AN ANALYSIS ON THE PERSISTENT DEPRECIATION OF THE NAIRA IN THE FOREIGN EXCHANGE MARKETS : CAUSES, EFFECTS AND SOLUTIONS

1.1 Introduction

The persistent decline in the foreign exchange rate of naira since the introduction of adjustment programme in 1986 has generated both concern over increased inflation and reduced hope for improvement in the output level. This concern derives from the experience of countries such as Mexico and Argentina where real depreciation of their domestic currencies have consistently been associated with decline in output and increases in inflation (Cooper, 1971; Gylfason and Schmid, 1983). The term depreciation refers to an accounting method used to allocate the cost of a tangible or physical asset over its useful life or life expectancy. Depreciation represents how much of an asset's value has been used. Depreciating assets helps companies earn revenue from an asset while expensing a portion of its cost each year the asset is in use (BDC, 2021).

As a prelude to other parts of this study, this chapter will discuss the background upon which this study was initiated, the statement of problems that led to this study, the Aim and Objectives of the study. Others are Significance of the study, Scope of work, Limitations of the Study and Definition of technical terms.

---

1.2 Background of Study

Foreign exchange is the means of payment for international transactions and it is made up of convertible currencies that are generally acceptable for the settlement of international trade and other external obugations. The foreign exchange market is an arrangement or medium of interaction between the sellers and buyers of foreign exchange in a bid to negotiate a mutually acceptable price for the settlement of international transactions (ile 1999: 325). Afolabi (1999) defined exchange rate as the price of one currency in terms of the other. In other words, it is the rate at which one currency will exchange for another.

In the pre-babangida administration years the Nigeria currency was above the dollar and on par with the pound. However the naira has depreciated in value to a great extent since 1986 with the introduction of the structural adjustment programme (SAP), under the babangida administration since the introduction of SAP in 1986, exchange management has been at the core of macroeconomic policy. The overriding objective has been to have a realistic and stable exchange rate consistence with the internal rate of naira and to reduce the economy’s dependence on the external sector.

Prior to 1986, one official foreign exchange market existed in Nigeria and exchange rates were officially fixed by the CBN. Then in the September 1986, the foreign exchange market was divided into two : the first-tier foreign market and the second – tier foreign exchange market (STEM). The major aspect of the SFEM was that the prices of foreign currencies as against the naira was determined through competitive bidding with the prices settling at points. Where the available supply of the currencies are cleared the bidding was in terms of one currency. The us dollar, against the naira and the rates for other currencies were correspondingly determined after the determination of the dollar rate (Essien, 1990:129).

ith the establishment of SFEM the rate of naira depreciation by the central bank gathered momentum. With the view of merging the first and second tier markets within the shortest possible time, which was about one year. In July 1987, the first and second tier foreign exchange market were merged and called the foreign exchange market (FEM). On march 20 1987 the central bank introduced the Dutch auction system which was intended to inject more caution in the bidding sessions since dealers who bid above the marginal rate would be made to buy at that rate the Dutch auction system was expected to control the sharp depreciation of the naira.

In 1994 a natural merger of the official market and the parallel market occurred. The parallel market gradually marginalized the official market. The foreign exchange market was liberalized in 1995 with the introduction of the autonomous foreign exchange market (AFEM) for privately sourced fund at market determined exchange rates (CBN Annual Report 2001).

In 1995, the foreign exchange market was split into three tiers, the administratively fixed through the manipulation of the market mechanism, and the parallel market. Still, there was greater depreciation of the naira. There was also an introduction of dual exchange rate regime in 1995 which was a mixture of both the fixed and the market determined rate. The dual exchange rate regime was restricted in 1997 with the official selling rate fixed at #21.9960 to us$1for selected priority government transactions. The stability of the nominal exchange rate achieved in 1995 and 1996 at the AFEM was generally sustained in 1997.

The exchange rate of the naira depreciated in all segments of the foreign exchange market prior to the introduction of IFEM (Inter-Bank Foreign Exchange Market) which commenced operation on October 25, 1999. The exchange rate depreciated to N97.42 to US$1.00 and depreciated on the average by 6.5 percent to N101 to US$ !>)) in 2000. there was a phenomenal depreciation in early April 2001 with the naira sinking to N113.2263 to US$1.00 as against the official rate. This fall in value continued as the naira sank again to N126.38883 to US$1.00 in December 2002 and N136.5000 to US$1.00 in December 2003 then to #132.85 in December 2004.the CBN was successful in keeping to its target on growth of broad money M2 in 2004 from 2002 – 2005. The naira has performed 15 times better than in both 2000 and 2001.

