EFFECT OF EXCHANGE RATE AND INFLATION ON NIGERIA’S ECONOMIC GROWTH

CHAPTER ONE

INTRODUCTION

1.1      Background of the study

The Nigeria economy has witnessed a great degree of instability ever since the end of Civil War. From 2.48824 to 1.24414 grains of fine gold following the exchange of the Nigerian Pound to Naira in 1973, fixed exchange rates were establish for both Pound sterling and the US Dollar at £0.5833 and US 1.5200 respectively to N1.00 this has caused havoc to the Nigerian economy in that exchange rate the Naira to both Dollar and Pound sterling has been observed that the economy has it also been witnessed the highest degree of inflation. The result is that Nigeria as a country has last it’s financial credibility in the outside world at the home front because the exchange rate is net to our favour the country has witnessed the greatest degree of brain drain. The exchange rate fluctuations has effected most our industries that import whole or part of their raw materials and the result is that production is below capacity utilization, resulting in unemployment. Again, because of the exchange rate, most local home made goods are expensive thereby pricing themselves out of the market. The rate at which Naira exchange for Dollar determines the rate at which goods are sold in the market. Therefore, the exchange rate fluctuation effects the prices of imported goods upwards or downwards as the case may be. At the same time, it affects the price of locally produced goods that most of the raw materials and machines are imported and prices at which the currency of exchange are secured effect the price positively or negatively. Inflation is neither new in the economy system of Nigeria nor the world at large. There have been in existence, variations in magnitude or rats. The rate of inflation in Nigeria was about 10% between 1969 and 1970. In 1970, prices rose by about 14%( immediately after the war of 1970) then fell to 3% in 1972, rose by about 16.1% in 1974 and reached a rate of about 34% increase in 1975. Inflation seemed to be the greatest task to government’s policy makers in the 1970’s history. In 1974, inflation rose to about 13 percent before the Udoji salary award of the same year only to leap to 34 percent in 1975 mainly as a result of the award. It went down gradually until it hit 10 percent in 1080. It went crazy and leapt to about 22% the following years and come down again to 7% in 1982. However, the official inflation figures are known to substantially understate the actual inflation rate. Nevertheless they act as a rough guide of the inflationary activities in the country. Evidence has shown that inflation persist both the developed countries and developing countries, with difference in magnitude or rates, however, making comprising with present situation. The rates in developing countries are more than those in the developed countries. The above-mentioned rates were attained during the seventeen century and the early part of the eighteenth century (1799-1807), and the early mid-parts of the nineteenth century (1969-1975). Inflation simply means a continuous upward movement in the general price level, inflation does not mean that each and every price is rising, nor that all prices are rising at the same rate. It is a process by which paper money loosed values, this depreciation is reelected quantitatively in a rise in prices. The fast prices rises in a given country, the faster its currency losses its purchasing power on the domestic market and through certain connecting link on foreign market too. Inflation may be defined as a continuous rise in the price of goods of services a+ result of large volume of money in circulation used in the exchange of the few available goods and services.   Also, the high price of imported goods arising from increase in foreign price and instability of international exchange rate. Sub-charge from port congestion, storage facilities, marketing arrangements plus the distribution network, the impact of second tier foreign exchange market and removal of oil subsidy. There has been an increase in the price of oil since the removal  and this level led to price increment of most items, and increase in transportation fare is a living example at hared.  At this junction, it  worthy to note that all these issues accused accelerated increase in the  aggregate demand not being match by appropriate expansion in domestic output and the import of goods and services.  In conclusion, had inflation affected everyone in exactly the same way and degree, it would have no importance whatsoever, it’s social sign-finance arises from the fact that it always dose effect the people differently. It’s effect on personality, income and family background corporation, source of income , etc, also their locations, whether in the local places or ion the city are of relevance of the study’s.

The growing interest in price stability as a major goal of monetary policy is an acknowledgement of the observed phenomenon that high inflation disrupts the smooth functioning of a market economy. High inflation is known to have many adverse effects: it imposes welfare costs on the society; impedes efficient resource allocation by obscuring the signaling role of relative price changes; discourages savings and investment by creating uncertainty about future prices; inhibits financial development by making intermediation more costly; hits the poor excessively, because they do not hold financial assets that provide a hedge against inflation; and reduces a countrys international competitiveness by making its exports relatively more expensive, thus impacting negatively on the balance of payments, and perhaps more importantly, reduces long-term economic growth (See Ghosh and Phillips, 1998; Khan and Senhadji, 2001; Billi and Khan, 2008; Frimpong and Oteng-Abayie, 2010). Overall, businesses and households are thought to perform poorly in periods of high and unpredictable inflation, Barro (1996).

