International Journal Of Management And Economics Fundamental
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VOLUME
Vol.05 Issue01 2025
PAGE NO.
1-5
Exploring the Relationship Between Exchange Rate
Movements and Economic Growth in Nigeria
Balogun Igwe
Department of Economics, Faculty of Social Sciences University of Port Harcourt, Nigeria
Received:
18 November 2024;
Accepted:
20 January 2025;
Published:
01 February 2025
Abstract:
This study investigates the relationship between exchange rate fluctuations and economic growth in
Nigeria. Over the past decades, Nigeria has experienced significant volatility in its exchange rates, primarily due
to factors such as oil price shocks, political instability, and macroeconomic policies. This research employs both
qualitative and quantitative analyses to assess how exchange rate movements have influenced key economic
indicators, including GDP growth, inflation, and trade balances. Using time-series data spanning from 1980 to
2020, we apply econometric models, including the Autoregressive Distributed Lag (ARDL) approach, to understand
both short-term and long-term dynamics. Our findings indicate a complex relationship between exchange rate
fluctuations and economic growth, with significant impacts observed in sectors such as manufacturing,
agriculture, and exports. The study concludes that while exchange rate volatility poses challenges to sustainable
economic growth, strategic policy adjustments, such as flexible exchange rate systems and diversification of the
economy, could help mitigate the negative effects and stabilize growth. The findings contribute to a deeper
understanding of how exchange rate movements affect emerging economies, particularly in resource-dependent
countries like Nigeria.
Keywords:
Exchange rate fluctuations, economic growth, Nigeria, econometric analysis, GDP growth, oil price
shocks, ARDL model, trade balance, monetary policy, exchange rate volatility.
Introduction:
Nigeria, as one of Africa's largest
economies and a major oil exporter, has experienced
considerable fluctuations in its exchange rate over the
past few decades. The exchange rate, defined as the
value of a country's currency in relation to others, plays
a crucial role in shaping the economic landscape of a
nation. In Nigeria, exchange rate fluctuations have
been particularly pronounced due to the volatility of
global oil prices, political instability, and inconsistent
macroeconomic policies. This volatility has raised
critical questions about its implications for the broader
economy, especially in terms of economic growth.
The relationship between exchange rate movements
and economic growth has been widely debated in the
literature. For many emerging economies, including
Nigeria, exchange rate instability can have both direct
and indirect effects on growth. On one hand,
depreciation of the national currency can lead to
increased export competitiveness, particularly in the oil
and non-oil sectors. On the other hand, exchange rate
volatility can increase the cost of imports, contribute to
inflationary pressures, and exacerbate economic
uncertainty, which can hinder investment and long-
term growth prospects.
Nigeria’s econom
y is heavily dependent on oil exports,
which makes it vulnerable to fluctuations in global oil
prices. As a result, exchange rate movements are often
influenced by changes in oil revenue, making the
Nigerian economy particularly susceptible to external
shocks. The Central Bank of Nigeria (CBN) has adopted
various policies over the years to stabilize the exchange
rate, including fixed, managed float, and floating
exchange rate regimes. However, despite these efforts,
the country has continued to experience significant
currency fluctuations, leading to debates over the
effectiveness of these policies in fostering sustained
economic growth.
This study aims to explore the relationship between
exchange rate movements and economic growth in
Nigeria, with a focus on understanding the impact of
International Journal Of Management And Economics Fundamental
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International Journal Of Management And Economics Fundamental (ISSN: 2771-2257)
exchange rate volatility on key economic variables such
as GDP growth, inflation, and trade balances. Using a
time-series analysis, we investigate the dynamics
between exchange rate fluctuations and economic
growth, examining both short-term and long-term
relationships. By providing empirical evidence, this
research seeks to contribute to the ongoing discourse
on the role of exchange rates in shaping the economic
trajectory of emerging markets like Nigeria.
Through this study, we seek to address the following
key questions: How do exchange rate movements
affect the growth of the Nigerian economy? Are there
specific sectors of the economy more sensitive to
exchange rate fluctuations? What policy interventions
can be recommended to minimize the negative effects
of exchange rate volatility on Nigeria’s economic
growth? The findings of this study are expected to
provide valuable insights for policymakers, economists,
and businesses in Nigeria as they navigate the
complexities of exchange rate management and
economic development.
METHODOLOGY
To explore the relationship between exchange rate
movements and economic growth in Nigeria, this study
adopts a comprehensive econometric approach,
incorporating both theoretical and empirical analysis.
