CHAPTER ONEINTRODUCTION1.1 BACKGROUND OF THE STUDY Foreign exchange is the means of payment for international transactions and it is made up of convertible currencies that are generally acceptable for the settlement of international trade and other external obugations. The foreign exchange market is an arrangement or medium of interaction between the sellers and buyers of foreign exchange in a bid to negotiate a mutually acceptable price for the settlement of international transactions (ile 1999: 325) Afolabi (1999) defined exchange rate as the price of one currency in terms of the other. In other words, it is the rate at which one currency will exchange for another.In the pre-babangida administration years the Nigeria currency was above the dollar and on par with the pound. However the naira has depreciated in value to a great extent since 1986 with the introduction of the structural adjustment programme (SAP) , under the babangida administration since the introduction of SAP in 1986, exchange management has been at the core of macroeconomic policy. The overriding objective has been to have a realistic and stable exchange rate consistence with the internal rate of naira and to reduce the economy’s dependence on the external sector.Prior to 1986, one official foreign exchange market existed in Nigeria and exchange rates were officially fixed by the CBN. Then in the September 1986, the foreign exchange market was divided into two : the first-tier foreign market and the second – tier foreign exchange market (STEM). The major aspect of the SFEM was that the prices of foreign currencies as against the naira was determined through competitive bidding with the prices settling at points. Where the available supply of the currencies are cleared the bidding was in terms of one currency. The us dollar, against the naira and the rates for other currencies were correspondingly determined after the determination of the dollar rate.(essien 1990 : 129).With the establishment of SFEM the rate of naira depreciation by the central bank gathered momentum. With the view of merging the first and second tier markets within the shortest possible time, which was about one year. In July 1987, the first and second tier foreign exchange market were merged and called the foreign exchange market (FEM). On march 20 1987 the central bank introduced the Dutch auction system which was intended to inject more caution in the bidding sessions since dealers who bid above the marginal rate would be made to buy at that rate the Dutch auction system was expected to control the sharp depreciation of the naira. In 1994 a natural merger of the official market and the parallel market occurred. The parallel market gradually marginalized the official market. The foreign exchange market was liberalized in 1995 with the introduction of the autonomous foreign exchange market (AFEM) for privately sourced fund at market determined exchange rates(CBN Annual Report 2001).In 1995, the foreign exchange market was split into three tiers. The administratively fixed through the manipulation of the market mechanism, and the parallel market. Still, there was greater depreciation of the naira. There was also an introduction of dual exchange rate regime in 1995 which was a mixture of both the fixed and the market determined rate. The dual exchange rate regime was restricted in 1997 with the official selling rate fixed at #21.9960 to us$1for selected priority government transactions. The stability of the nominal exchange rate achieved in 1995 and 1996 at the AFEM was generally sustained in 1997.The exchange rate of the naira depreciated in all segments of the foreign exchange market prior to the introduction of IFEM(Inter-Bank Foreign Exchange Market). Which commenced operation on October 25,1999. the exchange rate depreciated to #97.42 toUS$1.00 and depreciated on the average by 6.5 percent to #101 to US$!>)) in 2000. there was a phenomenal depreciation in early April 2001 with the naira sinking to #113.2263 to US$1.00 as against the official rate. This fall in value continued as the naira sank again to #126.38883 to US$1.00 in December 2002,and #136.5000 to US$1.00 in December 2003 then to #132.85 in December 2004.the CBN was successful in keeping to its target on growth of broad money M2 in 2004. from 2002 – 2005. The naira has performed 15 times better than in both 2000 and 2001. 1.2 STATEMENT OF PROBLEM. A review of the Nigeria economy shows a decline in the value of the naira in the years under study (1986 to date). This has brought about a series of problems, which include inflation, unemployment, balance of payment problems and increase in the level of poverty. Some of the measures adopted by the government to help reduce the incessant depreciation of the naira include the introduction of IFEM in 199, the AFEM and the re-introduction of the Dutch Auction System(DAS) in 2002. in spite of these measures, the value of naira has continued to cascade downwards.It is these set of problems encountered as a result of this depreciation that has motivated this research which apart from determining the causes and economic effects of the depreciation, is also aimed at proffering solutions to it 1.3 PURPOSE OF THE STUDYThe study has the following objectives:1. To determine the effect of the depreciation of the naira on Nigeria’s economic growth level and on the industrial sector.2. To find out the factors that cause the persistent depreciation of the naira.3. To investigate the various avenues through which it can be alleviated4. To make recommendations based on the findings. 1.4 RESEARCH QUESTION. To guide this study the following questions were formulated.1. To what extent does the depreciation of the naira have effect on the Nigeria’s economic growth level.2. To what extent have the depreciation of the naira affected the industrial sector.3. What is the extent to which relevant economic factors have caused the persistent depreciation of the naira.4. To what extent can these factors be alleviated? 1.5 STATEMENT OF HYPOTHESIS. The following hypothesis have been formulated to guide the study:HYPOTHESIS IHo: The depreciation of the naira has no significant effect on Nigeria’s economic growth level.Hi: the depreciation of the naira has a significant effect on Nigeria’s growth level. HYPOTHESIS IIHo: The depreciation of naira has no significant effect on the performance of the industrial sector.Hi: The deprecation of the naira has a significant effect on the performance of the industrial sector. 1.6 SIGNIFICANT OF THE STUDY. This research work will be of immense benefit to the following groups of people:1. Policy makers of the various governmental organisms. Nigeria who formulate and issue the regulatory economic guidelines.2. Industrialists who engage in import and export of both rate materials and finished goods.3. Students and researchers who may desire to research further on the topic or related topics in future.4. The general public who directly or indirectly affected by the depreciation of the Naira. 1.7 SCOPE AND LIMITATION OF THE STUDY. This study centers on the cause and effects of the persistent depreciation of the Naira in the foreign exchange market and the solutions to it. The years under study are 1986 to date. The analysis will be limited to the effect of the naira / dollar exchange rate on the cross Domestic product at current factor cost, which will be used as proxy for economic growth and on the industrial sector. Some products were encountered in then course of the study. Firstly, the researcher could not benefit substantially from previous works because enough research work has not been carried out in the area of study. Secondly, the officials of the establishments from where must of the data was soured did not offer their full co-operation. As such they could not be easily obtained. There were also financial constraints such as high cost of text books and transport cost. 1.8 DEFINITION OF TERMS.1. Autonomous foreign Exchange market (AFEM): this is a market where banks are allowed to source their foreign exchange and sale and used at market determined rates.2. Current factor cost: this is used to measure the rate of cross Domestic product (GDP)3. Dual exchange rate: This situation exists where two exchange rates are in existence in an economy.4. Dutch Auction System (DAS) This is a method of determining the exchange rate through auction.5. First – Tier Foreign Exchange Market This was the market where government and its agencies buy foreign currency a foreign currency at officially determined rate of exchange.6. Inter-Bank foreign Exchange market(IFEM): This was conceived to deepen the foreign exchange market through active participation of other players e.g bank, oil companies, non- bank financial institutions. It is the market where banks can sale foreign exchange to one another and to other users at their own rates7. Paralopee market: This is also known as blank market’. It is the unofficial market where foreign currencies are bought and sold. 8. Second-tier foreign exchange market (SFEM): This was the market where non-governmental bodies buy and sale foreign exchange at a market determined exchange rate.