despite these arrays of exchange rate management policies, volatility in exchange rate still persists.  Azidet.al (2005)  define  volatility as  instability,  fickleness or  uncertainty and  as  a measure of risk, whether in asset pricing, portfolio optimisation, option pricing, or risk management, and presents a careful example of risk measurement, which could be the input to a variety of economic decisions. Volatility of exchange ratecould lead to uncertainty in international transactions in both goods and financial assets. Exchange rate volatility is a form of risk and obstacle to international trade, which is traced to the breakdown of the Bretton-Wood’s agreement, and the adoption of the floating exchange rate regime (Poon, Choong and Habibullah,

2005). Volatility in exchange rate is the variance of the exchange rate, conditional on current information (Flood, 1981; Manuelli and Peck, 1990).

Real exchange volatility has important implications for Nigeria’s economic growth,especially on macroeconomic indicators such as foreign capital flows, reserve management, gross capital formation, international trade volume, agricultural trade, trade cost and equilibrium asset pricing. Studies on exchange rate volatility focused on economic growth (Jamil, Kousar and Kemal,

2005;  and  Furceri,  2008;  Barrell,  Holland,  Liadze  and  Pomerantz, 2008);    foreign reserve management (Cady and Gonzalez-Garcia, 2007; and Ramchander and Sant, 2010); equilibrium asset-pricing (Manuelli and Peck, 1990); sectoral trade aggregate bias (Pendy, 2003); trade cost (Bravo-Ortega and Giovanni, 2006; Aqeel and Nishat, 2006; Hooy and Choong, 2006; Arinze, Osang and Slottje, 2002; Darrat and Hakin, 2000; Koray and Lastrapes, 1989; Arinze, 1997; and Pozo, 1992); agricultural trade (Kandilov, 2008); currency substitution (Yinusa and  Akinlo,

2008; Levine and Carkovic, 2001); economic openness (Hau, 2002; Chowdbury, 1993; Wang and Barratt, 2007; Poon, Choong and Habibullah, 2005; and Anderson, Bollersleu, Diebold and Labys, 2001); currency mismatch (Cavusoglu, 2010); export performance (Boug and Fagereng,

2009); growth and exchange rate (Vieira, Holland, Da-Silva andBottecchia, 2002); employment growth (Belke, 2004); dual equilibrium and growth cycle (Nicolin-Liosa, 2011); macroeconomic news (Kim, 2002); and capital flows and real exchange misalignment (Kargbo, 2009).

For instance, theoretical analysis of the relationship between exchange rate volatility and international trade transactions have been conducted by Hooper and Kohlhagen (1978) and others. They argue that higher exchange-rate volatility leads to higher cost for risk-averse traders and to less foreign trade. This is because, the exchange rate is agreed on at the time of trade contract, but payment is not made until the future delivery actually takes place. If changes in exchange rates become unpredictable, this creates uncertainty about the profits to be made and, hence, reduces the benefits of international trade (Broll and Eckwert, 1999; Arinze, 2004). On the other hand, recent theoretical developments suggest that changes in rates could be expected to have either negative or positive effects on trade volume. De Grauwe (1988) stressed that the dominance of income effects over substitution effectscan lead to positive relationship between trade and exchange-rate volatility. This is because, if exporters are sufficiently risk averse, an increase in exchange-ratevolatilityraises the expected marginal utility of export revenue and therefore induces them to increase exports. De Grauwe (1998) suggested that the effects of exchange-rate uncertainty on exports should depend on the degree of risk aversion.