Therefore, in Nigeria where the research was carried out, the activities that was conducted is to analyze the Persistent Depreciation of the Naira in the Foreign Exchange Markets: Causes, Effects and Solutions.

---

1.3 Statement of Problem

A review of the Nigeria economy shows a decline in the value of the naira in the years under study (1986 to date). This has brought about a series of problems, which include inflation, unemployment, balance of payment problems and increase in the level of poverty. Some of the measures adopted by the government to help reduce the incessant depreciation of the naira include the introduction of IFEM in 199, the AFEM and the re-introduction of the Dutch Auction System (DAS) in 2002. in spite of these measures, the value of naira has continued to cascade downwards.

It is these set of problems encountered as a result of this depreciation that has motivated this research which apart from determining the causes and economic effects of the depreciation, is also aimed at proffering solutions to it.

---

1.4 Aim and Objectives of Study

The aim of the study is to analyze the Causes, Effects and Solutions of Persistent Depreciation of the Naira in the Foreign Exchange Markets. In achieving this aim, the following objectives of study were laid out as follows:

1. To determine the effect of the depreciation of the naira on Nigeria’s economic growth level and on the industrial sector.
2. To find out the factors that causes the persistent depreciation of the naira.
3. To investigate the various avenues through which it can be alleviated
4. To make recommendations based on the findings.

---

1.5 Research Questions

The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:

• To what extent does the depreciation of the naira have effect on the Nigeria’s economic growth level?
• To what extent has the depreciation of the naira affected the industrial sector?
• What is the extent to which relevant economic factors have caused the persistent depreciation of the naira?
• To what extent can these factors be alleviated?

---

1.6 Research Hypothesis

In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.

Hypothesis One

• H0: The depreciation of the naira has no significant effect on Nigeria’s economic growth level.
• H1: The depreciation of the naira has a significant effect on Nigeria’s growth level.

Hypothesis Two

• H0: The depreciation of naira has no significant effect on the performance of the industrial sector.
• H1: The depreciation of the naira has a significant effect on the performance of the industrial sector.

---

1.7 Significance of Study

This research work will be of immense benefit to the following groups of people:

1. Policy makers of the various governmental organisms.
2. Nigeria who formulate and issue the regulatory economic guidelines.
3. Industrialists who engage in import and export of both rate materials and finished goods.
4. Students and researchers who may desire to research further on the topic or related topics in future.
5. The general public who directly or indirectly affected by the depreciation of the naira.

This study will also be of immense benefit to other researchers who intend to know more on this study and can also be used by non-researchers to build more on their research work. This study contributes to knowledge and could serve as a guide for other study.

---

1.8 Scope of the Study

This study centers on the cause and effects of the persistent depreciation of the Naira in the foreign exchange market and the solutions to it. The years under study are 1986 to date. The analysis will be cover to the effect of the naira / dollar exchange rate on the cross Domestic product at current factor cost, which will be used as proxy for economic growth and on the industrial sector.

---

1.9 Limitations of the Study

During the course of this study, many things militated against its completion, some of which are:

1. Time Constraint: The time frame given to accomplish this project was very short due to school academic calendar and it was carried out under pressure which made the researcher not to implement some necessary features.
2. Establishment Policies: Establishment policies posed a serious limitation as most staffs are not ready to release information needed for this project work. There were lots of information needed from the staffs of this establishment to enhance the study which took them time to release or they did not release at all for security purposes, hence the scope was reduced.
3. Research material: availability of research material is a major setback to the scope of the study.
4. Frequent power failure: This made the researcher append more money on fuel to ensure sustainable power.
5. Financial Constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

---

1.10 Definition of Terms

1. Autonomous foreign Exchange market (AFEM): this is a market where banks are allowed to source their foreign exchange and sale and used at market determined rates.
2. Current factor cost: this is used to measure the rate of gross Domestic product (GDP)
3. Dual exchange rate: This situation exists where two exchange rates are in existence in an economy.
4. Dutch Auction System (DAS): This is a method of determining the exchange rate through auction.
5. First – Tier Foreign Exchange Market This was the market where government and its agencies buy foreign currency a foreign currency at officially determined rate of exchange.
6. Inter-Bank foreign Exchange market (IFEM): This was conceived to deepen the foreign exchange market through active participation of other players e.g bank, oil companies, non- bank financial institutions. It is the market where banks can sale foreign exchange to one another and to other users at their own rates
7. Blank market: It is the unofficial market where foreign currencies are bought and sold.
8. Second-tier foreign exchange market (SFEM): This was the market where non-governmental bodies buy and sale foreign exchange at a market determined exchange rate.