Foreign Exchange Market Demand Pressure and Economic Growth in Nigeria

Samuel Ominyi ,David Terfa Akighir ,Roselynda Abayol-Ikwue

doi:10.7176/jesd/11-4-22

Abstract

The study has investigated the relationship between foreign exchange market demand pressure and economic growth in Nigeria from 1986 to 2018. The study has used the Marshall-Lerner theory of the demand and supply of foreign exchange. The employed the Autoregressive Distributed Lagged (ARDL) model and Granger Causality test to investigate this relationship. Findings of the study revealed that there exist negative relationships between the foreign exchange market demand pressure and economic growth in both short and long run on the one hand and negative relationship between inflation and economic growth on the other hand both in the short and long run. It was concluded that foreign exchange market demand pressure affects economic growth in Nigeria directly and indirectly via the exchange rate pass-through to domestic prices mechanism. The study recommended that first, the Nigerian economy should be diversified away from oil using the agriculture and manufacturing sectors as articulated in the Economic Growth and Recovery Plan of the Buhari’s administration. By diversification, multiple streams of supply of foreign exchange in the economy will be created to close the existing gap between its demand and supply in the country. Also, by diversification of the economy, the demand for imported goods will reduce. The reduction in the demand for imported goods into the country presupposes reduction in demand for foreign exchange. With this, the scarce foreign exchange can be conserved for only importation of capital goods for onward production of goods and services in the country. Thirdly, the Central Bank should regulate the supply of foreign exchange to only critical sectors of the economy. The activities of the importers should also be checked to avoid cases of over invoicing and under invoicing. These activities generally lead to round-tripping with its adverse consequences on the demand and supply of foreign exchange in the country. Key Words: Autoregressive Distributed Lagged Model, Economic Growth, Foreign Exchange Market Demand Pressure, Granger Causality Test, Marshall-Lerner theory, Nigeria DOI: 10.7176/JESD/11-4-22 Publication date: February 29 th 2020

Highlights

Demand pressure in the foreign exchange market is related to increase in demand for foreign currency over its supply and depreciation of exchange rate under a flexible exchange rate regime rather than a fixed regime
The data for the study were analysed using the ordinary least square (OLS) econometric technique and the results showed that while both labour and capital were positively significant in explaining industrial production in the country, exchange rate and inflation negatively and significantly explained it
In order to investigate the relationship between foreign exchange market demand pressure and economic growth in Nigeria, the study followed the modelling approach of Rawlins and Praveen (2004)

Summary

Introduction

Demand pressure in the foreign exchange market is related to increase in demand for foreign currency over its supply and depreciation of exchange rate under a flexible exchange rate regime rather than a fixed regime. Most banks have neglected their core traditional function of intermediation in providing finance to the real sector of the economy and have relied more on foreign exchange trading as a cheap source of generating profit This disturbing trend has continued to pose serious challenge to the monetary authorities considering the need to ensure an effective management of the foreign reserves of the country and to deploy resources to the productive sectors of the economy. The main objective of this study is to investigate empirically the effect of foreign exchange market demand pressure on the economic growth in Nigeria. Towards this end, the paper is structured into five sections following the introductory section. Section two borders on theoretical review, section three is on the empirical literature, section four dwells on the methodology of the study; while section five deals with the empirical data analysis and interpretation of the results and section six considers the conclusion and policy recommendations

Theoretical Review

Empirical Review

Methodology of the Study

Empirical Results