NAIRA EXCHANGE RATE DEPRECIATION AND DOMESTIC INFLATION IN NIGERIA
The position of a country’s currency in the international market relies on a number of factors including the quality of goods and services produced internally, the state of economy, the competitiveness and volume of export. In free market economy exchange rate of a currency is determined by the forces of demand and supply. It is also partially determined by foreign reserves.
This chapter intends to review the literature as related to this research work.
2.1 THE CONCEPT OF EXCHANGE RATE
The price at which one country exchange its currency for other currencies is referred to as exchange rate i.e. the rate at which the domestic currency is exchanged in terms of foreign currencies. This established exchange rate is mostly important in international transaction, where goods are traded to make direct comparison of prices of the goods.
Exchange rate state the price in terms of one currency, at which another currency can be bought (Baumol and Blinder, 1971).
According to Lipsey (1993), exchange rate is the rate at which two currencies are traded. It is the amount of foreign currency that exchange for one unit of domestic currency or the amount of domestic currency that exchanges for one foreign currency. It is the quantity or amount of foreign currency that must be given up in order to purchase a unit of another currency.
(Oyejide and Ogun 1995) saw exchange rate to a representation of the fulcrum of a liberalization process, hence the introduction of an auction market for the determination of the exchange value of the naira in 1986 which marked the beginning of the comprehensive adjustment process in the country. The currency of a country is said to depreciate when exchange rate changes so that a unit of its currency can buy fewer units of foreign currency. Lipsey, (1993) observed that when exchange in the exchange rate lowers the value of one currency, the currency is said to have depreciated. Depreciation therefore, implies a fall in the price of export and hence increase in the volume of export and also a rise in effect of currency depreciation and is similar to devaluation in practice. Devaluation is an intentional act put forward by the government of a country with the aim of sustaining equilibrium. An economy under recession can devalue its currency to attain a sustaining equilibrium. The disequilibrium may be that more get are imported than exported. Such situation will affect the balance of payment of the importing country negatively.
Devaluation of the currency therefore, means that the price of import will be very high. This is to discourage imports and encourage export in order to arrive at equilibrium i.e. a nation in the pursuit of macroeconomic goal of a healthy external balance as indicated in the balance of payment (BOP) position control measures.
Also Read: Budgeting In All Inflationary Environment
Henderson and Poole, (1991) simply defined exchange rate as the price of one currency terms to another currency, it depends to a large extent on the level of a country’s external reserves. The level of a country’s external reserves depends on the quantum of inflow of foreign exchange to the country and the rate of deployment of such receipts for financing of imports and external debt service payment (CBN 2001).
After the Second World War, major trading nation as of the world met under the United Nations auspices at Bretton Woods, New Hamphsire, to forge a new world monetary system.
That system administered by the newly created international Monetary Fund (IMF) was based on fixed exchange rates by which each member country establish a par value for its currency based on gold and US dollar. This par value became the benchmark by which the country related it’s currently to the currencies of the rest of the world. This system was based on a set of country’s fixed exchange rates; e.g. four West Germany Marks to a dollar, five French France to the dollar and so on.
The fixed exchange led to the over-valuation of naira by about 45 percent in the 1970’s. The story, thirteen countries had fixed exchange rates for long periods, going back usually to the 1950’s. The exceptions were the relatively high inflation countries of South America – Argentina, Brazil, Chile and Colombia and surprisingly, the public of Korea (Little et al 1993). The 13 countries are from developing nations. Case and Fair (1992) noted that exchange rate were not really fixed under the Bretton Woods system; they were someone remarked, only fixed until further notice. Therefore, within the Bretton system, the adjustable peg or dollar standard, exchange rates are fixed by countries allowed occasionally to alter their exchange rates. This regime was operating for a quarter of a century after the world word II. Under this system, other countries agreed to fix their exchange rate against the dollar and by implication against each other; hence the system also became known as the dollar standard. This system came in as a result of crime that developed within the world exchange rate management undergold and dollar standard. It became more and more evident that, as world’s reserve currency, the dollar was in a difficult position. As other countries economies began to strengthen, it appears that gold and internationally acceptably currencies (initially known as official resources) could not handle the reserve requirements of the country. The free flow goods and capital put increasing pressure on a country’s reserve assets. Also, the growth in accumulation of dollars outside of the United State during the 1960’s threaten to wreck the stability of fixed exchange rate.
