Impact of Foreign Exchange Rate On Performamce of Manufacturing Sector in Nigeria

IMPACT OF FOREIGN EXCHANGE RATE ON
PERFORMAMCE OF MANUFACTURING SECTOR IN
NIGERIA
BY
OLABODE, ESTHER AFOLAKEMI
PG/15/16/239691
BEING A DISSERTATION SUBMITTED TO THE POST GRADUATE SCHOOL,

DELTA STATE UNIVERSITY, ABRAKA IN PARTIAL FULFILMENT OF THE
REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF
SCIENCE (M.Sc) DEGREE IN BANKING AND FINANCE.
SUPERVISOR: DR. OSUJI, C. C.
FEBRUARY, 2018
DECLARATION
I hereby declare that this dissertation is my original work and has not been previously
presented wholly or in part for the award of other degrees.
OLABODE ESTHER AFOLAKEMI
Signature……………………………… Date……………………….
CERTIFICATION
We the undersigned, certify that this research dissertation titled foreign exchange
rate on performance of manufacturing sector in Nigeria is the original work of the
candidate and has been fully supervised, and found worthy of acceptance in partial
fulfillment of the award of Master of Science (M.Sc) Degree in Banking and
Finance.
……………………………… ………………………………
Dr. C.C Osuji Date
(Supervisor)
……………………………… ………………………………
Dr. C.C. Osuji Date
(Head of Department)
……………………………… ………………………………
Prof. (Mrs.) R.N. Okoh Date
(Dean Faculty of Management Science)
……………………………… ………………………………
External Examiner Date

DEDICATION
To God Almighty.
ACKNOWLEDGEMENTS
I wish to acknowledge all those who have contributed in one way or the other
towards the successful completion of this academic programme.
Special thanks to the Dean of Faculty of Management Sciences Prof. (Mrs.) R. N
Okoh, the Head of department Dr. C.C Osuji, Faculty Post graduate Coordinator Dr.
(Mrs.) A.C Onuorah, my supervisor Dr. C.C Osuji, who provided me with direction,
technical knowledge and confidence throughout this programme. To Dr. Victor
Ehiedu, Dr. Andrew O. Agbada, Mr. A. Erijakpor, Mr. I. Eferakaya, Mr. E.
Ugherughe, Mr. Enakirerhi Lucky and other lecturers in the Faculty of Management
Sciences. Also to Emordi Bidget, Omovo Charles Mercy, Okafor Drocas, Akin Dayo
(non-teaching staff) in the Department of Accounting, Banking & Finance, Delta
State University, Asaba Campus, thanks a lot for your utmost support and input.
Also to my parents Mr. and Mrs. Olabode, my siblings, and friends, God bless you
all.
ABSTRACT
This study the impact of foreign exchange rate on performance of manufacturing sector in Nigeria.
The study spanned from 1990-2016. The independent variables used for the study are real effective
exchange rate, parallel exchange rate, interest rate, inflation rate, money supply while the
dependent variable is returns on equity for fifteen manufacturing firms in Nigeria. Time series data
were used and gotten from CBN Statistical Bulletin 2016 and annual report of the firms under
study. The study applied E-view 7.0 version and the estimation technique applied are ordinary
least square (OLS), diagnostic test, serial correlation test, stability test, unit root test, granger
causality and co integration test. The result revealed the p-value of real effective exchange rate
(REER) is 0.036, parallel exchange rate (PER) is 0.000, interest rate (INT) 0.031, inflation rate
(INF) 0.000, money supply (MSP) 0.017. The result also reveals that all the independent variables
under study have significant impact on returns on equity of manufacturing firms in Nigeria because
their p-values are all less than 5% significant level. The normality test and suggest that the series
distribution is normal as the p-value is 0.389 which is greater than 5% significant level, we accept
H0 which states that the residuals are normally distributed and it is desirable and further connote
that the influence of other omitted and neglected variables is small and at best random. While serial
correlation test and shows that the p-value of the f-statistics is 0.122 which is greater that the
critical value of 5%, we conclude by accepting H0 that there is no presence of serial correlation
which is desirable and implies that the variables are independently distributed. The study
recommended that the monetary authority should continue to initiate policies that will stabilize
exchange rate and remove negative effect of exchange rate fluctuations on Nigeria’s
manufacturing performance.
TABLE OF CONTENTS
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgement v
Abstract vi
Table of Contents vii
List of Tables xi
List of Figures xii
CHAPTER ONE: INTRODUCTION
1.1 Background to the study 1
1.2 Statement of the Problem 5
1.3 Research Questions 5
1.4 Objectives of the Study 6
1.5 Statement of Hypotheses 6
1.6 Scope of the Study 7
1.7 Significance of the Study 7
1.8 Limitations of the Study 8

1.9 Definition of Terms 8
1.10 Organization of the Study 9
1.11 Summary 10
CHAPTER TWO: LITERATURE REVIEW
2.1 Conceptual Framework 11
2.1.1 An Overview of Manufacturing Sector Performance in Nigeria 11
2.1.2 An Overview of Foreign Exchange Rate Policy in Nigeria 15
2.1.3 Determinants of Nigeria’s Foreign Exchange Rate Volatility 18
2.1.4 Effect of Exchange Rate Fluctuations on Export 19
2.1.5 Manufacturing Sector Export in Nigeria 21
2.1.6 The Effect of Exchange Rate Changes on Business 24
2.1.7 Exchange Rate 25
2.1.8 Real Effective Exchange Rate (REER) 29
2.1.9 Interest Rate 30
2.1.10 Inflation Rate 32
2.1.11 Money Supply 39
2.1.12 Interest and Exchange Rates Management in Nigeria 40
2.1.13 What Makes Currencies Fluctuate 43

2.2 Theoretical Framework 44
2.2.1 Balance of Payment Theory of Exchange Rate 44
2.2.2 Monetary Model of Foreign Exchange Rate 48
2.2.3 Purchasing Power Parity Theory of Exchange Rate 49
2.2.4 Uncovered Interest Rate Parity Theory of Exchange Rate 50
2.2.5 Abstinence or Waiting Theory of Interest Rate 51
2.2.6 Mark-up Theory of Inflation Rate 51
2.2.7 The Classical School Theory of Money 52
2.2.8 The Keynesian Position Theory of Money 52
2.3 Empirical Framework 53
2.4 Literature Gap 60
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Introduction 61
3.2 Research Design 61
3.3 Population and Sample Size 62
3.4 Sampling Technique 62
3.5 Method of Data Collection 62

3.6 Techniques of Data Analysis 63
3.7 Model Specification 63
3.8 Summary 65
CHAPTER FOUR: RESULTS AND DISCUSSION
4.1 Introduction 66
4.2 Data Presentation 66
4.3 Discussion of Data 68
4.4 Analysis of Data Technique 69
4.4.1 Ordinary Least Square (OLS) 69
4.4.2 Diagnostic Test 70
4.4.3 Unit Root Test 72
4.5 Discussion of Findings 75
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary 79
5.2 Conclusion 79
5.3 Recommendations 80
5.4 Contribution to Knowledge 81
References 82
Appendix 87
LIST OF TABLES
Table 4.2.1: Data for the Independent Variables 66
Table 4.2.2: Data for the (Dependent Variable) Returns on Equity (ROE %) 67
Table 4.2.2: Ordinary Least Square (OLS) Result 69
Table 4.2.3: Normality test 70
Table 4.2.4: Serial Correlation Test 71
Table 4.2.5: Heteroskedasticity Test 71
Table 4.2.6: Stability Test 71
Table 4.2.7: Unit root test for ROE 72
Table 4.2.8: Unit root test for REER 72
Table 4.2.9: Unit root test for PER 72
Table 4.2.10: Unit root test for INTR 73
Table 4.2.11: Unit root test for INF 73
Table 4.2.12: Unit root test for MSP 73
Table 4.2.13: Granger Causality Test 74
Table 4.2.14: Johansen Co integration 74

LIST OF FIGURES
Figure 2.1: Diagrammatical Representation of Foreign Exchange Rate Variables 25
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The desire of every developing country like Nigeria is to ensure rapid industrialization. It is logical
to say that industrialization if correctly harnessed can transform and stabilize a country
structurally. For these developing economics, industrialization is seen as a conscious effort of
growing the manufacturing sector of the economy. Hence, industrial reforms and policies are
tailored to have a strong impact on manufacturing outputs.
