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PRICE, EXCHANGE RATE VOLATILITY AND NIGERIA AGRICULTURAL TRADE FLOWS- A DYNAMIC ANALYSIS

CHAPTER ONE

1.1    INTRODUCTION

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 projectedsalesprice 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.

Thus, this work will study the relationship between price of Agricultural product, Exchange rate volatility and the Agricultural trade flows.

1.2    STATEMENT OF PROBLEM:

Changes in income earnings of export crop producers come as a result of either increase/ decrease in international world price of exports or devaluation of the currency and the subsequent increase in producer prices. Such price/exchange rate changes, however, may lead to a major decline in future output if they are unpredictable and erratic. Fluctuation whether positive or negative is not desirable as it increases risk and uncertainty in international transactions and thus discourages trade. In a sense, trade will be reduced similarly to a reduction following an increase in transportation costs.

An IMF (1984) study cites arguments that exchange rate variability would also tend to induce macroeconomic phenomena that are undesirable, for example inflation and protectionism.

Despite this assertion and that of other studies, more recent research explains why a positive effect could also be possible (de Grauwe, 1988; Caballero and Corbo, 1989).

If firms hedge against exchange rate risk, 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 the uncertainty faced by traders is transformed. A forward market represents, in effect, a guaranteed forecast of the exchange rate that will prevail at the end of the contract period, which a trader can take advantage of by payment of a small margin around the forward rates. Since currency uncertainty can be removed from the short-term trading transaction by payment of this margin, the cost of such uncertainty cannot be higher than the cost of purchasing insurance against it.

Unfortunately, the future market is absent in Nigeria and the possibility of hedging via this route is remote. In fact, most studies have not taken hedging possibilities into account.

It has been argued that hedging foreign exchange via future/forward markets is an imperfect and costly method of avoiding exchange rate risk. This is because, hedging transactions have a cost. Secondly several studies (Cumby and Obstfeld, 1981; Frenkel,1981; Hakkio and Rush, 1989) have indicated that the forward rate is a poor predictor of the future spot rate. Thus, even in the presence of forward markets for exchange rates and hedging, trade is likely to be hurt. The IMF (1984) argues that forward/ future markets can be used to hedge against nominal exchange rate risk in the short run at small cost.

However, long-term export oriented activities would be exposed to higher and possibly unhedgeable risks.

It therefore follows that hedging notwithstanding, exchange rate volatility-which tends to increase the risk and uncertainty in international transactions-may adversely affect trade and investment flows. This will further increase risk on supply of exports.

Exchange rate risk measures the volatility and erratic pattern of exchange rate movements, the more volatile the movements, the higher the risk. Producers exports are not only concerned with the magnitude of the price they receive, they also bother about the stability of such prices as it relates to earning a consistent income, In a developing country, where export price increases, as a result of currency devaluation are expected to be an incentive for export growth, a primary concern is the nature and magnitude of risk introduced by the price/exchange rate movements. This concern has strengthened in recent years in response to increasing protectionist trends and slowing growth in world trade. Many related empirical studies have been conducted on the effect of price or exchange rate on trade (Schuh, 1974; Ihimodu, 1993; Ogiogio, 1993; Osuntogun et al., 1993; Obadan, 1994). However, most of these efforts have concentrated on the price and export effects in a static setting. These studies, either econometric or judgmental, are thus incapable of portraying the dynamic adjustment to a devaluation. Also, the likely relationships between price and exchange rate volatility were ignored in their estimations and a possible impact of price and exchange rate risk on trade flows was neglected. The major goal of this study is to address these issues. The research intends to provide an empirical basis for the analysis of the effect of price, exchange rate volatility on the volume of trade flow in Nigeria.

1.3    OBJECTIVES OF THE S1'UDY

The overall objective of the study is to determine empirically the dynamic effects of price, exchange rate volatility and Nigerian trade flows.

Specifically the study intends to:

·       Evaluate the nature and extent of the impact of price and exchange rate volatility on trade flows.

·       Estimate the relationships between price and exchange rate volatility and their effects on exports and imports prices.

·       Investigate the dynamic characteristics of exchange fluctuations on the economy.

·       Provide policy recommendations based on the outcome of this research work.

1.4    RESEARCH QUESTIONS:

For a more detailed research work, the following questions below would be looked in to answered in full detail:

· What is the impact of persistent exchange rate on the economy?

· What is the effect of exchange rate volatility on the trade flow in Nigeria?

· What is the nature of Nigerian trade flow?

·  What is the relationship between price, exchange rate volatility and trade flows?

1.5    SIGNIFICANCE OF THE STUDY:

There is no other time or period that a research work of this nature can be carried out than now.

Although, there have been numerous research work similar to this study, however, this study is so unique in the sense that it will help to achieve the following below:

·        Widen the horizon of both past, present and future researchers in this research topic area.

·        Help the government and all concerned stakeholders to make accurate and timely decisions based on the findings of this research report.

·        Enhance the value of research work

·        Act as a valuable addition to the existing body of knowledge.

·        Serve as an additional stepping stone to future research work in this subject area.

1.6    RESEARCH HYPOTHESIS:

To ensure a more analytical and genuine result oriented research, hypothesis are formulated and tested on the research objectives.

The decision criteria is to accept the null hypothesis (Ho) and reject the alternative hypothesis (Hi) or otherwise based on the result of the test performed.

In the light of the research questions stated above, the following hypotheses would be tested in the course the work:

Ho:    There is no significant relationship between price, exchange rate volatility and Nigerian trade flow.

H1:    There is a significant relationship between price, exchange rate volatility and Nigerian trade flow.

1.7    ORGANISATION OF THE RESEARCH:

This research work would be divided into five chapters.

The first chapter will be introduction and overview of the study.

Chapter two will focus on the literature review and theoretical framework of the research topic.  The third Chapter would be based on the methodology to be used for the data analysis.

Chapter four would focus on the interpretation and analysis of the data collected using econometric, mathematical and simple statistical tools for easy understanding while the final chapter, which is chapter five, shall comprise of the summary of findings, conclusion and recommendation.

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