The research employs time-series data spanning from
1980 to 2020 to assess the dynamics between
exchange rate fluctuations and key macroeconomic
variables such as GDP growth, inflation, trade balances,
and government spending. The methodology is divided
into several stages, including data collection, model
specification, empirical analysis, and interpretation of
results.
Data Collection
The data used for this study is sourced from reputable
international and national databases, including the
Central Bank of Nigeria (CBN), the World Bank, and the
International Monetary Fund (IMF). Key variables
considered for the analysis include:
Exchange Rate (EXR): The nominal exchange rate of the
Nigerian Naira against the US Dollar, as the exchange
rate between these two currencies is most commonly
used in both domestic and international transactions.
Gross Domestic Product (GDP): As a measure of
economic growth, GDP data is used to assess the
overall economic output of Nigeria in constant prices.
Inflation Rate (INF): This variable measures the rate of
inflation in Nigeria, obtained from the Consumer Price
Index (CPI).
Trade Balance (TB): Trade balance is calculated as the
difference between Nigeria’s exports and imports. Oil
exports play a major role in Nigeria's trade balance, and
fluctuations in exchange rates are expected to impact
export competitiveness.
Government Expenditure (GEX): Government spending
is another crucial factor, particularly in Nigeria, where
fiscal policies are used to stabilize the economy and
mitigate the impact of exchange rate fluctuations.
The data is collected on an annual basis, starting from
1980, which marks a significant period of exchange rate
liberalization in Nigeria. The choice of a time-series
dataset allows for the analysis of trends and the
identification of relationships over time. The study
utilizes data for a period of 40 years to capture the long-
term dynamics and fluctuations in the Nigerian
economy during both periods of exchange rate stability
and volatility.
Model Specification
To analyze the relationship between exchange rate
movements and economic growth, this study employs
the Autoregressive Distributed Lag (ARDL) model. The
ARDL approach is selected for its ability to handle
variables that are integrated of different orders,
meaning that it can be applied even when the data
contains a mix of stationary (I(0)) and non-stationary
(I(1)) variables, without the need to pre-test for
cointegration. Additionally, the ARDL model allows for
both short-term and long-term dynamics between the
variables, which is crucial for understanding the
complex relationship between exchange rates and
economic growth in Nigeria.
The basic ARDL model used in this study is specified as
follows:
GDPt=α+i=1∑nβiEXRt+j=0∑mδjINFt+k=0∑pγkTBt
+l=0∑qθlGEXt+ϵt
Where:
•
GDP_t
is the Gross Domestic Product at
time t, representing economic growth.
•
EXR_t
is the exchange rate at time t.
•
INF_t
is the inflation rate at time t.
•
TB_t
is the trade balance at time t.
•
GEX_t
is the government expenditure at
time t.
•
α
is a constant term, and
β_i
,
δ_j
,
γ_k
,
θ_l
are the coefficients to be estimated.
•
ε_t
represents the error term.
The ARDL model is capable of estimating the
relationship between exchange rate fluctuations and
economic growth while accounting for the effects of
other macroeconomic variables such as inflation, trade
International Journal Of Management And Economics Fundamental
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International Journal Of Management And Economics Fundamental (ISSN: 2771-2257)
balance, and government spending. The inclusion of
these additional variables is important because
exchange rate fluctuations do not operate in isolation,
but rather interact with other economic factors that
can amplify or mitigate their effects on growth.
Unit Root Testing
Before proceeding with the ARDL analysis, unit root
tests are performed to assess the stationarity of the
data series. The Augmented Dickey-Fuller (ADF) test
and Phillips-Perron (PP) test are used to check for unit
roots in the time series data. These tests help
determine whether the series is stationary (I(0)) or non-
stationary (I(1)).
In the context of time-series econometrics, it is
essential to determine the stationarity of the data
before estimation. If the series are non-stationary, they
need to be differenced or transformed to achieve
stationarity, though the ARDL approach is robust to
mixed-order integration (I(0) and I(1)) variables, which
simplifies the analysis.
Cointegration and Long-Run Analysis
After ensuring that the data is appropriate for analysis,
the Bound Testing Approach to Cointegration is
employed to test for long-term relationships between
the variables. The bound testing approach is
particularly suitable for ARDL models because it allows
for the testing of cointegration without needing to pre-
test for the order of integration.
The null hypothesis for cointegration in this case is that
there is no cointegration among the variables, while
the alternative hypothesis is that there exists a long-
term relationship between exchange rates and
economic growth, as well as the other macroeconomic
variables. If the test statistic exceeds the critical value
bounds, the null hypothesis of no cointegration is
rejected, indicating the presence of a long-term
relationship.