To help increase international reserves during this period when US was expected to be able to reduce its balance of payment deficit, the IMF created the Special Drawing Right (SDR). The SDR is a unit of account that was created by IMF and distributed to nations to expand their official reserve base.
Brazil for instance, could trade some of its SDR’s to the United States for dollars.
On August 15, 1971, President Nixon announced a new economic policy that included suspension of exchange gold for dollars. Following the weakness of this exchange rate gold standard, the managed floating system was introduced in 1971 under the Smithsonian Agreement of December 18, 1971. This resulted in 8 percent devaluation of dollars, a revaluation of some other currencies, a widening of exchange rate flexibility from (1 to 25% on either side of par value) and a commitment on the part of all countries to reduce trade restrictions, thus allowing goods and services to flow according to demand and supply. The (Group of ten) including the United States, Japan, Switzerland, also, Korea, Jamaica and other under the Agreement introduced new stable exchange rate system wider bands.
With the break down of Smithsonian Agreement in 1973 following the US dollar devaluation and most of the countries went back to floating exchange rate. Individual countries in this system therefore, can float their currencies against US dollar and other currencies. In this regime, the exchange rate is allowed to attain it free market equilibrium level without government intervention.
Ogo (1998), advised that adopting it, it is necessary for to determine the equilibrium exchange rate of the currency, often done using the Purchasing Power Party (PPP) approach, in its simplest interpretation, the PPP states that identical goods should cost same in all countries or in general, that the price of a basket of goods produced in two countries should then be same when expressed in a common currency.
Before now, the EEC had signed an agreement allowing their currencies to be tied together and they called the system (the snake in the tunnel). Under the system, the currencies of Belgium, Denmark, German France, Norway and Sweden were floating jointly, such that these counties maintain fixed rates between their currencies with a maximum mark of 2.25 percent on either side of the parity in the official market, while floating as a group against non-member currencies. The tunnel represented a band of 4.5 percent within which this currencies could float collectively against the dollar. As observed by (Anyanwu, 1990) the system really represented an attempts to exploit the merits of fixed exchange rate stability within a wider framework of floating exchange rate flexibility. This system did not succeed in providing a measure of European exchange rate stability while maintain the flexibility of an European joint float against the dollar.
However, following the collapse of the Bretton Woods system and the floating of the dollar in March 1973, the snake in the tunnel became redundant and hence abandoned. The snake was retained as the European joint float, and was called (snake in the lake). In 1979, the European Monetary System (EMS) was formed which created the European Currency Unit (Thina, 1999).
Exchange rate management policies from the foregoing discussion; has to do with different exchange rate regimes carried out by different countries.
The numerous conditions under which depreciation policy may or may not function has taken us to a wider view on how various foreign exchange rate managed. What most counties do even the underdeveloped ones is to have an indirect or covert or defector depreciation rather than a direct one leaving the formal official rate of exchange and then impose high import duties, established by a regime of direct foreign exchange countries and giant various incentives and subsidence to exports.
Some countries like Britain even go further to set up an exchange rate management addressed to particular products or sectors to encourage those sectors or products for example tourism. In designing a feasible foreign exchange management programmes, it is well always to remember that payments flow are only on financial view, underneath which are the real flows of production and trade. It is also true that a member of underdeveloped countries like Ghana have little room for foreign exchange measurement techniques sanctioned by economic theory and controlled by the IMF.
The Srilanke devaluation of 1977 was associated with trade liberation and not a balance of payment crises; similarly, the 1978 Indonesia devaluation was designed to offset the real appreciation of 1970 – 1978 and was provoked by a balance of payment problem.
It should be noted that in the period between 1980 – 83 none developing countries depreciated their currencies as an obvious response by that time to a combination of external and domestically generated (public spending) shocks. Also, Turkey‘s devaluation was combined with large scale trade liberation.
Sierra Leone had an economy that was open and strongly exposed and was extremely dependent on depreciation process based on international trade. The country has a high import propensity and a low export growth, which combines to pay the country in constant crises of BOP. Most of the exchange rate, the rate management would in context of its supply and demand of trade elasticity only succeed in restraining developmental process.
