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Price, Exchange Rate Volatility And Nigeria Agricutural Trade Flows

CHAPTER ONE

1.0                      INTRODUCTION.

1.1            BACKGROUND OF THE STUDY.

This chapter lays the foundation of the research work on price, exchange rate volatility and Nigerian trade flows. The economy of Nigeria is a middle income, mixed economy emerging market with well-developed financial, legal, communications, transport, and entertainment sectors.

It is ranked 31st in the world in terms of GDP (PPP) as of 2009, and its emergent, though currently underperforming manufacturing sector is the second-largest on the continent, producing a large proportion of goods and services for the West African region. Previously hindered by years of mismanagement, economic reforms of the past decade have put Nigeria back on track towards achieving its full economic potential.

Nigerian GDP at purchasing power parity more than doubled from $170.7 billion in 2005 to $374.3 billion in 2010, although estimates of the size of the informal sector (which is not included in official figures) put the actual numbers closer to $520 billion.  Although much has been made of its status as a major exporter of oil, Nigeria produces only about 3.3% of the world's supply, and though it is ranked as 15th in production at 2.2 million barrels per day (mbpd), the top 3 producers Saudi Arabia, Russia, and the United States produce 10.7mbpd (16.8%), 9.8mbpd (15.4%), and 8.5mbpd (13.4%) respectively, collectively accounting for 63.6mpd (45.4%) of the world's total production.

To put oil revenues in perspective at an estimated export rate of 1.9mbd, with a projected sales price of $65 per barrel in 2011, Nigeria's anticipated revenue from petroleum is about $52.2 billion. This accounts for less than 14% of official GDP figures (and drops to 10% when the informal economy is included in these calculations). Therefore, though the petroleum sector is important, it remains in fact a small part of the country's overall vibrant and diversified economy. The largely subsistence agricultural sector has not kept up with rapid population growth, and Nigeria, once a large net exporter of food, now imports some of its food products. In 2006, Nigeria successfully convinced the Paris Club to let it buy back the bulk of its debts owed to the Paris Club for a cash payment of roughly $12 billion (USD).

Nigeria's foreign economic relations revolve around its role in supplying the world economy with oil and natural gas, even as the country seeks to diversify its exports, harmonize tariffs in line with a potential customs union sought by the Economic Community of West African States (ECOWAS), and encourage inflows of foreign portfolio and direct investment. In October 2005, Nigeria implemented the ECOWAS Common External Tariff, which reduced the number of tariff bands. Prior to this revision, tariffs constituted Nigeria's second largest source of revenue after oil exports.However, the volatility and instability of the exchange rate movement since the beginning of the floating exchange rate raise a concern about the impact of such movement on agricultural trade flows.

ANANLYSIS OF SAP.

Most African nations are implementing SAP, an economic `solution inspired by the World Bank and the IMF. The objectives of a Structural Adjustment Program are largely the same for most African nations, because the world bodies presume that African economies are at the same level of development and are experiencing similar problems.

The stated objectives of the Nigerian SAP are to:

• restructure and diversify the productive base of the economy

• achieve fiscal stability and positive balance of payments

• set the basis for a sustained non-inflationary or minimal inflationary growth, and

• reduce the dominance of unproductive investments in the public sector.1

The corresponding program instruments include the strengthening of demand management policies, adoption of a realistic exchange rate policy through the establishment of Foreign Exchange Markets (FEM), rationalization and privatization of public sector enterprises, and the adoption of appropriate pricing policies for public enterprises.

Nigeria has implemented SAP for almost a decade now, but none of the objectives has been achieved, and there is no indication that any of them can be achieved using the chosen program instruments. Indeed, all that is still conspicuously present in Nigeria is the foreign exchange market and the ceremonies associated with it.  Financial institutions and Nigerian economists campaigning to establish SAP continue to insist that there is no alternative to SAP. They point out that Nigeria had become indebted and seemed unable to repay because it had been involved in indiscriminate importation and had also neglected non-oil export as potential foreign exchange earners. To these economists, the solution to the problem lay in a mechanistic manipulation of the import-export equation, which dictates that a country must export (or earn) more than it imports (spends) to generate a positive balance of trade.

Foreign exchange markets, as part of structural adjustment programs, served to increase the cost of imports and hence reduce import spending. The indirect impact of this instrument affects all sectors of any economy in which it operates. The implications of FEM in African countries are especially harsh. The effect of mandatory foreign exchange markets has been to erode the value of the local currency over time. Most countries undergoing adjustment have seen their currency values fall in relation to international currencies.

Earnings from primary commodities, the basis of African economies, have been decreasing for over a decade. The United Nations publication "Africa Recovery," reported recently that the prices of most export commodities, already at record low levels in the 1980s, have continued to fall every year in the 1990s.2 Recent efforts by SAPs to increasing primary exports have only led to reduced earnings from commodities.