Most policymakers, however, agree that they should not allow inflation to fall below zero because the costs of deflation are thought to be high, Billi and Khan (2008). Even though some evidence suggests that moderate inflation helps in economic growth, Mubarik (2005), the overall weight of evidence so far clearly indicated that inflation is inimical to growth. Consequently, policymakers should aim at a low rate of inflation that maximizes general economic well-being.

1.2      STATEMENT OF THE PROBLEM

The inflationary period is a time of high price of goods and service. Onah (2005) this works the quantity and type of products (good and services) purchasable by individuals and corporate body at any point in time. The problem passed by this, is that individuals and corporate bodies in the society are unable to purchase the quantity of desired products during inflation. The fluctuation of exchange rate and its attendant effects on price of imported goods in Nigeria has posed a big challenge to financial institution importance of various goods and Nigeria institutions, importance of various goods and Nigerian populace in general. It is in view of this that the researcher intends to investigate the effect of exchange rate and inflation on Nigeria’s economic growth.

1.3 OBJECTIVE OF THE STUDY

The main objective of the study is to ascertain the effect of exchange rate and inflation on Nigeria’s economic growth. But to aid the completion of the study, the researcher intends to achieve the following specific objectives;

1.  To examine the effect of inflation rate on the economic growth of Nigeria.

2.  To know the reason of this upward movement of the pricing of goods in Nigeria. 

3. To discover why Nigeria depends solely on imported industrial inputs for its industrial use.

4.  To evaluate the relationship between inflation and economic growth and development of Nigeria.

5.  To examine the inflation rate at which inflation has affected on the gross national product of Nigeria

1.4       RESEARCH QUESTIONS

        The following questions will guide the study:

1.     Is upward movement of the pricing of goods in Nigeria due to exchange rate of fluctuation? 

2.     Is over dependence on importation of industrial equipment in Nigeria due to lack of economics of scale?

3.     Does the price of made in Nigeria goods fluctuate with the prices of imported goods?

4.     Does the steady rise in prices of imported goods in Nigeria due to the exchange rate of Naira to Dollar

1.5 RESEARCH HYPOTHESIS     

The researcher formulated the following research hypothesis:

H0: Inflation rate has no effect on the economic growth of Nigeria

H1: Inflation rate has affected the economic growth of Nigeria.

H0: There is no significant relationship between inflation and economic growth and development of Nigeria.

H2: There is significant relationship between inflation and economic growth and development of Nigeria.

1.6      SIGNIFICANCE OF THE STUDY

It is believed that at the completion of the study the findings will be beneficial to the policy makers as the findings will assist in the planning of government unit through the provision of more efficient feedback information on the effectiveness of their anti-inflationary policies.  It will help individuals and corporations in the planning of their marketing mix for their products.   It will help the IMF on how to advice the Nigerians to overcome the effects of inflation. The study will also be beneficial to financial institution (CBN) central bank of Nigeria as the study will help them regulate the volume of money in circulation

1.7      SCOPE AND LIMITATION OF THE STUDY

The scope of the study covers the effect of exchange rate and inflation on Nigeria’s economic growth. In the cause of the study, there were some factors which militate against the scope of the study which were beyond the control of the researcher;

a) AVAILABILITY OF RESEARCH MATERIAL: The research material available to the researcher is insufficient, thereby limiting the study 

b) TIME: The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

c) Organizational privacy: Limited Access to the selected auditing firm makes it difficult to get all the necessary and required information concerning the activities.

1.8 OPERATIONAL DEFINITION OF TERMS

Inflation

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time

Open And Suppressed Inflation: Open inflation is the result of the uninterrupted operation of the market mechanism

Stag inflation: This is a situation whereby recession is accompanied by a high rate of inflation also called inflationary recessing

Exchange rate

Exchange rate is the price of one currency in terms of another. More accurately an exchange rate is the number of units of foreign currency and vice versa.

Nominal Exchange Rate

The nominal exchange rate is defined as units of domestic currency per unit of foreign exchange.

Trade Tables

These are goods what could be exchange for in the international market.

Non Trade Table

These are the outputs of an economy that can be consumed domestically and therefore for exportation e.g. electricity.

Misalignment

This is the deviation of the actual real exchange rate from its equilibrium value.

1.8 ORGANIZATION OF THE STUDY

This research work is organized in five chapters, for easy understanding, as follows Chapter one is concern with the introduction, which consist of the (overview, of the study), statement of problem, objectives of the study, research question, significance or the study, research methodology, definition of terms and historical background of the study. Chapter two highlight the theoretical framework on which the study is based, thus the review of related literature. Chapter three deals on the research design and methodology adopted in the study. Chapter four concentrate on the data collection and analysis and presentation of finding.  Chapter five gives summary, conclusion, and recommendations made of the study.