Lawal (2016) stated that in Nigeria, the government and economic experts have emphasized the
role that industrialization and manufacturing can play in the structural transformation of the
economy. The industrial policy for Nigeria launched in 1988 opined that its major goal is to
achieve an accelerated pace of industrial development for the nation making the industrial sector
the main source of strength for the economy. Hence, several fiscal, monetary, exchange rate and
commercial policies and measures have been adopted to encourage industrialization within the
ambit of available resources.
To resolve the bottlenecks and mark a watershed in the evolution of the manufacturing sector of
Nigeria; the Structural Adjustment Program (SAP) was embarked on in July 1986 with a primary
objective of removing the structural distortions and bottlenecks occasioned by Government
controls with the knowledge that foreign exchange rate is a major determinant in the efficient
allocation and utilization of scare resources to enhance the flow of capital into a country,
stimulating domestic industrial production, promotion of export, create a favourable purchasing
power, favourable balance of payment, prices of goods and services, import structure, export
earnings, government revenues, external reserves and the ability of local manufacturers to compete
with their foreign counterpart.
Foreign exchange rate refers to the price of one currency (the domestic currency) in terms
of another (the foreign currency). Foreign exchange rate plays a key role in international economic
transactions Movements in foreign exchange rate have ripple effects on other economic variables
such as interest rate, inflation rate, import, export, output, unemployment, money supply, etc.
These facts underscore the importance of exchange rate to the economic well-being of every
country that opens its doors to international trade in goods and services. The importance of
exchange rate derives from the fact that it connects the price systems of two different countries
making it possible for international trade to make direct comparison of traded goods. In other
words, it links domestic prices with international prices. Through its effects on the volume of
imports and exports, exchange rate exerts a powerful influence on a country’s balance of payments
position.
According to Chong and Tan (2016) empirical analysis revealed that foreign exchange rate is
responsible for changes in macroeconomic fundamentals for the developing economies. It is
relevant to establish that foreign exchange rate fluctuations influence domestic prices through their
effects on aggregate supply and demand. In general, when a currency depreciates it will result in
higher import prices if the country is an international price taker, while lower import prices result
from appreciation. The potentially higher cost of imported inputs associated with exchange rate
depreciation increases marginal costs and leads to higher price of domestically produced goods
(Kandil, 2014). Also, import-competing firms might increase prices in response to foreign
competitor price increases to improve profit margins. However, the extent of such price adjustment
depends on a variety of factors such as market structure, the relative number of domestic and
foreign firms in the market, the nature of government exchange rate policy and product
substitutability, (Fouquin, Sekkat, Mansour, Mulder, and Nayman, 2012).
The Manufacturers Association of Nigeria (MAN) (2012) in a survey carried out as part of
its membership operational audit in January 2010, recorded that of the 2780 registered members,
a total of 839 (30.2%) manufacturing firms closed their factories in 2009. This is due to their
inability to cope with the challenges posted by the harsh operating environment in Nigeria; which
include the exchange rate management problems and infrastructural decay. In the annual report of
MAN for 2006, it was also claimed that the job loss in the sector between 1983 and January 2006
was estimated at 4.2 million. In addition, in the Newsletter edition of the Association for March,
2010, it was reported that one million jobs have been lost in the sector between 2006 and 2010.
In the bid to achieve macroeconomic stability, Nigeria’s monetary authorities have adopted various
exchange rate arrangements over the years. It shifted from a fixed regime in the 1960s to a pegged
arrangement between the 1970s and the mid-1980s, and finally, to the various types of the floating
regime since 1986, following the adoption of the Structural Adjustment Programme (SAP). The
fixed exchange rate regime induced an overvaluation of the naira and was supported by exchange
control regulations that engendered significant distortions in the economy.
However, for the purpose of this research the independent variable is foreign exchange rate, which
the researcher intends to use proxies like parallel rate, real effective exchange rate, interest rate,
inflation rate, money supply. While performance of manufacturing sector will be proxy by returns
on equity of the manufacturing firms under study.
The real effective exchange rate is the weighted average of a country’s currency relative to
an index or basket of other major currencies, adjusted for the effects of inflation. The weights are
determined by comparing the relative trade balance of a country’s currency against each country
within the index.
Parallel exchange rate: it is expedient to note that an illegal market determines parallel
exchange rate. It is the rate at which one currency is exchanged for another.
Interest rate is the percentage of principal charged by the lender for the use of its money.
The principal is the amount of money lent. A country's central bank sets interest rates. In the United
States, the fed funds rate is that guiding rate. It's what banks charge each other for overnight loans.
The Federal Reserve requires banks to maintain 10 percent of total deposits in reserve each night.
Otherwise, they would lend out every single penny they have. Interest rates make loans more
expensive. When interest rates are high, fewer people and businesses can afford to borrow. That
lowers the amount of credit available to fund purchases, slowing consumer demand. At the same
time, it encourages more people to save because they receive more on their savings rate.
Inflation rate is a sustained increase in the general price level of goods and services in an
economy over a period of time. When the price level rises, each unit of currency buys fewer goods
and services; consequently, inflation reflects a reduction in the purchasing power per unit of
money, it’s a loss of real value in the medium of exchange and unit of account within the economy,
Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (2013).
Money supply: The introduction of money is a substitute to a barter trade system which
was a very important event in the history of finance. Finance is nothing but money needed to
consummate economic and business, transactions and exchange processes for Economic
development (Osiegbu and Onuorah 2012). Money supply is the entire stock of currency and other
liquid instruments circulating in a country's economy as of a particular time. Also referred to as
money stock, money supply includes safe assets, such as cash, coins, and balances held in checking
and savings accounts that businesses and individuals can use to make payments or hold as short-
term investments.
Conclusively, it is hoped that this research explains the impact of foreign exchange rate on
performance of manufacturing sector in Nigeria.
1.2 Statement of the Problem
In any developing country like Nigeria, foreign exchange policy is an important policy instrument.
Up to the time of (SAP), it appeared that Nigerian’s exchange rate policy tends to encourage over-
valuation of the Naira. This, in turn, encouraged imports, and discourages non-oil export and over
dependence on imported inputs. Exchange rate policy was not geared towards the attainment of
long-run equilibrium rate that would equilibrate the balance of payment in the medium and long-
term and facilitate the achievements of certain structural adjustment objectives e.g. export
diversification. The problems of the Nigerian economy however is seen as failures of the
manufacturing sector characterized by low level of foreign investment in manufacturing, low
capacity utilization, low value added, high production cost, absence of a sound technological base,
poor returns, low contribution to Gross Domestic Product. The performance of the manufacturing
sector since 1986 has been poorly attributed to macroeconomic instability and inconsistence in the
exchange rate. The manufacturing sector is weak and heavily import dependent. The source of
concern comes from the structure of our manufacturing sector. It is in the light of the foregoing
that this study seeks to examine the impact of foreign exchange rate on the manufacturing sector
performance in Nigeria.
1.3 Research Questions
The study answers the following questions:

i. To what extent does real effective exchange rate (REER) affect return on equity (ROE) of
manufacturing firms in Nigeria?
ii. To what extent does parallel exchange rate (PER) affect return on equity (ROE) of
iii. What is the effect of interest rate (INTR) on return on equity (ROE) of manufacturing firms
in Nigeria?
iv. Is there any relationship between inflation rate (INFR) and return on equity (ROE) of
v. What is the effect of money supply (MSP) on return on equity (ROE) of manufacturing
firms in Nigeria?