The exchange control to which most underdeveloped countries resort to the way of correcting the overvaluation resort to the way of correcting the overvaluation of their national currencies on the world financial markets do not themselves work effectively. The administration bottleneck and consequent corruption also tends to aggravate some structural distortions embedded in the underdeveloped countries.
In Zaire there are establishment of questionnaires import substitutes industries, smuggling of luxury import etc. All these affected the effective management of the exchange rate in the country. Exchange rate management can be effective in contest of overall depreciation planning strategy that is directed to the mobilization and allocation of total national resources (Aboyade 1985).
Exchange rate may be flexibly of floating or fluctuating in which the interplay of demand and supply determines the exchange rate. The interference of government is absent here. United State between the civil war and 1879, Canada from 1850 to 1967 used this exchange rate system.
At the beginning of 1973, Canada, India, Italy, Japan, Switzerland, UK as well as several other smaller countries and flexible exchange rates, (Heller, 1974).
At different tines the countries of the world equally used administratively fixed or pegged exchange rates. This type of exchange rate is determined by the monetary authorities. Nigeria from 1960 – 1972 adopted this system (Onimode, 1995).
2.2 EXCHANGE RATE MANAGEMENT IN NIGERIA
The requirement of a good external reserve management strategy usually compels a country to maintain realistic exchange rate. The use of exchange rate policy has been a significant instrument for macro-economic management in Nigeria, as it has been frequently applied in the past to preserve the value of naira, maintain a comfortable external reserve position and ensure price stability (Ojo, 1998). In the past, different exchange rate policies have been used depending on the condition of the economy at any given period and sometimes in response to the exchanging exchange rate policies in the rest of the world. In the case of Nigeria such policies include inter-bank foreign exchange rate market (IFEM), import duty procedure; export trade and promotion and invisible trade transaction among others (CBN 2001). The different policy stances of the country’s exchange rate regime and management data back to 1959 and have undergone various changes to date. During the past period of exchange control (1962 – 1986), following the exchange control act of 1962, ad-hoc administrative measure were applied. For instance, between a parity with pounds sterling until the devaluation of the naira by 10 percent in 1967 (CBN bullion, 1998). Thereafter, the currency was allowed to move independently of the pound sterling to include the US dollar in the basket of currencies for determining the value of naira. Following the change of the Nigerian pound to naira in 1973, fixed exchange rates were established for both pounds and US dollar of ₤0.5833 and US $1.5200 to N1.00 respectively. Furthermore, the naira was deliberately appreciated progressively to source imputes cheaply to implement developmental projects. The encouraged reliance on imports and capital flight, which eventually led to the depletion of external reserves.
After December, 1971 when the US abandoned her obligation to convert the US dollar into gold as the currencies of the world were realigned the value of the naira was then adjusted in relation to the pounds sterling or the US dollars performance against a basket of currencies. The basket of the currencies included the Deutsch mark, Swiss Franc, French Franc, Dutch guilder, Japanese yen and Canadian dollar.
By 1978, a basket method of calculating the exchange rate was introduced. The seven currencies mentioned above were designated with different trade weights based on the relative shares the countries whose currencies were included in Nigeria’s imports. However, the weights of the pounds sterling and US dollar where alternatively higher than others, reflecting the importance of the two currencies in Nigeria’s external payments. Foreign exchange crises in 1982, led to the application of comprehensive exchange control and the enactment of the economic stabilization act, that year 30 percent of foreign exchange receipt went into debts servicing.
To minimize the perennial problem of high incidence of arbitrage in naira exchange rate quotation, it was agreed in 1985 that a one currency intervention system be adopted. In this system the naira exchange was quote helped to wipe out incidence or arbitrage that prevailed during this period before its adaptation, it has the disadvantage of making the naira to be tied to the fortune of the dollar (Ojo, 1998) i.e. naira is to float or sink with dollar in international exchange market. The system used the determine the value of other currencies in terms of the naria was to maintain the US dollar / N rate at a point and driving the cross rates of other currencies against the naira through such quotation i.e. the other currency rate taking a cue from which quoted US / N rates.
