Project Materials

THE ANALYSIS OF EXCHANGE RATE FLUACTUATIONS ON NIGERIA’S BALANCE OF PAYMENT (1983-2013)

Chapter one

INTRODUCTION

1.1 Background of the Study

The currency rate is probably one of the most hotly debated topics in Nigeria today. This is not surprising given its macroeconomic importance, particularly in a heavily import-dependent economy like Nigeria. However, following the Naira fluctuations in 1986, the structural adjustment plan (SAP) prompted a policy change. This raised the issue of exchange rates in Nigeria. Every economy aims for stability and a balanced balance of payments. The country achieved this through the use of the floating foreign exchange determination mechanism. The country also devalued its currency to boost exports and stabilise the exchange rate.

Prior to 1986, Nigeria used a fixed exchange rate determination mechanism. At the time, the naira was very strong in comparison to the dollar. The currency rate was one naira for one US dollar, therefore #1 equalled $1.

The fixed exchange rate determination system was discarded on September 26, 1986, due to increased demand for foreign exchange and the exchange control system’s inability to evolve an appropriate mechanism for foreign exchange allocation in accordance with the goal of internal balance, while the structural adjustment programme (SAP) was implemented.

The primary purpose of the new exchange rate strategy (SAP) was to pressure the value of the native currency, maintain a favourable external balance while achieving macroeconomic stability, and establish a fair exchange rate for the Naira. Between 1973 and 1979, the new SAP strategy generated more than 70% of the nation’s GDP and played a critical role in increasing the country’s balance of payments.

According to Nzolta (2004), foreign exchange is the value of a foreign currency in relation to the currency of the home country. In finance, the exchange rate between two currencies indicates how much one currency is worth in relation to the other.

Devaluation is the fall in a fixed exchange rate that reduces a currency’s worth in relation to other currencies. What is being explored in this study, however, is how a currency’s value decreases in relation to the currency of another country, resulting in exchange rate fluctuations.

It also addresses how this reduction will influence the record of all monetary transactions between countries, whether visible or invisible throughout time.

Nigeria is currently experiencing major challenges with its foreign exchange ratio (which is quite low in contrast to other countries) and balance of payments, which is plainly in disequilibrium and in deficit. As a result, the economy is declining, and citizens are plainly suffering.

It is crucial to understand that economic objectives are typically the primary considerations in choosing exchange control. From 1982 to 1983, when Nigeria’s naira was devalued by 10%, the British pound sterling and the naira had a 1:1 relationship.

Since 1979, the Central Bank of Nigeria has used a basket of currency strategy to calculate the exchange rate, which is typically decided by the relative strength of the currencies of the country’s trading partners as well as the volume of trade with them. Weights were assigned to these countries using the American dollar and the British pound sterling on the exchange rate system.

Following the structural adjustment programme, the government established the foreign exchange market (FEM) to stabilise the exchange rate based on the situation of the balance of payments, inflation rate, domestic liquidity, and employment.

Between 1986 and 2003, the federal government experimented with various currency rates. None of them had a significant impact on the expansion of the economy’s balance of payments before it was modified.

The inconsistency of policies, along with a lack of continuity in exchange rate policies, resulted in an unstable Naira rate.