1.4 Objectives of the Study
The study ascertains the impact of foreign exchange rate on performance of manufacturing sector
in Nigeria. The intended specific objectives are to:
i. Examine the relationship between real effective exchange rate (REER) and return on equity
(ROE) of manufacturing firms in Nigeria.
ii. Ascertain the relationship between parallel exchange rate (PER) and return on equity
iii. Determine the relationship between interest rate (INTR) and return on equity (ROE) of
manufacturing firms in Nigeria.
iv. Evaluate the relationship between inflation rate (INFR) and return on equity (ROE) of

v. Ascertain the relationship between money supply (MSP) and return on equity (ROE) of
1.5 Statement of Hypotheses
Ho1: There is no significant relationship between real effective exchange rate (REER) and return
on equity (ROE) of manufacturing firms in Nigeria.
Ho2: There is no significant relationship between parallel exchange rate (PER) and return on
equity (ROE) of manufacturing firms in Nigeria.
Ho3: Interest rate (INTR) does not have any significant impact on return on equity (ROE) of
Ho4: Inflation rate (INFR) does not have any significant impact on return on equity (ROE) of
Ho5: There is no significant relationship between money supply (MSP) and return on equity
1.6 Scope of the Study
This research focuses on the impact of foreign exchange rate on manufacturing sector performance
in Nigeria. The time frame for the research is twenty-seven years (1990 – 2016). The study used
secondary data (time series data), for fifteen (15) manufacturing firms quoted in the Nigeria stock
exchange. The study covers all manufacturing classifications of productivity sector such as
industrial sector and consumer goods, they are: Flour Mills Nigeria Plc (Lagos State), Dangote
Cement Plc. (Lagos State), Berger Paints Plc. (Lagos State), Beta Glass Plc. (Lagos State), Premier
Paints Plc. (Ogun State), Cutix Plc. (Anambra State), Portland Paints & Products Nigeria Plc.
(Lagos State), Meyer Plc. (Lagos State), Honeywell Flour Mill Plc. (Lagos), 7-UP Bottling
Company (Lagos), Cadbury Nigeria Plc. (Lagos), Guinness Nigeria Plc. (Lagos), Nestle Nigeria
Plc. (Lagos), Golden Guinea Brewery Plc. (Lagos), and VitaFoam Nigeria Plc. (Lagos). The source
of data included all annual reports and statement of accounts of the fifteen (15) manufacturing
firms.
1.7 Significance of the Study
To recommend more sophisticated method of managing and controlling foreign exchange rate that
would guarantee optimum level of profitability in manufacturing firms in Nigeria.
This work would also serve as a base to other researchers who tend to quest for more understanding
on the topic under study.
This study will be useful to investors in order to serve as a guide on investment decisions.
It will enable individuals and the general public to know if positive or negative influence exists
between foreign exchange rate and manufacturing sector in Nigeria.
1.8 Limitations of the Study
i. Attitudinal behavior of the staff of most of the manufacturing firms in releasing their annual
reports, the researcher made attempt to get the relevant annual report from the internet of
which much data will be needed but limited financial resources hindered full download of
the relevant annual report.
ii. Unfriendly behavior of staff of Nigeria stock exchange to release the number of
manufacturing firms quoted.

iii. Transportation Challenge: The researcher has to move to the different manufacturing firms
under study in order to obtain annual report and also transport to Nigeria stock exchange
office, but insufficient fund at hand hindered such movement effectively.
All these limitations did not negatively affect the findings and the data available for this study is
sufficient to achieve the desired result.
1.9 Definition of Major Terms
1. Exchange Rate: In finance, an exchange rate (also known as the foreign-exchange rate,
forex rate or FX rate) between two currencies is the rate at which one currency will be
exchanged for another. It is also regarded as the value of one country’s currency in terms
of another currency.
2. Real effective exchange rate: This is the weighted average of a country’s currency relative
to an index of other major currencies, adjusted for the effects of inflation.
3. Parallel exchange rate: It is the rate at which one currency is exchanged for another.
4. Inflation: Inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. When the general price level rises, each unit of currency
buys fewer goods and services. Consequently, inflation also reflects erosion in the
purchasing power of money, a loss of real value in the internal medium of exchange and
unit of account in the economy.
5. Interest Rate: An interest rate is the rate at which interest is paid by a borrower for the use
of money that they borrow from a lender.
6. Money supply: Is the entire stock of currency and other liquid instruments circulating in
a country's economy as of a particular time. Also referred to as money stock, money supply
includes safe assets, such as cash, coins, and balances held in checking and savings
accounts that businesses and individuals can use to make payments or hold as short-term
investments.
7. Performance: The accomplishment of a given task measured against preset known
standards of accuracy, completeness, cost and speed.
1.10 Organization of the Study
This study is organized into five different chapters. The current chapter has provided a
comprehensive background to the study, research problem, research question, research hypotheses,
etc. Other section of this study was organized as follows.
The second chapter (i.e. literature review) was organized into five sections, including a brief
introduction to the current status of the study, a conceptual framework; a theoretical framework;
and an empirical framework, contribution to knowledge.
The third chapter (i.e. research methodology) was organized into an introduction, and statements
on the research design to be employed in the study, the population and sample size to be studied,
the sampling technique with which the study sample is to be drawn, and the technique to be used
for data collection and analysis.
The fourth chapter (i.e. results and discussions) was organized into introduction, data presentation,
data analysis, test of hypotheses already formulated, and a summary of the research findings.
The last chapter of this study include summary, conclusion and recommendations.
1.11 Summary
Following the fluctuation of the Naira in 1986, a policy induced by the Structural Adjustment
Programme (SAP), the subject of exchange rate fluctuations has become a topical issue in Nigeria.
This is because it is the goal of every economy to have a stable rate of exchange with its trading
partners. In Nigeria, this goal was not realized inspite of the fact that the country embarked on
devaluation to promote export and stabilize the rate of exchange. The failure to realize this goal
subjected the Nigerian manufacturing sector to the challenge of a constantly fluctuating exchange
rate. This was not only necessitated by the devaluation of the naira but the weak and narrow
productive base of the sector and the rising import bills also strengthened it.
CHAPTER TWO
LITERATURE REVIEW
2.1 Conceptual Framework
2.1.1 An Overview of Manufacturing Sector Performance in Nigeria
Manufacturing activities have significant impact on the economy of a nation as their
contributions which account for a substantial proportion of total economic activities play a crucial
role in the development process of any economy. In 2008, Nigeria manufacturing accounted for
4.13% of the Gross Domestic Product (GDP) down from 11.05% in 1980.
In terms of employment generation, manufacturing activities accounted for about 12% of the
labour force in the formal sector of the nation’s economy but aggregately, accounted for about
6.77% of the labour force in year 2008. Before independence, Nigeria with its large population
notwithstanding had very little industrial development; a few tanneries and oil crushing mills that
processed raw materials for export. During the 1950's and 1960's, a few factories including the
first textile mills and food-processing plants, opened to serve Nigerians. During the 1970's and
early 1980's industrial production increased rapidly, principally in Lagos, Kaduna, Kano and Port
Harcourt. Factories also appeared in smaller, peripheral cities such as Calabar, Bauchi, Katsina,
Akure and Jebba due largely to government policies encouraging decentralization.
Nigeria’s major manufactures food and beverages, cigarettes, textiles and clothing, soaps and
detergents, footwear, wood products, motor vehicles, chemical products and metals. Smaller scale
manufacturing businesses engage in weaving, leather making, potteiy making and woodcarving.
The smaller industries are often organized in craft guilds involving particular families who
pass skills from generation to generation. In an attempt to broaden Nigeria’s industrial base, the
government invested heavily in joint ventures with private companies, since the early 1980's. The
largest such project is the integrated steel complex at Ajaokuta, built in 1983 at a cost of $4 billion.
