An Analysis Of Foreign Exchange Reserve Holdings And Macroeconomic Stability In Nigeria.

ABSTRACT

This study stems the depletion of Nigeria’s Reserves in recent times and the possible

implications of this fluctuation of the Foreign Exchange Reserves on the macroeconomic

stability of Nigeria in tandem with factors like holding of Reserves in excess and the

desirability or otherwise of holding Reserves as embedded in the nation’s Reserve

Management Strategy. The study used quarterly data ranging from the first quarter of 1981

to the first quarter of 2015. A Reserve demand function was developed using a simultaneous

equation model to provide a theoretic cover of the interdependence between Real GDP and

Foreign Exchange Reserves while VAR Models were used to estimate the implications of

Reserves on some macroeconomic indicators which included Inflation Rate, Exchange Rate

and Investment. Cointegration tests reveal that there was no long-run relationship amongst

the variables in their respective models. It was found that the opportunity cost of holding

Reserves though negatively affecting Reserve holdings was not significant, while other

factors like the Capital and Current Account Vulnerability, Trade Openness, lagged value of

Nominal Exchange Rate all significantly determine Foreign Exchange Reserves in Nigeria.

The IMF condition and Guidotti-Greenspan condition for Reserves Adequacy were

significant determinants of Reserve holdings. Inflation in Nigeria was found to respond

negatively to fluctuations from the Reserves while Exchange Rate and Investment were found

to positively respond to shocks from the Reserves. Conclusions drawn were that the decision

to hold Reserves is not motivated by the return on Reserves; Reserves is sensitive to both

Capital and Current Account instability, thus the need to account for both the Short Term

Debts as well as the 3 months of Import cover and that Exchange Rate management is a

predominant cause of the depletion of Reserves in Nigeria. Recommendations rendered were

that intertemporal expenditure using a present value analysis should be considered so as to

account for the opportunity cost of holding Reserves, the Federal Government should review

her Exchange Rate policy in order to allow the other reasons for the demand of Reserves

prevail, since Reserves was found to be held in excess, the excess should be spent in

improving the investment climate of the economy in order to balance the complementarity

expected of the economy’s size and Reserves accumulation and finally the economy should be

diversified to reduce the burden imposed on the Reserves by Oil price shocks.