As a result of the trade practices in vogue before 1986, which also informed the fixed regime adopted in the determination of the exchange rate of the naira, the currency was perceived to have been over value. This was the main contributory factor to the problems of Nigeria’s external sector in those years, a fact which has also made the country to be more import dependent and less non-oil export driven in the past quarter of the century. The country was therefore unable to achieve the main objectives of the policy during the period. In order to find a realistic value of naira, the approach of the second – tier foreign exchange market was tried under the Structural Adjustment Programme adopted at time to reverse the structural distortions in the economy. In September 1986, the second-tier Foreign Exchange Market (SFEM) Decree was promulgated, introducing a flexible or floating rate regime. The main objectives of the exchange policy contained in the decree was to have a realistic exchange rate, which would remove the existing distortions and disequilibria in the external sector of the economy as well as ease the country’s persistent balance of payments problems.
Oyejide et al (1995) also saw that the main importance of the exchange rate under Structural Adjustment Programme (SAP) is perhaps more aptly underscored by the programme details for Nigerian’s which assert inter-alia, that such a realistic exchange rate is expected to eliminate the distortions in all major sectors of the economy, reduce imports, stimulate exports and pave way to a more self-reliant and sustainable growth” the subsequent drive towards achieving these ideals, saw the nominal exchange rate (NER) an exchange rate defined as the number of currency (hone currency) per dollar foreign currency, i.e. the number of naira per dollar which tumbled by over 30 percent by the end of the first quarter of the introduction of SAP, and generally experiencing an average depreciation rate of about 83 percent in the first four full years of SAP.
By going contrary to its objective (Essien, 1990), argued that SFEM was not the (deal) foreign exchange market but rather a method of circumventing the human element in the issue of import licenses and exchange rate determination and more importantly a method of ensuring that export an foreign goods and services matched the country foreign income.
This policy did not achieve its objectives in as such as exchange inflow continue to decline following over dependence of the economy on oil export, low level of foreign exchange receipts constituted serious constraint to the country’s capacity to import essential raw materials and machinery to sustain capacity utilization rate of existing industries.
From 1986 to date, the flexible exchange rate mechanism, which started with dual exchange rate system, has undergone several modifications, which includes the unified exchange rate system and back again to the current dual exchange rate system.
The dual exchange rate system was introduced at the inception of the SFEM. Two different rates operates side by side in the market and these were first and second – tier exchange rate.
While pre-SFEM transaction, debt service payments expenses of Nigerian embassies abroad and contributions to international organization were settled at the first tier or official rate, the second – tier rate was determined by action at the SFEM which was operated by the Central Bank various method were applied to fine-tune the system while the regime lasted. These included the average pricing method, margin rate and the Dutch action system. The system, however, created the problem of multiplicity of rates, which resulted in further depreciation of the naira.
By July 1987, the two rates, the first and second – tier were merged due to abuses associated with the system and called foreign exchange market (FEM) thereby subjecting all transaction to market prices. But the persistent depreciation of naira exchange rate led to the separation of the inter bank market for banks from the official market resulting in the emergence of an autonomous market with its independent rate for privately source foreign exchange. This autonomous rate was subsequently merged with FEM rate in January 1988 to form the Interbank Foreign Exchange Market (IFEM) because, the autonomous rate had depreciated continually. To further eliminate the abuses inherent in the system and reduce exchange rate instability, the naira exchange under this regime was determined using several methods, namely marginal and average rate pricing, highest and lowest bids, weighted average, average of successful bids. Again the Dutch Action System (DAS) was re-introduced in December 1990 while weighted average method was adopted in 1991, in order to reduce wide.
Even under the method in the Unifier Exchange Rate System, there was persistent instability in the exchange rate and this led the Central Bank to deregulate the exchange rate system further on 5 March, 1992 by depreciation the naira exchange rate at the IFEM again in order to equate it with the parallel rate which was considered the more appropriate indicator of the market perception of the value of naira vis-à-vis other currencies. This is called full deregulation.
The Fixed Exchange Rate System was re-introduced in 1994 to stabilize and shore up the value of naira by pegging the naira exchange rate at N22.00 to $1.00 and by centralizing all foreign exchange receipts in the Central Bank.