It is also argued that increased real exchange rate volatility could increase the uncertainty of profits on contracts denominated in a foreign currency, and would therefore reduce economic growth to levels lower than would otherwise exist if uncertainty were removed (Cote, 1994). Various studies, particularly, in the developed and middle-income countries, have also explored the  impact  of exchange rate  volatility and  associated uncertainty on trade,  investment  and economic growth. Majority of these studies have found that exchange rate volatility can affect trade directly, through uncertainty and adjustment costs, and indirectly through its effect on the structure of output and  investment  (Cote 1994; Serven 2002; Pickard 2003; Cheong 2004; Kikuchi 2004; Arize et. al. 2004). In Nigeria, abundant literature also exists because of the adoption of Structural Adjustment Progamme (SAP) in 1986. In spite of the abundant literature on the effects of exchange rate volatility on macroeconomic variables in Nigeria, empirical literature on this subject matter is inconclusive.

Volatility of exchange rate in Nigeria is generally attributable to flexible exchange rate regime. There are two situations in which flexible exchange rates may be described as too volatile. First, exchange rates can be fully consistent with fundamental economic variables, such as relative prices, and macroeconomic policies, while still responding excessively to shocks to those variables before adjusting gradually to new long-term equilibrium levels. Such exchange rate

‘overshooting’ may occur because international capital markets adjust almost instantaneously to shocks, while goods and services markets adjust slowly (Dornbush, 1976). While predictable, this  type  of  exchange  rate  volatility  is  costly  since  it  amplifies  the  domestic  impact  of disturbances arising in foreign markets, exacerbating fluctuations in domestic growth and unemployment. Second, flexible exchange rates may be too volatile if they are primarily influenced by factors unrelated to fundamental economic variables. In this case, exchange rate movements would be largely unpredictable, especially, in the short term. Furthermore, the short- term independence of exchange rates from fundamental variables can lead to long-term exchange rate misalignment volatility which could also have an impact on growth.

Hitherto, there are at least five competing theories of the exchange rate, which may either be classified as traditional or modern. The traditional theories are based on trade financial flows, and purchasing power parity, which are important in explaining exchange rate movements in the long run. The theories are the elasticity approach to exchange rate determination, the monetary

approach to  exchange  rate  determination,  the  portfolio  balance  approach to  exchange  rate determination, and the purchasing power theory of exchange rate determination. The modern theory, however, focuses on the importance of capital and international capital flows, and hence, explains the short run volatility of the exchange rates and their tendency to overshoot in the long run.

Exchange rate volatility has remained a re-occurring decimal in Nigeria, which theoretically, should have negative effect on the economy. Despite the import dependent nature of Nigerian economy, coupled with low productive base and strong preference for foreign product, economic indicators have maintained positive posture in recent times. For instance, in the first quarter of

2014,  Nominal Gross Domestic Product (at  basic  prices)  was estimated at  N20,169,778.04 million, or 15,438,679.50 million in real terms. In the corresponding quarter of 2013, nominal GDP was estimated N18,295, 631.91 or N14,535,420.95 million in real terms. As a result, the growth rate of real GDP was recorded at 6.21 per cent in first 2014, higher than 4.45 per cent recorded in the corresponding quarter of 2013, but lower than 6.77 per cent recorded in the fourth quarter of 2013 (National Bureau of Statistics, 2014). Similarly, trade was the largest contributor to real GDP in the first quarter of 2014. It contributed N2,678,514.71 million or

17.35 per cent of real GDP in the first quarter of 2014, marginally higher than the 17.34 per cent contribution to GDP recorded in the corresponding quarter of 2013. The sector saw strong growth of 6.28 per cent in the opening quarter of 2014, marginally higher than the record for the corresponding quarter of 2013(National Bureau of Statistics, 2014b).

In spite of the growth in gross domestic product, Nigerian external reserve has maintained declining trend from December 14, 2013 till date (CBN, 2014). Specifically, the value of the gross foreign reserve decreased from US$43.06 billion as at December 31st, 2013 to US40.12 billion and $38.65 billion February and March 14, 2014, respectively. The continuous depletion of Nigeria’s foreign reserve has far reaching implications for monetary policy and the economy at large. Persistent depletion of foreign reserve could erode confidence on the economy, trigger panic among investors, promote the use of foreign currency (dollarization), precipitate the down- grading of government bond by international rating agencies, weaken the value of naira, reduce foreign inflow into the economy, promote interbank rate volatility, among others.

