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CHAPTER ONE

INTRODUCTION

1.1  BACKGROUND OF THE STUDY

Foreign exchange is defined by Samuelson and Mordhaus (1983) “as a currency or other financial institution that allows are country to settle amounts owed to another country” According to lisped ((1982) “the term foreign exchange refers to what is traded actual foreign currency or various claims on it.” These different definitions of foreign exchange all mean or refer to the effecting payment for international transaction foreign exchange can be acquired by a country through the export of goods and service direct investment inflow draw down on external loans aids and grants and it can be extended to settle international obligations when foreign exchange expenditure is lower than foreign exchange receipt the surplus is added to external reserves. These external reserves which are also saving from foreign exchange transactions are held by the authorities to finance short falls in foreign exchange receipts and to safe guard the international value of the domestic currency A country’s external reserves are the financial assets available to the monetary authorities to meet temporary imbalance in the external payments position and to purpose other policy objectives. External reserve management is the technique of optimizing a nations external resources to meet its economic needs. As the nations apex financial institution the central bank of Nigeria (CBN) has the sole responsibility for the management of external reserves comprising monetary fund (IMT) holding of special drawing right (SDRS) and foreign exchange (CBN) 1995.

The bank started exercising this power in 1962 prior to this date the country’s external reserves were held by the federal and regional governments as well as their parastatals. This arrangement made is difficult to manage the external resaves with adverse imputations for the conduct of monetary policy in order to redress the problem the foreign exchange component of the external reeves was consolidated with the CBN in January 1962 leaving only working balance with other holders (CBN 1995). Nigeria as a member of internal community has bilateral and multilateral relations with other countries and organization which necessitate the exchange of goods and services. External reserves are kept and carefully managed to facilitate such business and diplomatic transactions. More importantly the management of the reserves eect the conduct of monetary policy and ultimately the performance of the nations economy. T his is because the exchange in net foreign assets. Influence the total money supply. External reserve management by the CBN involves the constant review of the country’s exchange position so that external financial obligation are met according One of the major objective of external reserve management is to maintain adequate level of reserves to facilitate international transaction from one asset to another incurs minimums cost in addition reserves are managed to yield income measure of adequacy of reserves used by the bank is the reserves importation. It is desired that external reserves be available to pay for at least four months of imports at the current rate of monthly import demand. In practice the standard is a guide.

Another measure as adequately used by the CBN to monitor the reserves in the reserve is total demand liabilities ration. Under the exchange control act of 1962 the CBN was required to maintain external reserves equivalent to 60 percent of total demand liabilities (CBN 1995) like the other adequacy criterion the external reserves total demand liabilities ratio is implement by the bank according to the realities of the country’s foreign exchange earnings. When there is a disequilibrum in the foreign exchange market caused by inadequate supply of foreign exchange reserves pressure. If these reserves are not adequate this may deteriorate into balance of payments problem there is therefore need to manage a nations foreign exchange resources so as to reduce the adverse eects of foreign exchange volatility The management of foreign exchange resources is further informed by the need to set an appropriate clearing price in the foreign exchange market that would guarantee adequacy of supply in relation to the demand for foreign exchange. Therefore the art of foreign exchange management is a conscious attempt to control and use foreign exchange resources dogleg them to reserve the economy and to meet other international commitments while saving some to raise the level of the country’s international reserves so as to prevent the economy from experiencing shocks to foreign exchange. Volatility. Foreign exchange resources are derived and a expanded I the course of affecting economic transactions between the residents of the country and the rest of the world in this sense there is a close the balance of payments.

While foreign exchange transaction reflects cash flows arising from international operations the balance of payment look at the actual movement of goods services and changes in financial assets and liabilities. According to types (1983) foreign exchange transaction is the difference between foreign receipts and foreign exchange disbursements. If receipts are higher than disbursements there is a set inflow or an accretion reserves. On the other hand if receipts are lower there is a net outflow and reserves would be depleted. Balance of payment position is the difference between the receipts by the residents of one economy from the rest of the world . an excess of receipt over the payment shows a balance of payment surplus while the reserves represents a deficit. When foreign exchange receipts and payment are adjusted for valuation changes in reserves the net position would be identical to the balance of payment position. Fisher et- a; (1987) defined foreign exchange market as “the market where currencies are bought and sold it is where foreign exchange rates are determined. Foreign exchange market can also be defined as the medium of interaction between the seller and buyers of foreign exchange in a bid to negotiate a mutually acceptable price for the settlement of international transactions. According to CBN 1993 the objective of such a market include the provision of an avenue for the exchange of national currencies and the creation of an effective mechanism for the allocation of foreign exchange. The foreign exchange (supply) and the buyers of foreign exchanged (demand). The major participant in the foreign exchange market are authorized dealers (banks) the public sector the private sector and correspondent banks abroad. In Nigeria the supply of foreign exchange is derived from oil exports non- oil exports capital receipt including draw- down no loans expenditure of foreign tourists in Nigeria repatriation of capital be Nigeria resident abroad and other invisible receipts by the private sector. On the other hand the demand for foreign exchange reflect payment for imports external debt services obligations and financial commitment to international organization. Foreign exchange rate are determined. Exchange rates have been defined in different ways by different authors. Fishers etal (1987) defined exchange rate as “ the amount of one country’s currency (money) that it cost to buy one unit of another country’s currency” Exchange rate is defined by lapsey (1982) as “the price at which purchases and sales of foreign currency or claims on it such as cheque and promises to pay take place it is the price of the currency in terms of another.

According to Samuelson and hardhats (1983) “Exchange rate is the rate of price at which one country’s currency is exchange for the currency of another country. Exchange rate can also be defined as other currencies (CBN 1993 ) .The worth of a nations currency depends on a number of factors including the state of the economy the competitiveness of and volume of export the level of domestic production and the quatum of foreign reserves. In a free market environment the exchange rate of a currency I determined by the inter play of supply and demand for that currency. In many cases the exchange rate may be administratively  determined. This was the situation in Nigeria from independence until 1986 when a flexible exchange rate mechanism was adopted as part of the structure adjustment programme (SAP ) thereaer exchange rate determination has been largely influence by the force of supply and demand with occasional intervention by the authorities. The main objectives of exchange rate policy in Nigeria according to Umeh (1985) are to preserve the value of the domestic currency maintain favorable external reserves position and ensure price stability . exchange rate policies applied in Nigeria have traversed two main mechanism. The fixed and flexible regimes . between 1960 and 1986 the fixed exchange rate system was operated. The liability of the system to achieve the major objectives of exchange rate policy led to the reversal policy in September 1986 with the floatation of the Naira. The flexible system countries until January 1994 when the fixed exchange rate system was introduced with the pegging of the Naira relative to the us dollar some of the main instrument used in pursuit of these objectively were maintaining parity with the Birth pound sailing and the dollar fixing the Naira exchange rate independence with the dollar and sterling (depending on their relative strength) and the use of dissection (CBN 1995) This chapter discusses the management of foreign exchange in Nigeria including the policy that have been applied to reform it in two categories. Foreign exchange management before. SAP and foreign exchange management since SAP.

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