The government has also invested heavily in petroleum refining, petrochemicals fertilizers and
equipment for assembling automobiles and farm equipment. In terms of the manufactured goods
used within the Nigerian economy, it is of interest to examine the level of indigenous production
as oppose to the imported manufactured goods as this shows the pattern of employment in the
country. In Nigeria from independence to date, importation has been on the increase in which
export has not for 1 year catch up with the level of import. Nigeria has aspired equilibrium in trade
balance in the past by designing different forms of trade and exchange rate policies.
A number of reform measures have been carried out by successive government, however the
extent to which these policies have been effective in promoting non-oil export has remained
unascertained. This is because despite government efforts, the growth performance of Nigeria’s
non-oil export has been very slow. Generally speaking, manufacturing is underdeveloped in
Nigeria. Much of the nation’s modem industrial activity involves the processing of raw materials;
processed foods which are largely consumed by Nigeria’s expanding urban populations while raw
materials such as minerals, petroleum and timber are processed almost entirely for export. The
bulk of the rest of Nigeria’s manufacturing output consists of consumer goods such as textiles,
footwear beverages and soap which are largely sold and used within the country rather than being
exported. The technology used in manufacturing ranges from rudimentary tools used in small-
scale cottage industries to large-scale factories. Although, its impact on the national economy is
frequently underestimated, the cottage industry sector of the economy produces significant
amounts of goods both for local consumption and for the tourist trade.
Textile and footwear plants on the other hand can be sizable, often requiring modem
machinery. Heavy industry such as the production of metal cars, motorcycles, bicycles and
household appliances is limited in Nigeria. Nigeria manufacturing grew in the 1960's and 1970's
as the real manufacturing output rose from N114 million in 1960 and N15634 million in 1982 but
declined in the 1980's and 1990's as it dropped from N15634 million in 1982 and N14935 million
in 2001.
After this period of fall in output, real manufacturing output started rising as it moved from
N16431 million in 2002 and N27905 million in 2008. The reflection of this is shown in Table 1
as manufacturing real output contributed 6.98% to total output but decline in its contribution
during both SAP and post SAP periods to 5.78 and 4.23%, respectively.
In terms of employment generation, manufacturing contributes mean value of 12% to total
employment in the pre SAP period increased to 13.45% during the SAP period but later decline to
10.06% during the post SAP period. Talking about the employment growth experienced, the pre
SAP period is characterised with a mean growth of 2.6% year-1 while the SAP period experienced
a declining growth of 0.9% and the post reform period is characterised with a fall of 3.94%.
Referring to its export growth performance more volatility is observed than real output and
employment. It increased from a mean growth of 20.74% year during pre SAP to 121.95% during
the post SAP reform period. In terms of its aggregate contribution to export, it is of little
importance as the economy till today solely depends on oil as its major source of income (Annual
budgets are prepared in Nigeria based on the present and projected price of crude oil).
After the dominance of agriculture in the early 1960, Nigeria’s economic progress continued
to be dominated by the remarkable oil boom. Oil revenue rose from 4.4 million in 1960 to 489
million in 1971 when it accounted for 73% of export earnings and to $6.1 billion in 2008. In order
to mitigate the problems facing the manufacturing industry in Nigeria, various measures have been
put in place. Beginning from the period of independence, Imports Substitution Industrialisation
(ISI) strategy was pursued as a means of transforming the real sector, particularly the industrial
sector. This strategy requires that some goods that hitherto being imported be produced locally.
This is to make the economy to be self-reliant thereby, reduce vulnerability of the economy to
negative external shocks and promote balance of payments viability. This strategy was also aimed
at promoting activities in the manufacturing sector with the intention that it will have backward
linkages with the agricultural sector in terms of input sourcing and forward linkage with the
external sector in terms of promoting export of manufactured goods (Egwaikhide, 2016). Among
other objectives of the strategy were to promote small and medium scale industries and persuasion
for consuming locally produced goods and services.
To make the strategy work effectively, import was discouraged throughout the period covered
by the strategy. In 1972 and 1977, the government of Nigeria implemented another strategy to
promote indigenous and private participation in the manufacturing sector through the Nigerian
Enterprises Promotion Decree (Indigenisation Decree). These strategies are characterised with the
reservation of certain activities exclusively for Nigerians and specified others in which indigenous
ownership can be a minimum of 40%. The government provided incentives such as tax holidays,
high rate of protection (through tariffs and non-tariff barriers) etc., with a view to inducing
foreigners to invest in real sector activities.
In 1986, Nigerian government adopted the Structural Adjustment Programme (SAP) against the
conditions of persistence macroeconomic crises in the mid 1980's. SAP was an economic reform
programme which contains macroeconomic adjustment and stabilisation measures such as trade
liberalisation, currency devaluation, etc. The post-SAP reform period features mixed trade policy
stance while the promotion of export continues some controls were exercised on imports. Against
the upward trend of the parallel market premium, foreign exchange market witnessed various
reforms in terms of determination of the official exchange rate.
2.1.2 An Overview of Foreign Exchange Rate Policy in Nigeria
An international exchange rate, also known as a foreign exchange (FX) rate, is the price of one
country's currency in terms of another country's currency. Foreign exchange rates are relative and
are expressed as the value of one currency compared to another. When selling products
internationally, the exchange rate for the two trading countries' currencies is an important factor.
Foreign exchange rates, in fact, are one of the most important determinants of a countries relative
level of economic health, ranking just after interest rates and inflation. Exchange rates play a vital
role in a country's level of trade, which is critical to most every free market economy in the world.
Consequently, exchange rates are among the most watched, analyzed, and manipulated economic
measures, (Faff, Raboert, and Andrew Marshall, 2015).
The Nigerian exchange rate policy could be perceived from two major different periods since
its political independence in (1960). These are the Pre-Structure Adjustment Programme (SAP)
and the Post-Structure Adjustment Programme (SAP), respectively, they are discussed below:
i. The Pre-SAP (1960-86) Period
Certainly, there were a lot of shifts within the Nigeria foreign exchange rate policy during the
1960/85 period. Nonetheless, the monetary authorities maintained overvalued exchange rates,
probably to maintain a relatively low cost of imports, particularly at the initial stages of the post-
independence era. As time went on, there was policy shift in favour of gradual depreciation of the
naira particularly, under the adoption of the import substitution model development in Nigeria.
Incidentally, within the 1973/76 period when the need to douse the inflationary pressures arose
from the monetization of the windfall gains from the crude oil boom period, monetary authorities
deliberately kept the naira at an overvalued rate.
However, at the wake of weak balance of payments position in 1977, a gradual depreciation of the
naira became resorted to. Whatever the shifts, it is important to note that the determination of naira
exchange rate within the pre-SAP period was achieved, pegging the local currency to a single
intervention currency, and later to a basket of currencies. The naira overvaluation had its telling
implications on the economy. Such implications include, making imports cheaper relative to
domestic substitutes and exports relatively expensive and uncompetitive culminating in the
encouragement of the importation of various items on a large scale at the expense of discouraged
exports. It also encouraged capital flight and made for the dependence of the manufacturing sector
on imported inputs. In recognition of these implications, the overvalued local currency became
propped up by a pervasive system of exchange control which was not easy to administer while
breeding various corrupt practices which undermined its usefulness.
