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CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND TO THE STUDY

Exchange rate plays an increasingly significant role in any economy as it directly affects domestic price level, profitability of traded goods and services, allocation of resources and investment decision. The stability of the exchange rate is today a formidable bedrock of all economic activities. Since the adoption of the Structural Adjustment Programme (SAP) in 1986, Nigeria has moved to various types of floating regimes of exchange rate from the fixed/pegged regimes between 1960s and the mid-1980s. Floating exchange rate has been shown to be preferable to the fixed arrangement because of the responsiveness of the rates to the foreign exchange market (Otuori, 2013). The liberalisation of the exchange rate regime in 1986 has led to introduction of various techniques with the view of finding the most appropriate method for achieving acceptable exchange rate for the Naira. The frequency with which these measures were introduced and charged is informed by the determined efforts of the monetary authorities to unrelentlessly combat the unabating depreciation and instability of the Naira exchange rate.

According to Ngereboa and Ibe (2013) exchange rate is the ratio between a unit of one currency and the amount of another currency for which that unit can be exchanged at a particular time. Exchange rate of currency is the link between domestic and foreign prices of goods and services. Also, exchange rate can either appreciate or depreciate. Appreciation in the exchange rate occurs if less unit of domestic currency exchanges for a unit of foreign currency while depreciation in exchange rate occurs if more unit of domestic currency exchanges for a unit of foreign currency. In a continued effort to stabilised the exchange rate, as well as ensure a single exchange rate for the Naira, numerous variants of market determined rates have been adopted since 1986. The Second-tier Foreign Exchange Market (SFEM) was introduced in 1986, while the First and Second tier markets were merged into enlarged Foreign Exchange Market (FEM) in 1987, this was later changed to the Inter-Bank Foreign Exchange Market (IFEM) in January 1989. This new system allowed for bureau de change to source for their foreign exchange requirement from the IFEM. This was later modified the Autonomous Foreign Exchange Market (AFEM) in 1995 which allow the Central Bank to purchase foreign exchange from oil companies (Taiwo and Adesola, 2013).

Despite these policies, the exchange rate of the Naira has remained unstable since the deregulation period. The need to investigate the impact of this fluctuating exchange rate on the financial performance of the banking industry is important for the economy. For a country that is import dependent, the stability of its exchange rate is important for credit allocation (Adebiyi, 2006). It is therefore important to examine how the level of volatility of exchange rate affects economic growth in Nigeria. The impact of exchange rate fluctuations on economic growth in Nigeria still presents controversies because there is no consensus on whether the impact is negative or positive as shown in the results of previous studies. Hence, this study will close the gap in knowledge by exploring the impact of exchange rate fluctuation on economic growth in Nigeria focusing on 2000-2015.

1.2    Statement of the Problem

Unstable exchange rate of Nigeria’s domestic currency (Naira) which is domiciled in US dollars has in some cases made returns on investment to be negative, thereby discouraging investments in thecountry. Osinubi and Amaghionyeodiwe (2009) opined that the Naira/US Dollar exchange rate has witnessed a continuous slide in all the segments of the foreign exchange market (that is official bureau de change and parallel markets). In the official exchange market, it has depreciated progressively leading to a precarious operating environment which can be attributed to the reason why Nigeria has not only been unable to attract foreign investment to its fullest potentials but also has had a limited domestic investment. Despite the vast investment opportunities in the country, many would be investors shy away as a result of uncertainties in the investment climate which can be attributed to high exchange rate volatility in Nigeria. A historic examination of foreign exchange movement in Nigeria shows a considerable level of volatility, thus necessitating the need to determine its effect on economic growth in Nigeria. therefore, this study seeks to examine the impact of exchange rate fluctuation on economic growth in Nigeria focusing on 2000-2015.

1.3    Objectives of the Study

The study will be conducted with the following objectives:

i. To examine the impact of exchange rate fluctuation on gross domestic output in Nigeria.

ii. To investigate the impact of exchange rate volatility on foreign direct investment in Nigeria.

iii. To find out the link between exchange rate fluctuations and manufacturing sector output.

1.4    Research Questions

This study will be guided be the following research questions:

i.  What is the impact of exchange rate fluctuation on gross domestic output in Nigeria?

ii.  Does exchange rate volatility have any impact on foreign direct investment in Nigeria?

iii. What is the relationship between exchange rate fluctuations and manufacturing sector output?

1.5   Research Hypotheses

The researcher intends to test the following hypotheses: