EFFECTS OF EXCHANGE RATE ON HOUSE HOLD PURCHASING POWER IN NIGERIAN ECONOMY

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

According to Oleka (2015) Over the past sixty years, there have been substantial changes made to how exchange rates fluctuate in Nigeria. Nigeria had a fixed exchange rate system in place in the 1960s. Up until 1967, when the British pound underwent devaluation, the Nigerian currency was fixed at par with the pound. As a result of the break out of the Nigerian civil war in 1967, the monetary authority in Nigeria did not consider it reasonable to devalue the Nigerian currency alongside the British pound when the great Britain authorities devalued the pound sterling (Oleka 2015).

Nigeria dropped the dollar peg and once again maintained trust with the British pound until 1973, when the Nigerian currency was once again pegged to the United States dollar, during the early 1970s global financial problems that resulted in the devaluation of the United States dollar. With this occurrence, the serious disadvantage of linking the naira to a single currency was made clear(Oleka , 2015).

The exchange rate measures the value of a currency in relation to another and is said to be in equilibrium when the demand for a currency equals its supply. Any deviation from this equilibrium rate is referred to as a misalignment, in which case the exchange rate could be either overvalued or undervalued. Exchange rate could impinge on an economy causing distortions in various sectors by influencing the capital accumulation process and affecting the competitiveness of the tradable sector in relation to other countries (Ali et al., 2015). Literature on exchange rates has showed that misalignment can be measured using either price-based criteria such as the purchasing power parity (PPP) (Qayyum, Khan, & Khair-u-Zaman 2014).

As a price-based theory of exchange rate determination, the purchasing power focuses on changes in price levels, as the overriding determinant of exchange rates. The World Bank (2013) expressed purchasing power as the number of currency units required to purchase several goods and services equivalent to what can be purchased with one unit of currency of the referenced country. The purchasing power is thus, simply a theory of exchange rate determination used for comparing standard of living, evaluating productivity levels, and determining relative values of currencies across countries (Lafrance & Schembri, 2018). For the basis of comparison, Lafrance & Schembri (2018) noted that purchasing power exchange rates computed by comparing the prices of national consumption baskets are used to translate per capita national incomes into a common currency. Exchange rates deviate from purchasing power due to distortions in domestic and foreign prices as a result of some factors (Qayyum, Khan, & Khair-u-Zaman 2014). The factors include: (i) restrictions on trade and capital movements; (ii) speculative activities and official intervention; (iii) productivity bias between tradable and non-tradable goods which could result in systematic divergence of internal prices; (iv) sticky prices which do not move fast enough to offset changes in the nominal exchange rates and real shocks to the economy such as large commodity price changes, financial sector innovation, productivity growth differentials among countries and budget imbalances,

Exchange rate changes and fluctuations has been a major concern to policy makers in Nigeria due to its adverse effects on household purchasing power and the Nigerian economy. The foreign exchange market has come under intense pressure leading to the depreciation of the Naira and the widening of the premium between the inter-bank exchange rate and the Bureau de Change (BDC) rate. In a bid to realign the exchange rate, the Central Bank of Nigeria (CBN) embarked on several policy measures which included moving to a more flexible exchange rate regime in June 2016. Furthermore, to deepen the foreign exchange market and narrow the premium, the CBN introduced the Investors and Exporters (I&E) window, primarily to boost liquidity in the market and ensure timely execution and settlement of eligible transactions. Also, other specialized Secondary Market Intervention Sales (SMIS) were introduced to reduce demand pressure and moderate the price of the Naira. Given the developments in the foreign exchange market and the need to realign the exchange rate, this study seeks to determine effects of exchange rate on house hold purchasing power

1.2 Statement Of The Problem

Nigerian Government protects her local industries by making new monetary policies, but the introduction of these economic policies has made the Nigeria economy to suffer unstable and fluctuating exchange rate and thus a high degree of uncertainty in the Nigerian business environment which tends to scare away foreign investors.  Local investors face high risk as a result of fluctuation in exchange rate and as such local investors do not know when to import relevant machineries, equipment’s and raw materials for industrial use.

 Nigeria is a country that is highly dependent on imports for consumption because Almost the major industrial materials and intermediate factory goods are purchased from abroad. High degree of importation to meet domestic needs puts severe pressure on the foreign exchange market and may result in the reduction of external reserve in the country which negatively influence the economy of the country.

The fluctuation of exchange rate is one that cannot be avoided because it devalues the Naira which increases prices of imports and causes inflation which leads to balance of payment crises. This led to the extent the researcher to venture to this research, to investigate the exchange rate fluctuation rate has affected household purchasing power.

1.3 Research Questions

1) What is the relationship between exchange rate and house hold consumption?

2) what is the relationship between exchange rate and Economic growth?

3) what are the determinants of exchange rate in the Nigerian economy?

4) what are the factors that influence purchasing power of households in Nigeria?

1.4 objectives of the study

1 To examine the relationship between exchange rate and house hold consumption per capita

2 To examine the relationship between exchange rate and Economic growth

3 To asses the determinants of exchange rate in the Nigerian economy

4. To examine factors that influence purchasing power of households in Nigeria

1.5 Hypotheses

Hypothesis1

HO: There is no significant relationship between exchange rate and consumption per capita

HYPOTHESIS 2

HO: There is no relationship between exchange rate and Economic growth

1.6 Significance of the study

Government: This study is relevant to government (CBN) given the recent efforts by monetary authorities in Nigeria to revive the economy through the financial sector reform which among other things sought to maintain stability in exchange rate. Consequently, this study will assist the Government economic planners in their economic development planning

Students: This will serve as a medium for further research for students who want to research further on the topic

1.7 scope and limitation of the study

The study is delimited to the effects of exchange rate on house hold purchasing power . The researcher was faced with the following constraints in carrying out this study:

Resources: Another constraint of the researcher is financial resources to carry on the detail study of this topic.

Data: Another limitation to this study will be lack of data to make valid study on the research problem.

1.8 plan of the study

The present study will be divided into five chapters. First chapter gives the background to the study, statement of the problem, research questions, objectives of the study, hypotheses of the study, scope of the study and plan of the study  Second chapter deals with relevant studies found in the literature and that are related to the  i.e. review of literature. Third chapter deals with the methodology and procedure used in this study Fourth chapter deals with the analysis of data and presentation of the study which evaluates the data collected keeping in mind the set objectives. Fifth chapter deals with conclusions and suggestions which are derived from this study.