ii. The SAP and Post - SAP Period
Against the background given in the foregoing section, a floating exchange rate regime under a
deregulated foreign exchange market was proposed in the SAP document of 1986. Within this
process a Second-tier Foreign Exchange Market (SFEM) was introduced on the 26th of September,
1986. The SFEM was expected to evolve an effective mechanism for exchange rate determination
and allocation of foreign exchange in order to guarantee short –term stability and long-term
balance of payments equilibrium SFEM started off as a dual exchange rate system which produced
official first tier exchange rate and the SFEM or the “free” market exchange rate. Under SFEM,
authorized dealers would bid for foreign exchange whose exchange rate would be determined by
averaging the successful bid rates. There was actually the merger of the first and second tier foreign
exchange markets in July 1987 at the rate of N3.74:$1.00. Some analysts however described this
as forced (Obadan, 2016). A unified exchange rate system that emerged them was referred to as
the foreign Exchange Market (FEM). In order to achieve the objectives of exchange rate policy,
various modifications have been made on the institutional frame work and management strategies
such that SFEM later metamorphosed from FEM, later into the Autonomous Foreign Exchange
Market (AFEM), Inter-Bank Foreign Exchange Market (IFEM), the Dutch Auction System (DAS)
and currently the Wholesale Dutch Auction System (WDAS). The Inter-bank Foreign Exchange
Market became operational in January, 1989, to unify the rates in the official and autonomous
market to the reduction of the distortions inherent in the old system and was couched under daily
auctions. The exchange was determined relying on any or a combination of the following options:
weighted average of all quotations submitted by the banks; simple average of all quotations
submitted by the banks; the highest and lowest banks' quotations, provided that the latter does not
depreciate by more than 2% when compared with the rate that emerges above; intelligence reports
on exchange rate movements during the previous day both in the inter-bank and in some world
financial centres. For the correction of the noticeable deficiencies in the IFEM, the DAS was re-
introduced in 1990. However, in order to stabilize the exchange rate, the implementation of
complementary demand-management measures was an additional policy measure introduced.
These arrangements and re-arrangements are done within the FEM paradigm to provide
institutional framework for the determination of a realistic exchange rate in Nigeria relying on the
interplay of market of market forces of supply and demand. A critical review of the performance
of the exchange rate under IFEM shows that, there was sharp depreciation of the rate initially in
January, 2000; and thereafter it became relatively stable. Thus, the naira exchanged at the rate of
N102.10: $1in 2000, depreciated to N111.96:$1 in 2001. By 2002, DAS was re-introduced again
and then, it aimed at the achievement of a rate that would not erode the measures of the
competitiveness in the economy. This has served to stabilize the naira exchange rate. As at 2002
and 2004, the exchange rate moved to N121.0: US: $1.00 and N133.5: US$1.00 respectively.
It is noteworthy however that since 2005, the exchange rates has featured some notable
appreciation and stability. This development can be related to the increases in oil prices in the
international market which culminated into drastic increase in the foreign exchange earnings of
the country.
2.1.3 Determinants of Nigeria’s Foreign Exchange Rate Volatility
Exchange rate movements and exchange rate uncertainty are important determinants of
international transactions. In Nigeria, these fluctuations according to Omojimite and Akpokodje
(2014) have been influenced by changing pattern of international trade, institutional changes in the
economy and structural shifts in production. Furthering, Ogunleye (2014) noted that the real
exchange rate in Nigeria has been principally influenced by external shocks resulting from the
vagaries of world price of agricultural commodities and oil price, both major sources of Nigerian
export and foreign exchange earrings; contending that when the economy depended on agricultural
exports, real exchange rate volatility was less pronounced given the fact that these products were
subject to less volatility and that there were more trading partners’ currencies involved in the
calculation of the country’s real exchange rate. This to him minimally affected the real exchange
rate fluctuating by only 0.14 % between 1970 and 1977. The increased dependence of the country
on oil, resulted in severe trade shocks from global oil price stocks fluctuating the naira exchange
rate by 10% between 1978-1985 (Ogunleye, 2014). To Iyoha and Oriakhi (2012), movements in
real exchange rate during this period were nominal stocks resulting from fiscal deficits.
Collaborating, Ogunleye (2014) noted that the oil windfall resulted in excessive fiscal expenditure
in ambitious development projects; and when the windfall ended, the government resorted to
financing its expenditures through money creation. This expansionary monetary fiscal policy
according to him exerted upward pressure on inflation, aggravating sharp movements in real
exchange rate movements.
From 1986, the adoption of the structural adjustment program (SAP) became a contributory factor
in shaping the dynamics of real exchange rate in Nigeria. One of the cardinal points of this policy
was floating nominal exchange rate policy. As the naira was allowed to float, the nominal exchange
rate movement became more pronounced, contributing to stronger movements in exchange rate
during this period.
Between 1986 and 1992, Ogunleye (2014) observed that the mean annual charge in real exchange
rate in the country increased to 25% reducing to 4.5% between 2000 and 2006. Favourable terms
of trade, less fiscal dominance, effective monetary policy induced by more independent and
transparent central bank and well managed nominal exchange rate policy contributed to this
decline in foreign exchange rate volatility.
2.1.4 Effect of Exchange Rate Fluctuations on Export
Fluctuations, positive or negative, are not desirable to producers of export products as it has been
found to increase risk and uncertainty international transactions which according to Adubi and
kohmnl Okunmadewa (2013) discourage trade. Findings by the International Monetary fund
(2016) reveal that these fluctuations induce undesirable macroeconomic phenomena inflation;
though Caballero and Carba (2013) observed positive effect of exchange rate fluctuations on
export trade in European Union countries. Viewing the effect of these fluctuations from first from
its impact on foreign direct investment, Walsh and Yu (2014) noted that low exchange rate favour
the importation of productions machinery, and production and export in periods of high foreign
exchange rate. Furthering, Foot and Stein (2015) found a strong evidence of a weak host country
currency increase inward foreign direct investment within an imperfect capital market model as
depreciation (down change in exchange rate) makes a host country less expensive than export
destination countries. Making a firm-specific-asset analysis argument, Blonigen (2015) argued that
exchange rate depreciation in host countries tend to increase foreign direct investment inflows;
adding that a strong real exchange rate strengthens the incentives of foreign companies to produce
at home for export instead of investing in a host country for export.
To Lama and Medina (2014), different open economies experience different episodes of exchange
rate appreciation in response to different types of stocks, contending that an appreciation in
exchange rate induces a contraction of the exporting manufacturing sector. Maintenance of export
performance to them require the depreciation of the real exchange rate of a country’s currency, the
achievable through monetary injections; noting that a policy of exchange rate depreciation can
successfully prevent a contraction of export output, having an allocative effect in the economy.
Adubi and Okunmadewa (2013) posited that Nigeria, a developing nation, is expected to gain from
export conversion price increase as a result of currency devaluation. Findings by Obadan (2016)
and Osuntogun, Edordu, and Oramah. (2015) on the effect of stable exchange on export
performance showed that exchange rate affect a country’s export performance; adding that
instability in an exchange rate with its attendant risk affect export earnings, performance and
growth: positive to exporters when devalued.
Poor results from the floating exchange regimes of the 1970’s necessitated a change in foreign
exchange rate management. The structural adjustment program was introduced in 1986 with the
cardinal objective of restructuring the production base of the economy with a positive bias for
agricultural export production. This reform facilitated the continued devaluation of the Nigerian
naira with the expected increase in domestic prices of agricultural export boasting domestic
production.
2.1.5 Manufacturing Sector Export in Nigeria
Non-oil export performance was poor from 1980-1984. Nigeria’s total non-oil export resulted in a
net inflow of foreign exchange totaling N362.1million (in naira value) in 1984. This contrasted
with the net inflows of N244.8 million in 1983 and N1.398billion in 1982. Export performance
maintained a fairly stable growth rate of 19% to 1989, reducing sharply to 5% annual growth rate
to N21.8765billion in 1993; with a 5% decline in 1994. Nigeria’s export trade is dominated by oil
exports accounting for 95% of her export value. Notwithstanding, improvements have been
recorded in the non-oil exports.
From non-oil export value of N23, 096.1m in 1995, contributions from this sector of the economy
increased to N95.09 billion (unadjusted) at the end 2003.
