Impact of Exchange Rate on the Volume of Import in Nigeria (1986-2020)
CHAPTER ONE
Objectives of the study
The main objective of the study is to examine the impact of exchange rate on the volume of import in Nigeria (1986-2020). Specifically, the study sought to:
- Examine the long-run relationship between imports and the explanatory variables.
- Estimate the error correction model.
CHAPTER TWO
LITERATURE REVIEW
Definition of exchange rate
By definition, the foreign exchange market is organized as an over-the-counter market in which several dealers (banks, companies and government) stand ready to buy and sell deposits denominated in foreign currencies (Mishkin, 1997). In this era of globalization, the interconnectivity among nations has made it possible for different countries to trade its foreign currencies. Thus, Dornbusch and Giovannini (1990) was of the opinion that the worldwide financial development offers more opportunities to countries but it also comes with constraints on all economic decisions such as exchange rate, monetary or fiscal policies. Financial conditions affect the impact of nominal exchange rate fluctuations on growth stability mainly through balance sheets effects and impacts on foreign currency-denominated debt in developing and emerging countries. The net impact of exchange rate fluctuations will depend on the relative importance of competitiveness changes and costs from balance sheets effects. Financial markets development affects economic performances through efficiency in the allocation of productive resources and adjustment to shocks and may result in a more stable or unstable growth (Dornbusch and Giovannini, 1990).
The importance of exchange rate cannot be over emphasized, hence, Evan and Lyons (2005) was of the view that exchange rate is an important economic indicator that has a strategic role in an economy and say that exchange rate movements widely influence various aspects of economy, including inflation, import-export performance which in turn affects the output of economy. He concludes that in the market, there are two main forces that interact with each other, namely supply and demand and they form an equilibrium which is reflected in the price and quantity levels where supply and demand curves meet.
Different countries use several exchange rate regimes to protect their national currencies from the variation in its national currencies. The question of which exchange rate regime that a small open economy should choose has no definite answer, since such a choice depends on the objectives and focus of monetary authorities, as well as on assumptions about the structural characteristics of the economy. Structural characteristics of the economy in this sense imply the degree of openness, of capital mobility, of wage indexation, and of the level of economic growth and development.
Nations monetary policy is usually aimed at stabilizing exchange rate volatility. Such monetary policy formulation and implementation influence macroeconomic variables (hence, macroeconomic stability) in any economy be it developed or underdeveloped. The critical distinction often is the degree to which movements in the exchange rate pass through to affect domestic macroeconomic variables, most especially, consumer prices, output (as measured by the gross domestic product GDP) and private consumption. Hence the choice of an exchange rate regime is linked, to some extent, to the achievement of specific targets set by the monetary authorities. Therefore as argued by Devereux (2001) that the best monetary policy rule in an open economy is one which stabilizes non-traded goods price inflation and that policy of strict inflation targeting is much more desirable in an economy with limited pass-through. If the monetary authorities are concerned with consumer prices inflation then the flexible exchange rate regime brings some costs as well as benefits. Moreover, the same logic implies that a policy of strict inflation targeting is quite undesirable in an open economy, since it effectively amounts to a requirement of fixing the exchange rate. It stabilizes inflation at the expense of a lot of output instability.
CHAPTER THREE
RESEARCH METHODOLOGY
Data
Our seven data sets – import volume, import price index, exchange rate, real gross domestic product, government consumption expenditure, household consumption expenditure, and trade openness – covering the period 1986
– 2020 were gotten from secondary sources. Data on the gross domestic product, import volume, exchange rate, and trade openness were gotten from the Central Bank of Nigeria statistical bulletin; import price index was obtained from United Nations Conference on Trade and Development Handbook of Statistics; while government consumption expenditure and household consumption expenditures were obtained from World Bank database on world development indicators.
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
Descriptive Statistics
The descriptive statistics capture the statistical properties of the macroeconomic variables utilized in this study. The descriptive statistics cover the mean, maximum, minimum, and standard deviation and are presented in Table 1.
CHAPTER FIVE
CONCLUSION AND RECOMMENDATIONS
Conclusion
In this study, we studied the effect of the exchange rate on import volume in Nigeria for the period 1986 – 2020. We carried out a unit root test, cointegration test, and error correction mechanism in achieving our set objectives. It was discovered from the Augmented Dickey-Fuller unit root test that our variables were in a mixed order of integration (both at the level and first difference). In this regard, we utilized the ARDL Bounds test for cointegration to ascertain whether the variables are integrated into the long-run. Our result from both the Bounds test and error correction mechanism supported the existence of a long-run equilibrium relationship. The error correction mechanism showed that 94.15% of the short-run distortions in imports are corrected annually by the explanatory variables. This itself shows that the speed of adjustment is quite fast. Our R-squared indicated that the explanatory variables were able to explain about 86.16% of the total variations in the volume of imports in Nigeria.
From the short-run dynamics, it was discovered that though the exchange rate has no significant effect on import volume, its one-period lag had a significant effect with it reducing import volume by 0.44%. Also, the import price index had the desired a priori sign (negative), but it had no significant impact on the import volume in the Nigerian economy.
It was further discovered that though government consumption expenditure had a negative and insignificant effect on import volume, its one-period lag had a negative and significant effect on import demand by reducing import demand by about 99.67%. The a priori expectation did not conform with the idea that as the government tends to consume more, they will likely import more inasmuch as domestic production could not meet the demand. Also, household consumption expenditure exerted a positive but insignificant effect on import demand. Meanwhile, its one- period lag exerted a positive and significant effect and increases import demand by 68.50% in the short run.
The level of real income in the economy is also being seen to exert a negative and insignificant impact on import demand though its one-period lag exerted a significant effect accounting for about 323.12% decrease in import demand. The implication is that if the rise in income is due to an increase in domestic production of commodities that were earlier imported, such a boost in domestic production will bring down the demand for imports drastically. Meanwhile, trade openness and its one-period lag both affected import demand positively and in a significant way. So, while the lag of trade openness increases import demand by 2.42%, a unit percentage increase in trade openness will increase import demand by 3.19%.
In the long run, the exchange rate still maintains a negative though a significant effect on the demand for imports. It follows that a unit percentage increase in the exchange rate will lead to a 0.68% decrease in the long term demand for imports and vice versa. Also, the import price index now generates a negative and significant effect on the demand for imports. Thus, a unit percentage increase in the import price index will lead to a 0.20% long-run decline in import demand. Further, government consumption expenditure now has a positive and significant effect on import demand, while household consumption exerts a negative and insignificant long run effect on the demand for imports. Therefore, a unit percentage increase in government consumption expenditure will lead to a 113.76% increase in import demand in the long run and vice versa.
Income now yields a positive and significant long-run effect on import demand, while trade openness exerts a negative and insignificant long-run effect. Thus, a unit percentage increase in real income will lead to a 186.41% increase in import demand in the long-run and vice versa. This, therefore, supports the argument that as income rises, consumption will be stimulated. With domestic production not being able to contend with the surge in consumption, importation is inevitable.
Recommendations
The study recommends the need for boosting domestic production so as to contend high level of Import that may have a detrimental effect on our external reserves. With production being stimulated, most of the commodities that are imported will be produced locally and even for export. In this way, our domestic currency will appreciate, and the exchange rate problems facing the country will be drastically reduced.
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