There is a raging debate on measures to stem the volatility of foreign exchange rate in Nigeria. Barro and Gordon (1983), Calvo and Vegh (2004), Edwards and Savastano (2000), Eichengreen et al (1999), and Frankel (2003) among others, have vigorously advocated for the adoption of floating  exchange  management,  which  opponents (Berg et  al  (2002),  Borensztein and  Lee (2002), Lin (2001), McKinnon and Schnabel (2003), and Mussa et al (2000) among others) argued, is not feasible, given that it could lead to attack on a country’s currency, and may promote the use of foreign currency in the local economy (a concept usuallyreferred to as dollarization). They have also argued for the devaluation of the currency, which opponents are of the view that it is most suitable for balance of payments. Opponents actually argue that devaluation often invites a recession and inflation and thus pushes the economy into an inflation devaluation spiral, causing a serious setback in economic development. They also advocated for measures to increase the demand of naira, such as, increasing the monetary policy rate, liquidity tightening, stoppage of intervention, among others. While the debate is on, there is need to re- access the impact of foreign exchange volatility on the Nigerian economy. This study will strive to fill this important research gap, using Nigerian data for the period: first quarter of 1987- last quarter of 2014.

1.2  Statement of Problem

Exchange rate volatility is generally considered undesirable in any economy because of its perceived impact on the economy. The volatility of exchange rate in Nigeria therefore, raises an important research and policy problem on its impact on the economy.The use of exchange rate to stimulate economic growth is as old as the history of international trade. For instance, extensive literature has documented different exchange rate regimes adopted by countries, in order to stimulate economic growth. Specifically, many East-Asian economies fixed their exchange rates at  undervalued real parities, thereby fostering exports and contributing to the Asian growth miracle (Schnable, 2007). In Latin America, Brazil adopted a fixed exchange rate as part of a nominal anchor  strategy for  combating  high  inflation.  Argentina,  with  its  historically poor inflation performance, went the furthest down the fixed exchange-rate path by adopting a dollar- based currency board. This involved pegging the peso to the dollar and tying the supply of monetary base to dollar reserves (Palley, 2003). The adoption of these policies coincided with faster economic growth and significantly reduced inflation, particularly in Brazil and Argentina.

However, this good performance crumbled in the latter part of the decade. East-Asia was hit by financial crisis in 1997 that generated a massive real economic contraction and forced large exchange-rate devaluations. Brazil was hit by financial crisis in 1999 and again in 2000 and was forced to abandon its fixed exchange rate. Argentina was forced to abandon its currency board and move to a floating exchange rate in 2001. In each case, the fixed exchange-rate arrangement figured prominently in the crisis, with the countries’ monetary authorities unable to defend the exchange rate in the face of capital flight (Palley, 2003). This justifies the controversy that there is no perfect exchange rate regime, rather what is desirable is stable exchange rate.

Theoretical evidence on the impact of exchange rate stability on growth is inconclusive. The theoretical arguments in favour of stable exchange rates are mainly of macroeconomic nature, as it   allows   for   an   easier   adjustment   in   response   to   asymmetric   country   specific   real shocksBacchetta and van Wincoop (2000), Eichengreen and Hausmann (1999), Chmelarovaand Schnabl (2006), McKinnon and Schnabl, (2004).

From a microeconomic perspective,Breedon, Petursson and Rose, (2011)argued that low exchange rate volatility can be associated with lower transaction costs for international trade and capital flows thereby contributing to higher economic growth. Stable exchange rates may contribute to macroeconomic stability and help to avoid “beggar-thy-neighbor” depreciations in highly integrated economic regions. Furthermore it is argued that for small open countries in the economic catch-up process, stable exchange rates provide a more stable environment for the adjustment of asset and labour markets.