Export items from Nigeria, as in the world over, are measured using the Standard International
Trade Classification (SITC) of the quantities and values of goods moved out of the country. It
classifies export goods into 10 main groupings with codes 0-9. These are: 0-Food and live animals;
1- beverage and tobacco; 2-crude materials, inedible; 3-mineral fuel; 4-animal and vegetable oil;
5- chemicals; 6-manufactured goods; 7-machinery and transport equipment; 8-miscellaneous
manufactured articles and; 9-Miscellaneous transactions unclassified.
Nigeria according to the Central Bank of Nigeria (2016) has recorded consistently surpluses in its
trade balance. However, this has fluctuated widely along with petroleum export earnings. The
balance in services and income, on the other hand, has consistently been in deficit, reflecting
Nigeria’s position as a net importer of services. The current account deficit was reduced from US$
5.1 Billion in 2002 to US $1.6 Billion in 2003.
Exports are pivotal to Nigeria’s development prospects, as they have been a major driver of
economic growth, employment, and government revenue, and carry potential for poverty
reduction.
Since 1999, merchandise exports have accounted for between 34% and 52% of GDP; its share was
47.6% in 2003. Nigeria’s exports are dominated by crude oil and natural gas. Together, these two
commodities have accounted for between 95% and 99% of total merchandise exports (WTO 2015),
thus rendering export performance heavily susceptible to the vagaries of the international oil
market. In 2003, Nigeria was the third largest oil exporter amongst the members of the organization
of the petroleum exporting countries (OPEC), and the fifth largest in the world (OPEC 2004;
quoted by WTO 2015). Her oil earnings increased from US$17.7 billion in 2002 to US $27.4
billion in 2003 on account of the increased in its OPEC quota and in international oil market prices.
Exports of natural gas rose significantly from US $27 million in 1999 to US $1.7 billion in 2003,
contributing to the diversification of Nigerian exports. This could be attributable to Nigerian
government effort to reduce the level of gas flaring associated with oil production, as well as
measures to encourage the exploitation of Nigeria’s huge natural gas resource, largely untapped
until recently.
Non-oil exports, although relatively small, contribute to export diversification and serve as a
channel for poverty reduction. Non petroleum exports comprise agricultural products such as palm
nuts and kernels, sesame seeds, cocoa beans; and some manufactured products including
chemicals, corrugated asbestos sheets, machinery and transport equipment. The growth in this
export category is inhibited by uncertainties in world commodity prices, unstable domestic macro-
economic environment, supply side constraint (high cost of finance and infrastructural facilities)
and other factors affecting the competitiveness of her exports. In the face of these impediments,
the value of exports of products in this category increased from US$ 21.1 Million in 1999 to US$
735.1 Million in 2003; maintaining a 10% annual growth rate to 2005.
These exports are distributed across a large number of countries, but most were to industrialized
countries. In 2003, 72% of merchandise exports were to industrialized countries, of which the
United States accounted for 40% (mostly under the African growth and opportunity Act).
Exports to the European Union improved largely due to Cotonou agreement. Exports to African
and Asian Countries accounted for10% and 11% of total merchandise export respectively.
Exports in services have been insignificant. These performances have not met the export policy
expectations of the Nigerian government. Production for exports and local consumption stood at
45% of production capacity in 2005, compared to 53.0% in the NEEDS document. Non-oil income
in 2005 stood at N95.092 billion compared to N19.492 billion in 1999. Export growth rate was
7.51% compared to target of 10%. Growth in non-oil earning target was 5.0% and actual was 3.2%
for 2003; 5% target for 2004 and actual was 3.6%. Utilisation under AGOA scheme was only 40%,
falling short of the 100% target; a clear proof of underutilization of favourable export policy.
Countries at comparable levels of economic development with similar export policy targets, for
example the Central African Republic and Brazil, performed expectedly in response to export drive
policies initiated locally and through trade agreements. Brazil recorded 26% annual growth rate in
export in her agribusiness sector between 2000 and 2005 surpassing the target of 20%; while
exports to developed countries grew at annual rate of 13%, also surpassing the target of 10%. The
Country currently ranks first among world exporters of sugar, ethanol, beef, chicken, pork, coffee,
soy, orange juice and cotton (Veiga; 2008). Export performance of the Central African Republic
showed an increase in export value from US$ 87 million in 1997 to US $118.7 million in 2005, a
36.4 % increase (WTO 2007).
2.1.6 The Effect of Exchange Rate Changes on Business
The results of companies that operate in more than one nation often must be "translated" from
foreign currencies into U.S. dollars. Exchange rate fluctuations make financial forecasting more
difficult for these companies, and also have a marked effect on unit sales, prices, and costs. For
example, assume that current market conditions dictate that one U.S. dollar can be exchanged for
125 Japanese yen. In this business environment, an American auto dealer plans to import a
Japanese car with a price of 2.5 million yen, which translates to a price in dollars of $20,000. If
that dealer also incurred $2,000 in transportation costs and decided to mark up the price of the car
by another $3,000, then the vehicle would sell for $25,000 and provide the dealer with a profit
margin of 12 percent.
But if the exchange rate changed before the deal was made so that one dollar was worth 100 yen
in other words, if the dollar weakened or depreciated compared to the yen—it would have a
dramatic effect on the business transaction. The dealer would then have to pay the Japanese
manufacturer $25,000 for the car. Adding in the same costs and mark up, the dealer would have to
sell the car for $30,000, yet would only receive a 10 percent profit margin. The dealer would either
have to negotiate a lower price from the Japanese manufacturer or cut his profit margin further to
be able to sell the vehicle.

Under this FX scenario, the price of American goods would compare favorably to that of Japanese
goods in both domestic and foreign markets. The opposite would be true if the dollar strengthened
or appreciated against the yen, so that it would take more yen to buy one dollar. This type of
exchange rate change would lower the price of foreign goods in the U.S. market and hurt the sales
of U.S. goods both domestically and overseas.
Independent Variables Dependent Variable
Real Effective Exchange

rate
Parallel Exchange rate
Interest rate
Return on Equity
Inflation rate
Money supply
Figure 2.1: Diagrammatical Representation of Foreign Exchange Rate Variables
Source: Researchers Computation 2017
2.1.7 Exchange Rate
The exchange rate is the rate at which one currency is exchanged for another. It is the price of one
currency in terms of another currency (Jhingan, 2015). Exchange rate is the price of one unit of
the foreign currency in terms of the domestic currency. The debate over what determines the choice
of exchange rate regimes has continued unabated over some decades now. Friedman (2013) argued
that in the presence of sticky prices, floating rates would provide better insulation from foreign
shocks by allowing relative prices to adjust faster. His popular support for floating exchange rate
stipulates that in the long run the exchange rate system does not have significant real consequences.
His reasoning is that the exchange rate system is ultimately a choice of monetary regimes. In the
end, monetary policy does not matter for real quantities, but in the short run it does. While
Mundell’s (2013) posits that in a world of capital mobility, optimal choice of exchange rate regime
should depend on the type of shocks hitting an economy: real shocks would call for a floating
exchange rate, whereas monetary shocks would call for a fixed exchange rate.
Traditionally, it has been argued that a country’s optimal real exchange rate is determined by some
key macroeconomic variables and that the long-run value of the optimal real exchange rate is
determined by suitable (permanent) values of these macroeconomic variables (Williamson, 2014).
Incidentally, since the fall of Bretton-Woods system in 1970s and the subsequent introduction of
floating exchange rates, the exchange rates have in some cases become extremely volatile without
any corresponding link to changes in the macroeconomic fundamentals.
This however has led to higher interest in exchange rate modeling as the question of exchange rate
determination reveals to be one of the most important problems on theoretical field of monetary
macroeconomics. The options available to countries for adopting a particular exchange rate
regimes range from floating arrangements at one extreme to firmly fixed arrangements at the other
extreme, with the remaining regimes falling on a continuum in between.