Following the failure of these systems therefore, in 1995 the Autonomous Foreign Exchange Market (AFEM) was established and was expected to stabilize the country’s BOP position (CBN 2001). In order to strengthen the market, the CBN moved from monthly to weekly interventions in May 1996 during the review period CBN intervened in the market ten times as against three sessions in the same period of 1995.
According to Okonfuwa (1997), the advent of the SAP, the energy of all exchange rate policies were directed toward finding a realistic exchange for the naira. It was hoped that this would occur via the depreciation of the naira since the value of naira was to be grossly over-valued.
As a sort of comparison (Obadan, 1997) noted, the retention of dual exchange rate system in Nigeria is a sort of disappointment. He further argued that unified exchange will only avoid distortion from the differential between the autonomous and official exchange rate but will also diminish the activities of rent seekers and arbitrageurs. It will equally provide opportunities for the naira to be strengthen in the foreign exchange market as the government surrounds a significant proportion of its foreign exchange earning for dealing in the AFEM.
Also Hutcheson in the structure of the Nigeria Economy by Anyanwu observed that uniform rate will add transparency to the budget and will reduce the temptation to abuse it.
The policy package of Sap had its weakness, as there was inadequate supply of foreign exchange to fund the market.
In order to close the supply gap between the office rate parallel rate, the naira was depreciated by almost 80%.
Due to persistent supply widening foreign exchange measures introduced in 1994, aimed at centralization of foreign earnings must be through the Central Bank of Nigeria or designated banks an the parallel market was outlawed and operators in the market if caught would be severely penalized.
All these measures were aimed at securing the value of the currency and consequently the lever of the nations reserve.
2.3 INFLATION – A CONCEPT
Griffith, (1976) defined inflation as a sustainable rise in the general price level,
Similarly Viset, (1981) saw inflation as a substantial, sustained increased in the general level prices. This definitions are important because all pricing increase is the not inflation. Changes in individual prices resulting from individual market conditions does not constitute inflation. Inflation is said to occur when a large number of prices around the economy are rising together creating an increase in the average price (however calculated) of things that we buy inflation tells us how fast the average price is rising.
Pure inflation therefore is a special case where all prices of gods and factors of production are raising at a rate of percentage (Begg, 1978).
Dow et al (1988) opined that the paced of inflation is determine mainly but factors such as the pressure from wage or import prices. Although they recognize the impact of growth in monetary aggregate in causing fast expansion of demand, they observed that the relationship is not strong or systematic.
Solow (1979), as sited by Anyawu in monetary economics, sees inflation as going on when one needs are more and more money to buy some representatives bundle of goods and services, or a sustained fall in the purchasing power of money.
CBN (1998) referred to inflation as a social malady as well as pervasive economic phenomenon whose effects are felt in varying degree by every citizen of the country or the economy.
Shonekan (1992) referred to inflation as constituting the most deadly threat to domestic stability and social harmony turning to a monster without cage.
The problem of inflation has often provided difficult to tackle largely because any meaningful attempt at curbing it would entail a trade off among other important macro-economic and social objectives such as increased employment, economy growth and social safety nets (CBN, 1998).
To Mc Loed (1997) inflation as usually thought of as a steady increase in the average level prices, it is sometimes more apt to defined it as a steady decline in the value of money.
Lipsey (1993) noted that inflation as an increase in the price level and it is as a result of debasement of coin.
Inflation occurs when the volume of the ahead of output of goods and services, so that there is a continuous tendency for prices of both commodities and factors of production to rise because they fail to keep pace with demand for them (Hanson 1997).
The wide inflation historically came in the period of war. Limitation in the supply money is the essential conditions of money have value. Excess supply of it makes people spend much of it and this bid up prices (Samuelson, 1980).
Vesset (1982) sees inflation to be self-perpetuating. It can be self-fulling prophecy. Once people have experienced inflation for a white, it becomes a part of their expectations. If it is expected next year, worker will seek higher wages increase to protect themselves from the higher prices. Now, because of the high wages, it cost more to produce things, so business pass the higher prices and hence inflation.
Generally, some increase in prices level may be acceptable as those whose income are derived from profits may gain from inflation because the prices at which goods are sold may rise more rapidly then their cost of production.