Exchange  rate  volatility  might  strongly affect  the  growth performance of open economies through the trade channels on the short-run (IMF 1984, European Commission 1990). Though, Bacchetta  and  van  Wincoop (2000)  based  on a  general equilibrium framework  found that exchange rate stability is not necessarily associated with more trade. From a long-term perspective, fluctuations in the exchange rate level constitute a risk for growth in emerging markets economies as they affect the balance sheets of banks and enterprises where foreign debt tends to  be  denominated in  foreign currency (Eichengreen and  Hausmann, 1999).  That  is, exchange rate volatility inflates the liabilities in terms of domestic currency thereby increasing the probability of default and crisis. This is more indebtor countries with highly dollarized financial sectors, where the incentive to avoid sharp exchange rate volatility is even stronger

(ChmelarovaandSchnabl 2006). Maintaining the exchange rate at a constant level, in particular preventing sharp depreciations, is equivalent to maintaining growth (McKinnon and Schnabl,

2004).

To achieve stable exchange rate, Nigeria has adopted several policy options, moving from pegged exchange rate regime (1960 – 1985), to flexible exchange rate in 1986, and the managed float between 1986 till date (CBN, 2013).     Specifically, during the regime of pegged exchange rate management (1958-1986), controls were applied with varying stringency, depending on the country’s external sector position as well as the prevailing economic conditions. Consequently, import licensing and prescription of eligible transactions were employed under the exchange control regime to limit the volume of foreign exchange resources that could be used to fund non- priority items (Barry, 2008). However, with the liberalization of the foreign exchange regime in

1986, the use of managed float was introduced. Within the period, the Central Bank of Nigeria used the management of foreign exchange reserves to influence the banking system reserves by either increasing or reducing the sale of foreign exchange. In the bid to achieve the objectives of exchange stable exchange rate, various modifications have been made to the institutional framework such as the second-tier foreign exchange rate market (SFEM) which later metamorphosed into the foreign exchange market (FEM), autonomous foreign exchange market (AFEM),  inter-bank  foreign  exchange  market  (IFEM),  Wholesale  Dutch  Auction  System (wDAS) and currently Retail Dutch Auction System (rDAS). In addition, special auctions of foreign exchange,  forwards and  swaps were  adopted to  enhance  liquidity management  and economic stability. Despite these policy options, exchange rate volatility has persisted in the Nigerian foreign exchange market.

Thus, it has become imperative to empirically establish the impact of exchange rate volatility on the Nigerian economy. Relying on past empirical evidence on this subject matter given so recent developments in the economy might be misleading. First, is the decision of Nigerian Central Bank to migrate from monetary targeting to inflation targeting. Inflation targeting has sparked much interest and debate among central bankers and monetary economists in recent years. This is characterized by the announcement of official target ranges for the inflation rate at one or more horizon, and the explicit acknowledgement that low and stable inflation is the overriding goal of monetary policy  (Bernanke  and  Mishkin,  1997).  While  this  policy  might  have  worked  in

developed economies with strong and robust productive capacity-base, same might not be correct in  developing  economies  like  Nigeria  with  weak  productive  capacity-base.  For  instance, exchange rate volatility could amplify inflation through imported inflation (exchange rate pass- through) (Mishkin, 2004).

Second,is thecapital and current account liberalization and globalization being seriously advocated for by International Monetary Fund (IMF) for member countries. Current account and capital liberalization are enshrined in the Articles of Agreement; the International Monetary Fund has no explicit mandate to promote capital account liberalization. Even so, the IMF seeks to be a “center of excellence” in analyzing capital account  issues,  in light  of the growing financial globalization and its implications for macro management in member countries (Xafa,

2008).  Nigeria  has  adopted  this  policy,  and  allows  the  inflow  and  outflow  of  portfolio investments without restriction. This has influenced critics to accuse Central Bank of Nigeria of concentrating on countercyclical stabilization, through the increase of monetary policy rate.

