An empirical analysis of an exchange rate risk and its impact

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Over an extended period, it has been noticed that economy of Nigeria has been fluctuating. To uplift it economically foreign trade plays an important role. Oil and petroleum sector of Nigeria fills the void of oil supply around the world and produces 3.1% of oil around the world.

Foreign trade is a vital part of any country as no country around the world cannot be self-reliant and live without imports.An empirical analysis. Even the developed countries which are the economic giants cannot survive on their own. The value of a currency is so significant as it reflects the progress of a nation.

The amount of a country is known for its exchange rate. Exchange rates are between two countries. These countries are having good relations with each other. The relationship between exchange rate risk and its impact on foreign trade will be observed. The systematic pattern will be examined in Nigerian Economy, and the factors will be identified which affect international commerce.

Not all countries can achieve stable exchange rate. A country like Nigeria’s trade has always been a vital source of growth and development since 1981 for it.An empirical analysis. Nigeria is emerging open economy which heavily depends upon imports to meet the demand of the consumers (Reinhart & Rogoff, 2004).

The local currency is beginning was tremendously well in which the main exports were cocoa, rubber, and other agricultural products. There is a massive increase in volatility of exchange rate around the world since the 1970s after to exit of Bretton Wood system.

However, a country such as Nigeria, having a mono-product economy, is affected most. Jones & G.I (2000) the most important trading partner of Nigeria is the United States of America. So, Nigeria has to pay for the goods purchased from America in US dollars and supply the naira (Nigeria’s currency) to fund products and services.An empirical analysis of an exchange rate risk.

However, the rate of US dollars to pound Sterling (previous currency of Nigeria) was used to be 1:1 ratio from 1960 till 1973. After that, naira kept on increasing source imports cheaply to complete development projects.An empirical analysis of an exchange rate risk and its impact on foreign trade in nigeria

This increase in imports led to the depreciation of external reserves. Hence, a gradual decrease in amortization of naira started from 1981 (Omotunde, Sunday, & John-Dewole, 2013).An empirical analysis

Soludo & Governor (2007) several measures have been taken to strengthen naira against dollars includes some ban on foreign exchange by the central and federal government. However, it is kept from falling comparatively.

The core reason for this is the export of oil. Oil is the primary cause of energy in Nigeria and the world. Its industry was found in the starting of the century, and it was the end of the civil war (1967-1970) that oil industry started playing a vital role in the economy of the country and Nigeria was able to gather vast riches from its production.

The oil sector can be categorized into three main factors; upstream, downstream and gas (Collier, Soludo, & Pattillo, 2008). The most troublesome industry is downstream, which is the connection and distribution arm with final consumers of refined petroleum.

Thus, the domestic economy is affecting day by day. Therefore, this is the primary factor contributing to the downfall of the economy of Nigeria and a higher rate of USD as compared to naira (Madichie, 2005).

The five primary reasons for the downfall of Nigeria include:

Inadequate infrastructure: It has been observed that in recent years, imports have increased rapidly as compared to exports. The vital reason behind this is the insufficient supply of power, adequate transportation and unpredictably whether condition. It all leads to fewer products being manufactured in the country and leads to import more products to fulfill consumers’ needs.
Unwholesome practices of intermediaries: The gap between official and parallel market keeps on increasing. Round-tripping has been observed in Nigerian forex market. Thus, people buy dollars from the formal market and sell them at a high price on the parallel
Persistent negative predictions: Unfortunately, Nigeria is known to be indulged in several bad things worldwide. As a result, this portrays negative impact on the investors who resist putting money into Nigerian economy.
“Made Abroad” mentality of Nigerians: Rather than using local products, Nigerians often prefer imported good. However, this good could easily be produced As a result, imports further increase and naira is depreciated.
General instability: National stability including political, economic and social affairs has always been troublesome for Nigeria. Frequent clashes between local tribes resist the investors to trust them

Furthermore, the primary concern for naira’s exchange rate is instability. Since the exchange rate is an essential tool for measuring exports of a country worldwide, research is to be done to determine Nigeria’s nonoil exports.

Although the government is trying to promote international trade, their policies have remained uncertain (Liss, 2007).

Problem Statement

Foreign exchange plays an integral part in boosting the economy of Nigeria. This research will indicate the factors which affect the exchange rate and how exchange rate will change the trade in Nigerian Economy.

Research Questions:

The research questions sketched to conduct the study are listed below:

What is the relationship between real exchange rate and exchange rate volatility?
How can we measure the degree of openness and does it have an impact on the balance of payment in Nigeria?
What is the impact of real exchange rate, exchange rate volatility, the degree of balance of payment and openness on export-import in both short and long run in the same country?

Research Hypothesis

In the proposed research, following research hypothesis will be tested:

H_o: There is a significant impact on the real exchange rate, exchange rate risk, the degree of balance of payment and openness on import and export in Nigeria.

H₁: There is no significant impact on the real exchange rate, exchange rate risk, the degree of balance of payment and openness on import and export in Nigeria.

H_o: There is an impact of real exchange rate, exchange rate volatility, the degree of balance of payment and openness on export-import in both short and long run in Nigeria.

H₁: There is no impact of real exchange rate, exchange rate volatility, the degree of balance of payment and openness on export-import in both short and long run in Nigeria.

Purpose of the Study

This research is fundamental, specifically for the people of Nigeria as it will create an analytical approach in them towards the foreign exchange.

In this study researcher will also highlight some key factors because of which trade and foreign exchange are affected, negative factors can be looked and overcome. This research can act as a precautionary measure for Nigerian economy (Sarno & Taylor, 2001).

Limitation:

There are many limitations while looking into this research:

As it is a comparative study from the year 1981 to 2016, the conditions from the past and present are different. Because of change in many external factors, all the elements can’t be compared.
External factors like political conditions and policies have changed which can be a limiting factor.
The trade rate of Nigeria has an outlier because of which no consistent findings can be found(Quinn, Zimmerle, & Bradley, 2012).

Chapter 2: Literature Review

Introduction

No country in the world produces the commodities which they need, and because of which they import them from other countries, on the other hand, there are countries which export those products or commodities which they are having in excess.

Foreign trade increases the market for a country’s output. Exports can help in boosting the production of the nation because of which growth rate is increased. If country’s foreign trade prospers, it becomes a high time for a country to become economically stable, develop and grow economically (Meagher, 2010).

Because of the increased economy, the production of many products increases due to which cost per product decreases. Expanding exports help in creating more employment opportunities as the chances of investment are raised more investors look to capitalize their money on that country which benefits more people of the country.

Volatility represents the changes in the exchange rate over a particular time. There can be many factors which make the exchange rate volatility. For these countries degree of openness is also essential (Babalola, 2001)……