An Analysis of Foreign Exchange Reserve Trend, Adequacy and Their Relationship with Selected Macroeconomic Variables in Nigeria: 1980-2014

ABSTRACT

Due to the increasing uncertainty as a result of globalisation, economies of developed and developing nations maintained adequate level of foreign exchange reserve to protect and achieve general stability in an economy. Nigeria has witnessed an intermittent rise and fall in the level of its foreign exchange reserve without proportional effects in some key macroeconomic variables. Instead, persistent problems like exchange rate volatility, and general macroeconomic instability continuous to prevailed even in periods of a fall or a rise in the level of foreign exchange reserve. The specific objectives of this study were to establish the causal relationship between the trend in foreign exchange reserve with the selected macroeconomic variables, and also to identify the related macroeconomic variables associated with the observed fluctuating trend in foreign exchange reserve. To achieve these objectives, the two- stage- least square (2SLS), granger causality and error correction techniques were used to estimate the specified model of the study. The results from these estimations produced strong evidences of interrelationships among the variables in the model for the study period particularly from the causality analysis. The findings of the study further revealed that external variables showed significant positive interactions with the observed fluctuating trend in foreign exchange reserve. This is because oil revenue, exchange rate flexibility and net export were instrumental in explaining the behaviour of the target variable (foreign exchange reserve) than the rest of the variables in the model. However the size of the economy proxy by GDP previously found to influence foreign exchange reserve positively by past studies, interacted negatively with the trend in foreign exchange reserve for the period of this study. These findings are reflections of the export led growth strategy often known as mercantilist motive and also the pursuance of self insurance or precautionary motives of holding foreign exchange reserves in Nigeria. In view of these findings, it was recommended that the policy of export diversification, particularly in the area of non-oil sectors, to broaden the supply base of foreign exchange, also to protect the economy from external disturbances as well. Also, there would be a need for government to reduce the xiv over-reliance on the oil sector which often exposes the economy to external shocks and other internal consequences such as corruption, environmental challenges, and owing to its nonrenewable nature. There should also be a deliberate attempt to deploy the oil revenue into the stabilisation and sovereign wealth fund (meant for future generations in the event of depletion) against the practice of outright sharing of the proceeds of oil revenue among the three tiers which often mount further pressures on foreign exchange reserve. The study also suggested a policy for efficient and effective foreign exchange allocation to channel it particularly to small and medium scale industries that needed the foreign exchange to obtain imported inputs to boost production and continue operations.