1.2 STATEMENT OF RESEARCH PROBLEM.

Existing literature on volatility of exchange rate and its effect on agriculture trade flow remain inconclusive. While a large number of these studies have shown negative impact of exchange rate volatility on trade, export and imports, some have also reported positive and insignificant consequences. Illan (2005).

In Nigeria, Ajayi (1988) and Osagie (1985) while taking the structuralist approach in the study of external trade flows opposed the adoption of a more flexible exchange rate policy in Nigeria, there argument were based on the structural thesis that exchange rate devaluation would be stagflationary and have no significant effect on external trade balance in less developed countries.

Changes in income earnings of export crop products come as a result of either increase or decrease in international world prices of export or devaluation of the currency and subsequence increase in producer price. Such price/exchange rate changes may result to a major decline in future output if they are unpredictable and erratic fluctuations- whether positive or negative is not desirable as it increases risk and uncertainty in international transactions and thus discourages trade.

Despite this assertion, and that of other studies, more recent research explains why a positive effect can also be possible (De Grauwe 1985, Calbullero and Carbo 1989). That if a firm(s) hedge against exchange rate rise, one could not expect to find a strong negative effect on trade. Hedging against risk can be done via future or forward markets, where forward markets exist the nature of uncertainty faced by traders is transformed. A forward market represents in effect a guaranteed forecast of exchange rate that will prevail at the end of the contract period which a trader can take advantage of by payment of small margin ground in the forward market.

Unfortunately, the future market is absent in Nigeria and the possibility of hedging via this route is remote. In fact, most have not taken hedging possibilities into account. It has been argued that hedging foreign exchange through forward market is an imperfect and costly method of avoiding exchange rate risk. Exchange rate risk (refers to the potentials to lose money because of change in the exchange) measure the volatility and erratic pattern of exchange movements, the more volatile the movement, the higher the risk. (Head 2007).

Producers exports are not concern with the prices received, they bother about the stability of such prices as it relates to earning a consistent income. In developing countries like Nigeria for example where export price increases, as a result of currency devaluation are expected to an incentive for export growth , a primary concern is the nature and magnitude of risk introduced by the price/exchange rate movement.

Many related empirical studies have been conducted on the effect of price and exchange rate on trade (Schuh 1974, Ihimodu 1993, Ogiogio 1993, Osuntogun et al 1993, Obandan 1994), the likely relationship between price and exchange rate volatility were ignored in their estimations and a possible impact of price and exchange rate risk on trade flow were neglected.

As such, the research intends to provide an empirical basis for the analysis of the effect of price and exchange rate volatility on the volume of agriculture exports. Due to this varying opinion of researchers, some questions are raised,

§  Is there any relationship between exchange rate volatility and agricultural trade flows in Nigeria?

§  Does exchange rate volatility have a significant effect on agricultural trade flow in Nigeria?

§  Does the international price of agricultural products significantly affect agricultural trade flows in Nigeria?

1.3 OBJECTIVES OF THE STUDY.

The major objective of this research work is to determine whether exchange rate volatility has been a significant factor affecting agricultural trade flows in Nigeria. The other objectives are stated below;

§  To determine whether there is any relationship between exchange rate volatility and agricultural trade flows in Nigeria.

§  To determine if international prices of agricultural products significantly affects agricultural trade flows in Nigeria.

1.4 STATEMENT OF HYPOTHESES.

§  There is no significant relationship between exchange rate volatility and agricultural trade flows in Nigeria.

§  Exchange rate volatility has no significant effect on agricultural trade flows in Nigeria.

§  International prices of agriculture products have no significant effect on agriculture trade flows in Nigeria.

1.5 SIGNIFICANTS OF STUDY.

It is obvious that there has been a significant decline in the export of agricultural products. Economists have attributed many factor s as the cause. In this research, we want to find out whether exchange rate volatility is a contributing factor.

If at the end of the research, exchange rate volatility is found to be statistically significant and has a positive a piori expectation then it means that exchange rate volatility has an effect on agriculture exports and also volatility increases agriculture exports. Policy measures would then have to be geared towards the adoption of a more flexible exchange rate system in order to boost agriculture exports.

If on the other hand, exchange rate volatility is significant and negatively related o the export of agricultural products, policy measures would be directed towards adopting a less flexible and stable rate system. This research would also enhance policy formulation for countries that depend primarily on agricultural produces for revenue.

1.6 SCOPE AND LIMITATION OF STUDY.

This research work will cover a period of 34years that is from 1975-2009. The researcher would have also loved to research in other sectors in Nigeria hat have been affect by exchange rate volatility but unfortunately, data and information concerning the research of other sectors are missing.

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