Third is the rebasing of Nigerian gross domestic product. According to the National Bureau of Statistics (2014),rebasing of the GDP has increased GDP significantly over the period under review. The National Bureau of Statistics anchored their argument on the obsolete methodology, which applies the fixed base method for deriving the constant price GDP; the further away the base year is from the current year with the higher the trade off with respect to accuracy of the GDP  estimates; and  the  need to  capture other sectors of the  economy National Bureau of Statistics (2014).These lag pose a great challenge in recording accurately the true economic realities over time. So the distortions in the price configuration need to  be re-  aligned by obtaining and using a base year structure which is more representative for the current period. Rebasing therefore provides the opportunity to resolve this dilemma. The rebased estimates indicate that the nominal GDP for Nigeria was much larger than previously estimated. Results from the rebased GDP showed that the rebased nominal GDP stood at  N54, 204,795.12m, N63,258,579.01m, N71,186,534.89m and  N80,222,128.32m in 2010,  2011,  2012,  and  2013 respectively. This represents 59.5%, 69.10% and 75.58% increase from the previous GDP in

2011, 2012 and 2013 respectively (National Bureau of Statistics, 2014).

Additionally, the growth rate in GDP amounts to economic shock as a result of the structural breaks, which has placed Nigeria as the biggest economy in Africa and twenty-six (26th) largest

in the world. From January 1987 to June 2015, the Nigerian economy has witnessed several structural breaks which take the form of change in government, movement from one exchange rate regime to another, and the rebasing of GDP. Thus, any meaningful study along this line must adopt a methodology that accommodates these structural breaks in the economy. This study fills this  important  research gap  by  investigating  the  impact  of exchange  rate  volatility on  the Nigerian  economy,  using  the  generalized  autoregressive  conditional  heteroskedasticity that captures some of the structural breaks in the economy for the period under review.

1.3      Objectives of the Study

The main objective of this study is to determine the impact of exchange rate volatility on the

Nigerian economy. To achieve this, the study strives to achieve the following specific objectives;

a.   Ascertain the impact of exchange rate volatility on economic growth.

b.   Determine the impact of exchange rate volatility on foreign portfolio investment. c.   Establish the impact of exchange rate volatility on foreign direct investment.

d.  Examine the impact of exchange rate volatility on international trade volume.

e.   Evaluate the impact of exchange rate volatility on foreign reserve management.

1.4.1   Research Questions

To achieve the  following objectives, the study strives to  provide answers to the following questions;

a.   How far does exchange rate volatility impact on economic growth?

b.   To what extent does exchange rate volatility impacton foreign portfolio investment?

c.   How far does exchange rate volatility impact onforeign direct investment?

d.  To what extent does exchange rate volatility impact on international trade volume?

e.   How far does exchange rate volatility impacton foreign exchange reserves?

1.5      Research Hypotheses

To achieve the above objectives, the following hypotheses will be estimated;

a.   Exchange rate volatility does not  have positive  and  significant  impact on economic growth.

b.   Exchange rate volatility does not have positive and significant impact on foreign portfolio investments.

c.   Exchange rate volatility does not have positive and significant impact onforeign direct investment.

d.  Exchange rate volatility does not have positive and significant impact on international trade volume.

e.   Exchange rate volatility does not have positive and significant impact on foreign reserve management.

1.6      Scope of the study

The study focuses on the impact of exchange rate volatility on the Nigerian economy, with specific emphasis on the macro-economy. The study focuses on the impact of exchange rate volatility on the Nigerian macro-economy.

The macroeconomic variables are; total import value, total export value, gross capital formation, exchange rates, external foreign reserves, foreign direct investment, foreign portfolio investment, inter-bank foreign exchange rates, monetary policy rates, total population and gross domestic product.