Inflation can be caused by excess money supply fall in supply of goods and services especially agricultural products, budget deficits through importation, population explosion or increase activities of middlemen and monopolistic tendencies, excess demand high production cost, war etc.
Inflation has various economic effects, which according to Vesset (1981) include:
- Hurts people on fixed income e.g. retired people non-fixed person.
- It affects borrowers and lenders
- It discourages savings
- It disrupts the balance between the private and public sectors and
- Inflation dead weight loss-loss-due to wasted resources
One of the major objectives of macro-economic policies is price stability, which its target is to have an inflation rate of not greater than 5 percent per annum. Annual increase in price above 5 percent is an indication of inflation, which require policy response. General level of prices can therefore be prevented from rising because of imposition of price controls a situation usually referred to as “suppressed” or “represent” inflation.
Inflation can therefore be controlled using any of the following measure: price wage control and freeze, monetary, fiscal polices, total ban on the importation of certain goods, increase in the production on goods and services and overhauling of the entire network (Anyanwu 1993).
- THEORIES OF INFLATION
The literature identifies a number of theories of inflation. They include demand pull, cost-push, structural, monetary and imported inflation.
Felegan et al (1982) and Mundell (1986) grouped the various theories of inflation into two (schools; the monetarist school, which comprised the cost push and demand-pull theories and structuralist theory or school.
Mundell observed that the monetarist school believes inflation has a monetary cause, while the structuralist believe inflation has a “real” cause. Falegan et al however contented that while both “Schools” emphasis different factors as the contributing propagating factors, the two agreed that many factors, which may be similar in specification, must be brought into focus at one and at the same time.
Adekokun et al (1982), noted that demand pull inflation is caused by excess demand generated by an increase in money supply. The line of causation is that increase in money supply causes a decrease in the interest rate lending to increase investment in consumer and producers gods. This causes aggregate demand to increase leading to increase in output or prices or both, depending on whether there was previously full employment or not.
Lipsey (1963) and Odeh (1968) assert that demand pull theory of inflation link price level changes to inflationary for by changes in aggregate demand Lipsey’s argument is that a rise in aggregate demand in a situation of more or less employment will create excess demand in only individual market, price will bid upward.
Akinnifessi (1984) wrote on cost-push theory of inflation as a situation when price increases originate from supply side of the economy either through profit-push or a wage push resulting from trade unions.
Ajayi et al (1972) stated that cost push theory inflation. View inflationary framework with the study of institutional framework within which prices as well as wages are determined.
Brunner et al (1982) in support of the monetarist interpretation of inflation asset that inflation emerges and disappears, accelerates or decay according to the evolution of monetary growth. In more categorical sense, output price level is determined by behaviour of monetary aggregates, especially total bank credit which in turn is influenced by base money (Bruner 1976).
On the structuralist contention of the theory of inflation, Wachter (1976) and Means et al (1975) observed that the school found the roots of inflation in the weakness of the should leave agriculture, the international trade sector and or the income elasticity of the tax system. Structuralist theory then implies that any economic growth in the presence of the bottlenecks inevitably brings inflation.
Falegan et al (1982) and Onoh (1982) on strucuralist theory of inflation noted that what theory emphasized as the root cause of inflation are deficit government financing or government expenditure, export earning, variations in import price, demand shifts, agricultural bottlenecks and availability of foreign reserves. They however pointed that export earnings could be used as an explanatory of foreign reserves aviablity while deficit financing as an explanatory of the growth in money supply. Thus, Falegan et al conclude dthat the structuralist inadvertently emphasized money supply when they emphasized deficit financing. Thus Mundell (1976) Concluded” monetary causes have real consequences and causes have monetary implication. After all, the structuralist school believes inflation has a real causes.
Imported inflation arises from international trade whereby inflation is transmitted from one country and this is more so furring a period of rising prices all other the world (Harberger 1978).
Two competing theories of inflation however, are the Keynesian and the classical or monetarist theories.
The Keynesian theory of inflation has two separate theories, which are the quasi-competitive Keynesian theory of inflation and non-competitive Keynesian theory of inflation.
