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Price,
Exchange Rate Volatility And Nigeria Agricutural Trade Flows
ABSTRACT
The research
work investigates the impact of price; exchange rate volatility on agricultural
trade flows in Nigeria using the classical least regression model (CLRM) and
the ordinary least square (OLS) modeling approach with time series data
spanning 1975-2009 and a number of statistical tools are employed to verify this
hypothesis. The overall finding from all the technique employed in the paper
has established a statistical significant positive impact of exchange rate
volatility on agricultural trade flows in the short run and a negative impact
in the long run. Finally, the paper concluded by recommending, among others,
that monetary authorizes should adopt a mechanism that will lead to stability
of the exchange rate.
CHAPTER ONE
1.0 INTRODUCTION.
1.1 BACKGROUND OF THE STUDY.
Over the
years, Nigeria like other developing countries has pursued the objective of
accelerating economic growth /development in a bid to move the economy to a
more desirable state. Unfortunately, Nigeria has been a mono product economy
relying mainly on oil exports. Prior to the advent of oil Nigeria was dependent
on agriculture contributing about 57% of G D P. After independence, it was
still on the increase from (1960-1969), the early 70’s witnessed the advent oil
boom. This phased out agriculture and since then Nigeria has been a mono
product economy.
One of the
sudden and sticking events in Nigeria over the past years was the devaluation
of the naira with the structural adjustment program (SAP) in 1986. A
fundamental objective of SAP was to restructure the productive base of the
economy with a positive preference for the production of agriculture export. As
Nigeria’s economic situation worsened towards the end of 1985, the government
allowed exchange rate to be determined by market forces, in 1986, the SAP had a
major clause of devaluation of the naira among all things. The foreign exchange
reforms that facilitated a cumulative depreciation of the effective exchange
rate were expected to increase the domestic prices of agriculture trade and
therefore boost domestic productions.
Significantly,
this depreciation resulted in changes in the structure and volume of Nigeria‘s
agriculture exports as empirically determined by many researchers (oyejide
1986, ihimodu 1993, world bank 1994, osuntogu et al 1993). The depreciation
also increased the prices of agricultural exports and studies have shown a
marked increase in the volume of agricultural exports over the years.
However, the
volatility and instability of the exchange rate movement since the beginning of
the floating exchange rate raise a concern about the impact of such movement on
agricultural trade flows.
ANANLYSIS OF
SAP.
Most African
nations are implementing SAP, an economic `solution inspired by the World Bank
and the IMF. The objectives of a Structural Adjustment Program are largely the
same for most African nations, because the world bodies presume that African
economies are at the same level of development and are experiencing similar
problems.
The stated
objectives of the Nigerian SAP are to:
•
restructure and diversify the productive base of the economy
• achieve
fiscal stability and positive balance of payments
• set the
basis for a sustained non-inflationary or minimal inflationary growth, and
• reduce the
dominance of unproductive investments in the public sector.1
The
corresponding program instruments include the strengthening of demand
management policies, adoption of a realistic exchange rate policy through the
establishment of Foreign Exchange Markets (FEM), rationalization and
privatization of public sector enterprises, and the adoption of appropriate
pricing policies for public enterprises.
Nigeria has
implemented SAP for almost a decade now, but none of the objectives has been
achieved, and there is no indication that any of them can be achieved using the
chosen program instruments. Indeed, all that is still conspicuously present in
Nigeria is the foreign exchange market and the ceremonies associated with
it. Financial institutions and Nigerian
economists campaigning to establish SAP continue to insist that there is no
alternative to SAP. They point out that Nigeria had become indebted and seemed
unable to repay because it had been involved in indiscriminate importation and
had also neglected non-oil export as potential foreign exchange earners. To
these economists, the solution to the problem lay in a mechanistic manipulation
of the import-export equation, which dictates that a country must export (or
earn) more than it imports (spends) to generate a positive balance of trade.
Foreign
exchange markets, as part of structural adjustment programs, served to increase
the cost of imports and hence reduce import spending. The indirect impact of
this instrument affects all sectors of any economy in which it operates. The
implications of FEM in African countries are especially harsh. The effect of
mandatory foreign exchange markets has been to erode the value of the local
currency over time. Most countries undergoing adjustment have seen their
currency values fall in relation to international currencies.
Earnings from
primary commodities, the basis of African economies, have been decreasing for
over a decade. The United Nations publication "Africa Recovery,"
reported recently that the prices of most export commodities, already at record
low levels in the 1980s, have continued to fall every year in the 1990s.2
Recent efforts by SAPs to increasing primary exports have only led to reduced
earnings from commodities.
1.2
STATEMENT OF RESEARCH PROBLEM.