The time frame for the study is 1987 (first quarter) to 2015 (second quarter). The decision for the first quarter of 1987 is based on the fact that prior to 1986, the Nigerian government practiced the pegged exchange rate regime. The implication is that from 1960 to 1985, there was the absence of exchange rate volatility because of the pegged regime. However, the adoption of the Structural Adjustment Programme (SAP) in 1986 entailed the deregulation of the foreign exchange market, which allowed the forces of demand and supply to relatively determine the value  of  Naira  to  other  foreign  currencies  (managed  float).  The  use  of  1987  is  therefore considered most appropriate since the lag period allows the transitory effect which does not require any policy response to die down. Thus, the use of 1987 captures exchange rate volatility that are persistent, which is a major determinant of a robust and reliable results.

1.7Significance of the Study:

The study will be relevant to the following;

Policy Makers

This research will serves as a turning point in the study of exchange rate volatility on macroeconomic variables in Nigeria for three reasons. First, the rebasing of the Nigerian GDP in

2014 has in the main, brought to the fore, the imperativeness of re-examining and revalidating the findings of previous empirical studies along this line. Second, Nigerian foreign reserves, which the government through the Central Bank of Nigeria, uses to stabilise foreign exchange volatility is on a continuous decline. There is a current argument that if the Central Bank of Nigeria does not depreciate the Naira further, to maybe N165 to USD1, with a asymmetric corridor of ± 10, Nigerian foreign reserves might decline below the psychological acceptable threshold. These events are episodic and represent structural breaks for the period under study. The decision to use a methodology that accommodates these structural breaks is considered novel, and have the capacity of producing robust results that might be useful to policy making. The outcome of this study will be of immense benefit to policy makers, such as government and its  agencies,  in  providing  a  plat  form  for  designingfavourable exchange  rate  management policies that will be consistent with the Nigerian economic environment. Besides resolving the theoretical debates, providing empirical evidence on impact of exchange rate volatilityon the Nigerian economy will help in formulating favourable exchange rate management policies. This study will be of immense benefit to the Central Bank of Nigeria. Undoubtedly, understanding the impact of exchange rate volatility and economic growth forms the first basic step in designing appropriate regulation to guide the operations of the foreign exchange market in the country.

The Body of Academia

This study will contribute immensely in resolving the raging debate on the relationship between exchange  rate  volatility  and  macroeconomic  indices.  The  study will  contribute  to  existing literature, and will be of great value to further studies on exchange rate volatility. This research work will serve as a turning point in the study of exchange rate volatility, especially in Nigeria, because of recent economic developments such as; the rebasing of the Nigerian GDP in 2014, which in the main, has brought to the fore, the imperativeness of re-examining and revalidating the findings of previous empirical studies along this line; and the emerging trend of portfolio reversal in developing economies, as result to the Federal Reserve System tapering programme.

The General Public

This study contributes to the debate on exchange rate volatility by investigating the impact of the current volatility on the economy. Finally, the period covered in this study represents different paradigms, in terms of changes in exchange rate policies, the use of different base years and methods in GDP computation, and most importantly, different phases in Nigerian political and economic lives. The research work will be of great benefit to the general public as it  will enlighten them on the effect of exchange rate volatility on major macro-economic variables. The work will elucidate the various efforts of government in maintaining a sustainable exchange rate and the policy changes made by the government in achieving this sustainable exchange rate. This work will afford the general public the opportunity of being abreast with such major policy changes.

1.8      Limitations of the Study

This study has some limitations. First, the main limitation of the study is that the data was collected through publicly available data sources. If there are any problems relating to data disclosures or computational errors, then that would limit the validity of the findings. Second, though the focus of the study is Nigeria, as such the data used were purely Nigerian data. Also the external validity of this study is in question, since the data belongs to only Nigerian firms. This poses the problem of external validity. Using data from Nigeria alone would be difficult to generalize.

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