The quasi-competitive Keynesian theory of inflation was advanced by James Tobin et al, and it states that at-competitive equilibrium structural inspection inherent in a monetary economy generate upward pressure on price level. The non-competitive Keynesian theory of inflation generally assumes the forces of competition be so weak that a useful model of inflation should increase focus on real world institutions or on specific institutional arrangement in markets. The monetarist theory is a competitive model that relates inflation to the money supply growth (Anyanwu 1995).
- INFLATION IN NIGERIA
The rate of inflation in Nigeria has increased steadily and markedly since independence in 1960. During the period following independence (1965 – 1975). Nigeria’s rate of inflation was about equal to that if its trading partners, average of 10 percent annually, (Moser 1995). The inflationary rate can be said to be a direct result of the policies of the country’s governments to stimulate a fast rate of economic growth and development since 1951 when ministerial government was introduced. (Anyawu, 1993).
In Fisher’s view of money supply, he concluded that an increase in money supply would in general lead to a direct and appropriate increase in the price level. He sees growth in the money supply as an important causal factor for inflation (Essien 1996). This was the case of Nigeria after the Udoji Wage Award of 1974. workers in Nigeria demanded for higher wages and this was fulfilled by bringing more into circulation hence, the light rate of inflation especially in 1975.
External factors also contributes to Nigeria’ domestic inflation (Anyanwu 1993). And it includes rising world export prices, falling world output. While internal factors include increasing government expenditures, rising domestic credit creation and supply bottlenecks such as shortage of raw materials and span parts.
By 1966, the growth rate of inflation in Nigeria was a single digit number with the highest rate of 9%. In 1963, 1967, 1968 negative growth was recorded. By 1971 it was 16%, 1972 35% 1973 5.4%, 1974 12.7% by 1975 it was 33.9% (CBN 1980). The 1975 increase was indication of elect of the 1974 increase in money supply via Udoji Wage Award in the face of inadequate supply of commodities by 1976, it was 24.3% 1979 11.7%.
From 1980, the Nigeria economy has been characterized, in general by increase in prices; the trend in this variable has been moving except in 1976.
The inflationary rate in 1980 fluctuated, it fell from its 1979 11.8% to 9.9% in 1980. It is escalated against to 20.9% in 1981 only to drop sharply to 7.7% in 1982. The rise 1981 was as a result of increased aggregate demand and the slow growth in supply of money and basic consumer commodities especially for food items. Domestic output did not respond adequately to the escalating demand for food and government’s effort to supply with imports appeared to have been hampered by distribution other problems as most of the items reached consumers at high prices through third parties.
Following government anti-inflationary measures the introduction of the economic stabilization act resulted in fall in the inflationary rate to 7.7% in 1982 measure largely reflected the slow down in economic activity which considerably dampened the demand pressure in the economy. By 1983 and 1984, the inflation increased to 23.2% and 39.5%, respectively. The rate inflation dropped sharply 1985 and 1986 as favourable weather conditions led to abundant crop production and tight fiscal and monetary policies substantially reduced excess liquidity in the economy. Anchored by the tight fiscal and monetary policy and aided by favourable weather, the devaluation of the naira in 1986 (96 percent in domestic currency terms) had virtually no impact on that year’s rate of inflation (Moser 1995). Inflation increased moderately in 1987, averaging 10% with the onset of the 1987 – 1988 drought and the lagges impact of the substantial devaluation in1986.
A severe drought in key growing regions of the country in 1987 and 1988, combined with fiscal and monetary expansion led to a virtual doubling of the food prices in 1988. Consequently the rate of inflation jumped to 59% in 1988. While food prices actually fell in the second half 1989 as rain and production improved, the average rte of inflation remained about 50%, primarily as a result of cumulative impact of broad money growth and sizeable devaluation of naira in 1989.
Inflation showed considerably in 1990, to an average annual rate of 7.4%, largely reflecting the concretionary fiscal and monetary policies implemented during late 1989 and early 1990, and the improved harvest in 1989 and 1990 resulting from excellent rains. As a result, the increase in food prices was held 3% in 1990. Toward the end of 1990, fiscal and monetary policies loosened considerably, which led to the upward movement in inflation in 1991 to 13%. The depreciation of naira is by 23% during 1991 also added to the upward on prices.