Existing
literature on volatility of exchange rate and its effect on agriculture trade
flow remain inconclusive. While a large number of these studies have shown
negative impact of exchange rate volatility on trade, export and imports, some
have also reported positive and insignificant consequences. Illan (2005).
In Nigeria,
Ajayi (1988) and Osagie (1985) while taking the structuralist approach in the
study of external trade flows opposed the adoption of a more flexible exchange
rate policy in Nigeria, there argument were based on the structural thesis that
exchange rate devaluation would be stagflationary and have no significant
effect on external trade balance in less developed countries.
Changes in
income earnings of export crop products come as a result of either increase or
decrease in international world prices of export or devaluation of the currency
and subsequence increase in producer price. Such price/exchange rate changes
may result to a major decline in future output if they are unpredictable and
erratic fluctuations- whether positive or negative is not desirable as it
increases risk and uncertainty in international transactions and thus
discourages trade.
Despite this
assertion, and that of other studies, more recent research explains why a
positive effect can also be possible (De Grauwe 1985, Calbullero and Carbo
1989). That if a firm(s) hedge against exchange rate rise, one could not expect
to find a strong negative effect on trade. Hedging against risk can be done via
future or forward markets, where forward markets exist the nature of
uncertainty faced by traders is transformed. A forward market represents in
effect a guaranteed forecast of exchange rate that will prevail at the end of
the contract period which a trader can take advantage of by payment of small
margin ground in the forward market.
Unfortunately,
the future market is absent in Nigeria and the possibility of hedging via this
route is remote. In fact, most have not taken hedging possibilities into
account. It has been argued that hedging foreign exchange through forward
market is an imperfect and costly method of avoiding exchange rate risk.
Exchange rate risk (refers to the potentials to lose money because of change in
the exchange) measure the volatility and erratic pattern of exchange movements,
the more volatile the movement, the higher the risk. (Head 2007).
Producers
exports are not concern with the prices received, they bother about the
stability of such prices as it relates to earning a consistent income. In
developing countries like Nigeria for example where export price increases, as
a result of currency devaluation are expected to an incentive for export growth
, a primary concern is the nature and magnitude of risk introduced by the
price/exchange rate movement.
Many related
empirical studies have been conducted on the effect of price and exchange rate
on trade (Schuh 1974, Ihimodu 1993, Ogiogio 1993, Osuntogun et al 1993, Obandan
1994), the likely relationship between price and exchange rate volatility were
ignored in their estimations and a possible impact of price and exchange rate
risk on trade flow were neglected.
As such, the
research intends to provide an empirical basis for the analysis of the effect
of price and exchange rate volatility on the volume of agriculture exports. Due
to this varying opinion of researchers, some questions are raised,
§ Is there any relationship between exchange
rate volatility and agricultural trade flows in Nigeria?
§ Does exchange rate volatility have a
significant effect on agricultural trade flow in Nigeria?
§ Does the international price of agricultural
products significantly affect agricultural trade flows in Nigeria?
1.3
OBJECTIVES OF THE STUDY.
The major
objective of this research work is to determine whether exchange rate
volatility has been a significant factor affecting agricultural trade flows in
Nigeria. The other objectives are stated below;
§ To determine whether there is any
relationship between exchange rate volatility and agricultural trade flows in
Nigeria.
§ To determine if international prices of
agricultural products significantly affects agricultural trade flows in
Nigeria.
1.4
STATEMENT OF HYPOTHESES.
§ There is no significant relationship between
exchange rate volatility and agricultural trade flows in Nigeria.
§ Exchange rate volatility has no significant
effect on agricultural trade flows in Nigeria.
§ International prices of agriculture products
have no significant effect on agriculture trade flows in Nigeria.
1.5
SIGNIFICANTS OF STUDY.
It is
obvious that there has been a significant decline in the export of agricultural
products. Economists have attributed many factor s as the cause. In this research,
we want to find out whether exchange rate volatility is a contributing factor.
If at the
end of the research, exchange rate volatility is found to be statistically
significant and has a positive a piori expectation then it means that exchange
rate volatility has an effect on agriculture exports and also volatility
increases agriculture exports. Policy measures would then have to be geared
towards the adoption of a more flexible exchange rate system in order to boost
agriculture exports.
If on the
other hand, exchange rate volatility is significant and negatively related o
the export of agricultural products, policy measures would be directed towards
adopting a less flexible and stable rate system. This research would also
enhance policy formulation for countries that depend primarily on agricultural
produces for revenue.
1.6 SCOPE
AND LIMITATION OF STUDY.
This
research work will cover a period of 34years that is from 1975-2009. The
researcher would have also loved to research in other sectors in Nigeria hat
have been affect by exchange rate volatility but unfortunately, data and
information concerning the research of other sectors are missing.
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