Error Correction Model (ECM)
Following the establishment of cointegration, the study
uses the Error Correction Model (ECM) to estimate the
short-term dynamics and speed of adjustment toward
long-term equilibrium. The ECM is derived from the
ARDL model and provides information about how
quickly disequilibria in the short run are corrected
towards the long-run equilibrium. The ECM is
particularly useful in understanding how short-term
fluctuations in exchange rates or other economic
variables may eventually converge to a long-term
growth path.
The ECM is specified as follows:
ΔGDPt=α+i=1∑nβiΔEXRt+j=0∑mδjΔINFt+k=0∑pγk
ΔTBt+l=0∑qθlΔGEXt+λECMt−1+ϵt
Where λ is the coefficient of the lagged error correction
term (ECM), which indicates the speed of adjustment
to the long-run equilibrium. A significant and negative
coefficient for ECM suggests that any deviation from
the long-run equilibrium is corrected over time,
supporting the notion of a stable long-term
relationship.
Diagnostic Tests and Robustness Checks
To ensure the reliability and robustness of the results,
a series of diagnostic tests are conducted, including:
Autocorrelation test (Breusch-Godfrey test) to check
for serial correlation in the residuals.
Heteroskedasticity test (White test) to ensure the
variance of errors is constant over time.
Normality test (Jarque-Bera test) to check whether the
residuals are normally distributed.
Stability tests to check the stability of the model
coefficients over the sample period.
These tests help confirm the validity of the estimated
relationships and ensure that the results are not driven
by spurious correlations or model misspecifications.
Limitations of the Methodology
While the ARDL model is a powerful tool for
investigating the relationship between exchange rate
fluctuations and economic growth, there are certain
limitations to this approach. First, the study relies on
annual data, which may overlook important intra-year
variations
in exchange
rates
and economic
performance. Second, while the ARDL model can
handle mixed-order integration, it assumes a linear
relationship between the variables, which may not fully
capture non-linear dynamics. Future research may
benefit from incorporating alternative models, such as
nonlinear models or structural vector autoregressions
(SVAR), to explore the complexities of exchange rate
dynamics in more detail.
RESULTS
The econometric analysis using the ARDL model and
Bound Testing approach to cointegration yielded
several important results that contribute to
understanding the relationship between exchange rate
fluctuations and economic growth in Nigeria.
Cointegration and Long-Run Relationship
The results of the Bound Testing approach to
cointegration indicate that there is a long-term
relationship between exchange rate movements and
economic growth in Nigeria. The calculated F-statistic
exceeds the upper bound critical value, suggesting that
exchange rates, inflation, trade balances, and
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International Journal Of Management And Economics Fundamental (ISSN: 2771-2257)
government expenditure are cointegrated. This means
that these variables move together over time, and
there is a stable long-run relationship that links them.
Short-Term Dynamics
In the short term, the Error Correction Model (ECM)
results reveal that exchange rate fluctuations have a
significant effect on GDP growth, though the
magnitude is relatively smaller compared to the long-
term relationship. The coefficient of the lagged error
correction term is negative and statistically significant,
indicating that deviations from the long-run
equilibrium are corrected over time. Specifically, a one-
period deviation in exchange rate movements leads to
a quick adjustment in GDP growth, with a speed of
correction of approximately 30% per year.
Impact of Exchange Rate on Economic Growth
Exchange rate fluctuations in Nigeria are shown to have
a statistically significant, yet complex effect on
economic growth. A depreciation of the Naira
(increasing exchange rate) is associated with a short-
term boost in export competitiveness, especially in the
oil and agricultural sectors, which positively impacts
GDP growth. However, this effect is tempered by rising
import costs, inflationary pressures, and the
destabilizing impact of exchange rate volatility on
domestic investment. Over the long run, the study finds
that exchange rate depreciation has a negative effect
on economic growth due to the overall inflationary
pressure and the contraction of consumption and
investment in non-traded goods.
Inflation, Trade Balance, and Government Expenditure
Inflation has a negative relationship with economic
growth in both the short and long term, as expected.
The increase in prices resulting from exchange rate
depreciation erodes the purchasing power of
consumers and distorts investment decisions. The
trade balance, on the other hand, shows a positive
relationship with economic growth, suggesting that
improved export performance due to currency
depreciation can support economic expansion.
However, this positive relationship is contingent upon
the ability of the country to diversify its export base and
reduce dependence on oil exports.
Government expenditure, particularly in infrastructure
and industrial sectors, was found to have a positive and
significant impact on economic growth. Public spending
helps stabilize the economy and mitigate some of the
negative effects of exchange rate fluctuations.