These include pegs, target zones, and fixed but adjustable rates. As exchange rate management
have a defining goal of exchange rate stability, the fixed exchange rate regime and its variants are
more relevant. A fixed exchange rate system is one in which exchange rates are maintained at fixed
levels. Each country has its currency fixed against another currency, and it is seldom changed. For
example, Nigeria maintained fixed exchange rates from the time of attainment of political
independence in 1960 till the breakdown of the Bretton Woods Monetary System in the early
1970s. There are two major reasons why fixed exchange rates are appealing. They are to promote
orderliness in foreign exchange markets and certainty in international transactions. Some of the
variants of fixed exchange rates are as follows:

i. Crawling Peg
This exchange rate arrangement is a middle course between fixed and flexible exchange rates. It
is appropriate for countries that have significant inflation compared with their trading partners, as
has often been the case in Latin America.
Under the crawling peg, the government fixes the exchange rate on any day but over time adjusts
the rate in a pre-announced fashion, taking into consideration the inflation differentials between it
and its major trading partners. Essentially, the peg can be either passive, meaning that the exchange
rate is altered in light of past inflation, or active, whereby the country announces in advance the
exchange rate adjustments it intends to make. The advantage of this peg is that it combines the
flexibility needed to accommodate different trends in inflation rates between countries while
maintaining relative certainty about future exchange rates relevant to exporters and importers. The
disadvantage is that the crawling peg leaves the currency open to speculative attack because the
government is committed on any one day or over a period to a particular value of the exchange
rate.
ii. Adjustable Peg Exchange Rate
This refers to the system in which a national currency is pegged to a key currency, for example,
the U.S dollar, but the level of the peg could be changed occasionally, albeit within a narrow band.
This exchange rate regime features a strong exchange rate commitment, and its adherents before
the currency crises of the mid- and late 1990s, included Brazil, Mexico and Thailand. In these
emerging market economies, where capital mobility increased steadily during the 1970s and 1980s
and up to a high point in the 1990s, the authorities had difficulties in maintaining the peg (Corden,
2013). However, it is still workable for countries that have low capital mobility either because they
are not integrated with the capital markets (like some very poor countries) or because they have
effective capital controls (e.g. China).
iii. Target Zone
This is a compromise between floating rates and fixed but adjustable rates and is a popular regime.
Under it, a central rate that can be fixed, crawling or flexible is surrounded by a band within which
the central rate is permitted to float. It allows for flexibility among a country’s policy objectives.
It is also said to prevent extreme movements in the exchange rate.
iv. Currency Peg
In a currency peg a local currency is pegged to an external currency, e.g., that of a dominant trading
partner or to a basket of currencies, with weights reflecting the shares of the countries in foreign
trade. Pegging to a single currency may yield a number of advantages, one of which is the reduction
in the exchange rate fluctuations between the focus country and the country to which it is pegged.
This facilitates trade and capital flows between the two countries. One major weakness of the
single currency peg, however, is that where the currency is pegged to a floating currency, e.g., the
dollar, the local currency will float along with the dollar vis-à-vis other currencies. Another
disadvantage is that movements in the exchange rate in relation to the currencies of other countries
may interfere with domestic macroeconomic policy objectives.
In an attempt to stabilize its effective exchange rate the developing country may peg its currency
to a basket of currencies. Often this entails the weighted average of several currency values, the
resulting exchange rate being total trade-weighted, export weighted or import-weighted. One
major advantage of pegging to a basket is that a country may be able to avoid large fluctuations in
its exchange rate with respect to several trading partners’ currencies. Consequently, it is able to
stabilize its nominal effective exchange rate. Another advantage is that the system results in the
reduction of price instability which arises from exchange rate changes.
However, one major disadvantage of the basket peg is the determination of the exchange rate
without reference to the domestic policies of the pegging authorities. Another is that a basket-
weighted exchange rate, which, by definition, moves against all major currencies, might reduce
confidence on the part of foreign investors and reduce capital inflows.
2.1.8 Real Effective Exchange Rate (REER)
Real Effective Exchange Rate (REER) is a measure of the trade-weighted average exchange rate
of a currency against a basket of currencies after adjusting for inflation differentials with regard to
the countries concerned and expressed as an index number relative to a base year.
The nominal effective exchange rate (a measure of the value of a currency against a weighted
average of several foreign currencies) is measured with nominal parts, i.e. without taking into
consideration the differences between the purchasing power of the two currencies, whereas the
real effective exchange rate includes price indices and their trends. The REER is NEER with price
or labour cost inflation removed from it. A comparison of the REER of a number of countries can
show which ones have gained and which ones have lost some of their international
competitiveness.
REER is also seen as the average of the bilateral Real Exchange Rates (RER) between the country
and each of its trading partners, weighted by the respective trade shares of each partner. Being an
average, the REER of a country can be said to be in equilibrium if it is found overvalued in relation
to one or more trading partners whilst also being undervalued to the others.
Real Effective Exchange Rates are used for an array of purposes such as assessing the equilibrium
value of a currency, the change in price or cost competitiveness, the drivers of trade flows, or
incentives for reallocation production between the tradable and the non-tradable sectors. Due to
the significance of the REER in economic research and policy analysis, multiple institutions
including well-known bodies like the World Bank, the Eurostat, the Bank for International
Settlements (BIS), the OCED, Bruegel and others publish various REER indicators for free public
access. All these institutes combined publish data for 113 countries that contain all advanced and
several emerging and developing countries. However, different databases have different
methodologies, and even the 109 countries included in the World Bank database miss plenty of
countries of the world.
2.1.9 Interest Rate
Interest rate is the amount charged, expressed as a percentage of principal, by a lender to a
borrower for the use of assets. Interest rates are typically noted on an annual basis, known as the
annual percentage rate (APR). The assets borrowed could include, cash, consumer goods, large
assets, such as a vehicle or building. Interest is essentially a rental, or leasing charge to the
borrower, for the asset's use. In the case of a large asset, like a vehicle or building, the interest rate
is sometimes known as the "lease rate". When the borrower is a low-risk party, they will usually
be charged a low interest rate; if the borrower is considered high risk, the interest rate that they are
charged will be higher.
In the past two centuries, interest rates have been variously set either by national governments or
central banks. For example, the Federal Reserve federal funds rate in the United States has varied
between about 0.25% to 19% from 1954 to 2008, while the Bank of England base rate varied
between 0.5% and 15% from 1989 to 2009, and Germany experienced rates close to 90% in the
1920s down to about 2% in the 2000s, Mankiw, (2012). During an attempt to tackle spiraling
hyperinflation in 2007, the Central Bank of Zimbabwe increased interest rates for borrowing to
800%, (worldeconomice.co.uk, 2012).
The interest rates on prime credits in the late 1970s and early 1980s were far higher than had been
recorded – higher than previous US peaks since 1800, than British peaks since 1700, or than Dutch
peaks since 1600; since modern capital markets came into existence, there have never been such
high long-term rates as in this period.
Possibly before modern capital markets, there have been some accounts that savings deposits could
achieve an annual return of at least 25% and up to as high as 50%. (William Ellis and Richard
Dawes, Lessons on the Phenomenon of Industrial Life
Reasons for interest rate changes
i. Political short-term gain: Lowering interest rates can give the economy a short-run boost.
Under normal conditions, most economists think a cut in interest rates will only give a short
term gain in economic activity that will soon be offset by inflation. The quick boost can
influence elections. Most economists advocate independent central banks to limit the
influence of politics on interest rates.
ii. Deferred consumption: When money is loaned the lender delays spending the money on
consumption goods. Since according to time preference theory people prefer goods now to
goods later, in a free market there will be a positive interest rate.
iii. Inflationary expectations: Most economies generally exhibit inflation, meaning a given
amount of money buys fewer goods in the future than it will now. The borrower needs to
compensate the lender for this.