The rate of inflation increase markedly in 1992 to 46% on annual average basis, as a result of substantial excess liquidity in the economy brought about the continued monetization of the growing fiscal deficit, which increased to 18% of GDP in 1992. The Sharp devaluation of the naira (75 percent in local currency terms) during this expansionary period put further upward pressure on prices.
Inflation accelerated further in 1993 to an estimated 57% annually, reflecting the sharp increase in the fiscal deficit, to 18% percent of GDP. The devaluation of official exchange rate (28 percent in local currency terms) also added upward pressure on the rate of inflation, but this pressure was tempered somewhat by the estimated 4% of decline in the interest of foreign prices.
By 1994, inflation rate was 54.2% and a climax of 72.3% in 1995. Part of this increase may be due to external effects on the naira experienced on embracing depreciation. Other likely factors were the high interest rate, money supply increase and so on.
From the above the resulting causes of inflation are structural as well as monetary in nature. They seem from both demand as well as supply fueled factors. Thus, the determination of which variables influence it most is a matter of empirical evidence.
- EXCHANGE RATE DEPRECIATION AND INFLATION IN NIGERIA
In exchange rate management, two broad methods are usually adopted; name – fixed and flexible exchange rate system or regimes. The thrust of the argument for fixed exchange rate system is that it is a “vaccine against inflation” (Duesenberry et al 1994). It may also eliminate or reduce adjustment costs arising from temporal shifts in the fundamental determinants of supply and Demand for traded goods. It is also assumed to insulate an economy from severe capital movements generated by speculation about changes in exchange rate. However, Deusenberry et al argued that exchange rate can only act as insulation against inflation if and only if the rate is supported by a demonstrated commitment to use of monetary and fiscal policies as well as foreign reserve and lines of credit to defend it.
In a flexible exchange rate arrangement, market forces are allowed free hand to determine the rate with minimum intervention from the monetary authorities. Proponents of flexible arrangement argued that it permits a continuous response to change in the fundaments of the economy neutral with respect to inflation, causes higher growth and leads to BOP equilibrium without recourse to demand restraints and protection that may cause further distortion in resource allocation (Younger, 1993).
Nigeria has experimented with both regimes of exchange rate management. In 1986, Structural Adjustment Programme (SAP) followed by the second – tier foreign exchange market was introducer. Anifowose (1994) noted that introduction of the Second tier Foreign Exchange Market (SFEM) and the auction system introduce in Nigeria in the depreciation of the naira exchange rate with the attendant inflationary pressure in the economy worsen the situation.
Obasanjo (2001), equally observed that so long as Nigeria refused to abandon (our destructive habit of being a consumer rather than being a producer nation), inflation would continue to eat deep and the value of naira would continue to slide. He added that pure of the problems facing the naira was speculations from commercial and Merchant banks, which reaped benefits from a cow – valued currency.
Onanasanyo (1999) warned that anything could happen if the regulatory authorities did not take step to curb the situation.
- EMPIRICAL EVIDENCE
It has been shown that irrespective of all the strategies employed in Nigeria to reduce the level of inflation, its degree of severity has continued to aggravate in the economy.
The continued deterioration of the naira exchange rate has worsened all effort to reduce inflation.
As Anyanwu (1989) observed, the SFEM/FEM/IFEM is a disaster that is fast destroying the foundations of the Nigerian economy. The introduction of the above SAP were to achieve the following – depreciation of the real exchange rate to improve the balance of payments, restrictive fiscal and credit policies to reduce overall expenditure and curb inflationary pressures, among others (Okonkwo 1996).
(Anyanwu, 1987) observed that the continued naira depreciation at SFEM/FEM/IFEM has worsened and continued to aggravate the inflationary situation in Nigeria. This is so because, since domestic industries depend primarily on imported inputs whose cost have risen via the naira depreciation, cost of production rise hence, higher prices (Ojo, 1989).
He further observed that continued depreciation of the naira has continued to encourage smuggling out of goods leading to local scarcity and higher prices. Naira depreciation as he added, has encouraged brain drain, partly in an attempt to reap the benefit of naira depreciation, the remittance from which are mainly used for consumption activities thus aggravating local prices.
CBN (1999), observed that one of the factor that contribute to the sharp increase in the general price level in Nigeria up to 1995 was the substantial depreciation of the naira at the point of autonomous Foreign Exchange Market.
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