However, the effectiveness of government spending is
contingent upon its efficiency and targeting of
productive sectors.
DISCUSSION
The findings of this study align with existing literature
on exchange rate volatility and economic growth in
emerging economies, particularly those dependent on
a single commodity like oil. The results highlight the
dual nature of exchange rate fluctuations for Nigeria:
while
depreciation
can
improve
export
competitiveness and boost growth in the short term,
the longer-term effects are largely negative due to
inflation and macroeconomic instability.
Exchange Rate Depreciation and Economic Growth
Nigeria’s reliance on oil exports makes the economy
highly susceptible to external shocks, such as
fluctuations in global oil prices and exchange rates.
Depreciation of the Naira can be advantageous in the
short run, particularly for boosting oil exports, which
are priced in US dollars. This can lead to increased
foreign exchange reserves and a temporary
improvement in the trade balance. However, the
longer-term
consequences
of
exchange
rate
depreciation are problematic, as they drive up the costs
of imported goods, especially in sectors such as
manufacturing, which depend on imported raw
materials. The inflationary pressures generated by
higher import costs further undermine the purchasing
power of consumers and reduce disposable income,
thereby slowing down economic growth in the long
run.
The findings suggest that exchange rate management
in Nigeria must strike a delicate balance between
promoting export competitiveness and mitigating the
inflationary impact of exchange rate fluctuations. This
requires a more diversified economy that reduces
Nigeria’s dependence on oil and other vulnerable
sectors, such as agriculture, that are directly impacted
by exchange rate instability.
The Role of Government Expenditure
One of the key insights from this study is the positive
relationship between government expenditure and
economic
growth.
Government
spending
on
infrastructure, education, and industrial development
plays a crucial role in countering the adverse effects of
exchange rate fluctuations. However, the effectiveness
of government spending depends on the efficient
allocation of resources and the prioritization of sectors
that stimulate long-term economic growth, such as
non-oil export industries and manufacturing.
Nigeria’s fiscal
policy should focus on enhancing
productivity and reducing dependency on imports by
investing in domestic industries and creating an
environment conducive to foreign direct investment
(FDI). In the context of exchange rate volatility,
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International Journal Of Management And Economics Fundamental (ISSN: 2771-2257)
government intervention is crucial to stabilize the
economy and ensure that the country is not overly
reliant on global oil price fluctuations.
Policy Implications
The study suggests several policy recommendations for
Nigeria to minimize the negative impact of exchange
rate fluctuations on economic growth:
Exchange Rate Stabilization Policies: The Central Bank
of Nigeria (CBN) should consider adopting a more
flexible exchange rate system that allows the Naira to
adjust naturally to external shocks while maintaining
reserves. This would help alleviate the pressure on the
economy caused by artificial exchange rate
interventions.
Diversification of the Economy: Policies aimed at
diversifying Nigeria's economic base are crucial for
long-term growth. This includes investing in non-oil
sectors, particularly agriculture, manufacturing, and
services, to reduce the economy's vulnerability to oil
price volatility.
Inflation Control Measures: In order to protect
consumers from the negative effects of exchange rate
depreciation, inflation control policies must be
prioritized. This can be achieved through prudent fiscal
policies, control of import prices, and enhancing local
production capacity.
Improved
Fiscal
Management:
Government
expenditure should be channeled into productive
sectors that can absorb the shocks of exchange rate
fluctuations. Investment in infrastructure, human
capital, and industrial development would have long-
term positive effects on economic stability.
Strengthening Financial Markets: The development of
a robust and transparent financial system can help
buffer against exchange rate volatility. By improving
access to financing for domestic firms and increasing
financial literacy, Nigeria can build a more resilient
economy capable of weathering external shocks.
CONCLUSION
This study provides valuable insights into the
relationship between exchange rate movements and
economic growth in Nigeria, with a focus on
understanding both the short-term and long-term
impacts. The results suggest that while exchange rate
depreciation can stimulate export growth and improve
trade balances, it also presents significant challenges,
including
inflationary
pressures
and
reduced
purchasing power, which ultimately hinder long-term
growth. Government expenditure plays a key role in
stabilizing the economy, but its effectiveness is
contingent upon strategic and efficient investment.
The study’s findings underscore the need for a more
diversified Nigerian economy, less dependent on oil
exports and more resilient to exchange rate volatility.
The policy recommendations offered in this study aim
to guide policymakers in mitigating the adverse effects
of exchange rate fluctuations and fostering sustainable
economic growth.
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