iv. Alternative investments: The lender has a choice between using his money in different
investments. If he chooses one, he forgoes the returns from all the others. Different
investments effectively compete for funds.
v. Risks of investment: There is always a risk that the borrower will go bankrupt, abscond,
die, or otherwise default on the loan. This means that a lender generally charges a risk
premium to ensure that, across his investments, he is compensated for those that fail.
vi. Liquidity preference: People prefer to have their resources available in a form that can
immediately be exchanged, rather than a form that takes time to realize.
vii. Taxes: Because some of the gains from interest may be subject to taxes, the lender may
insist on a higher rate to make up for this loss.
viii. Banks: Banks can tend to change the interest rate to either slow down or speed up economy
growth. This involves either raising interest rates to slow the economy down, or lowering
interest rates to promote economic growth.[14]
ix. Economy: Interest rates can fluctuate according to the status of the economy. It will
generally be found that if the economy is strong then the interest rates will be high, if the
economy is weak the interest rates will be low.
2.1.10 Inflation Rate
The concept of inflation has been define as a persistence rise in the general price level of broad
spectrum of goods and services in a country over a long period of time. Inflation has been
intrinsically linked to money, as captured by the often heard maxim “inflation is too much money
chasing too few goods”. In the view of Hamilton (2012) inflation has been widely described as an
economic situation when the increase in money supply is “faster” than the new production of goods
and services in the same economy. According to Piana (2012), economists usually try to
distinguish inflation from an economic phenomenon of a onetime increase in prices or when there
are price increases in a narrow group of economic goods or services.
Inflation is described by Ojo (2013) and Melberg (2012) as a general and persistent increase in the
prices of goods and services in an economy. Inflation rate is measured as the percentage change in
the price index (consumer price index, wholesale price index, producer price index etc). In the
opinion of Essien (2012) he states that the consumer price index (CPI), for instance, measures the
price of a representative basket of goods and services purchased by the average consumer and
calculated on the basis of periodic survey of consumer prices. Owing to the different weights the
basket, changes in the price of some goods and services have impact on measured inflation with
varying degrees. There are several disadvantages of the CPI as a measure of price level. First, it
does not reflect goods and services bought by firms and/or government, such as machinery.
Secondly, it does not reflect the change in the quality of goods which might have occurred
overtime. Thirdly, changes in the price of substitutable goods are not captured. Lastly, CPI basket
usually does not change often. Despite these limitations, the CPI is still the most widely used
measurement of the general price level. This is because it is used for indexation purposes for many
wage and salary earners (including government employees). Another measure of inflation or price
movements is the GDP Deflator. This is available on an annual basis. However, it is rarely used
as a measure of inflation. This is because the CPI represents the cost of living and is, therefore,
more appropriate for measuring the welfare of the people. Furthermore, because CPI is available
on a more frequent basis, it is useful for monetary policy purposes. In recent times, there have been
three dominant schools of thought on the causes of inflation; the neo-classical/monetarists, neo-
Keynesian, and structuralists. The neo-classical/monetarists opine that inflation is driven mainly
by growth in quantum of money supply. However, practical experiences of the Federal Reserve in
the United States (US) have shown that this may not be entirely correct. Hamilton (2012) and
Colander (2015) the US money supply growth rates increase faster than prices itself. This has been
traced to the increased demand for the US dollar as a global trade currency. The neo-Keynesian
attributes inflation to diminishing returns of production. This occurs when there is an increase in
the velocity of money and excess of current consumption over investment. The structuralist
attribute the cause of inflation to structural factors underlying characteristics of an economy
(Adams, 2015). For instance, in the developing countries, particularly those with a strong
underground economy, prevalent hoarding or hedging, individuals expect future prices to increase
above current prices and, hence, demand for goods and services are not only transactionary, but
also precautionary. This creates artificial shortages of goods and reinforces inflationary pressures.
The literature is replete with those factors that could affect the level of inflation. These factors can
be grouped into institutional, fiscal, monetary and balance of payments. Several studies such as
Melberg (2012); Cukierman, Webb and Neyapti (2014); Grilli, et al (2014); Alesina and Summers
(2012); Posen (2012); Pollard (2015); and Debelle and Fisher (2015) have shown that the level of
independence (legal, administrative, and instrument) of the monetary authority is an important
institutional factor determines inflation, especially, in industrialized countries, while rate of
turnover of central bank governors in developing countries was seen as an important factor
influencing inflation. However, caution should be exercised in the interpretation of these findings,
given the difficulty in measuring the actual level of independence of a central bank. The fiscal
factors relate to the financing of budget deficits, largely through money creation process. Under
this view, inflation is said to be caused by large fiscal imbalances, arising from inefficient revenue
collection procedures and limited development of the financial markets, which tends to increase
the reliance on seiniorage as a source of deficit financing (Agenor and Hoffmaister, 2016; and
Essien, 2015). The monetary factors and demand side determinants include increases in the level
of money supply in excess of domestic demand, monetization of oil receipts, interest rates, real
income and exchange rate (Moser, 2015). Alesina and Summers (2013) prudent monetary
management was also found to aid the reduction in the level and variability in inflation. The
balance of payments or supply side factors, relate to the effects of exchange rate movements on
the price level. Melberg (2012); Odusola and Akinlo (2014) and Essien (2015) opined that
exchange rate devaluation or depreciation includes higher import prices, external shocks and
accentuates inflationary expectations.
Inflation Targeting in Developing Economies
The hallmark of inflation targeting is the announcement by government, the central Bank, or some
combination of the two that in the future the central Bank will strive to hold inflation at or near
some numerically specified level. Inflation targets are more often than not specified as for example
1-3 percent, rather than single number and are typically established for multiple horizons ranging
from one to four years (Bermanke & Mishkin 2013). However, Tutar (2012), reported that the
centre point of inflation target is referred to as their interpretation of the operational definition of
price stability. While in theory of inflation appears to be equal to price stability, in practice, the
concept of price stability is influenced by some other issues like price level measurement, and
nominal rigidity. The rationale for treating inflation as a primary goal of monetary policy is clearly
strongest when medium –to– long term horizons are considered, as most economists agree that
monetary policy can affect real quantity such as output and employment only in the short run. Of
course, some economists of new classical or monetarist persuasions might claim that inflation
should be the sole concern of monetary policy in the short run as well as arguing that using
monetary policy in the short run stabilization of real economy is undesirable, infeasible or both.
However in practice, central bank has completely for sworn the used of monetary policy for short
run stabilization, and so phraseology “primary” or “overriding” must be taken to refer to longer
term. However, what appeared to be more comprehensive regarding the concept of inflation
targeting was the one provided by Eichgreen (2013) where he defined inflation targeting as
follows: “a monetary policy operating strategy with four elements; an institutionalized
commitment to price stability as the primary goal of monetary mechanism rendering the central
bank accountable for attaining its monetary policy goals; the public announcement of target
inflation; and policy of communicating to the public and the markets the rationale for the decision
taken by central bank”.
To state it clearly, an inflation targeting arrangement is not just about public pronouncement of an
inflation target/range. Important features of an inflation target arrangement include the definition
of what type of inflation is being targeted, the inflation target range, the use of exclusion clauses
or caveat (for example under what circumstances the central bank is able to overshoot its target),
and the target horizon. All this information needs to be publicly available and fully transparent.
Also the definition provided by Mishkin (2014) captures most of the issues raised in the literature.
“Inflation targeting is a monetary policy strategy that encompasses five main elements i) the public
announcement of medium term numerical target of inflation; ii) an institutional commitment of
price stability as the primary stability as the monetary policy, to which other goals are
subordinated; iii) an information inclusive strategy in which many variables and not just monetary
aggregates or the exchange are used for deciding the setting of policy instruments; iv) increased
transparency of monetary policy strategy through communication with the public and markets
about the plans, objectives and decisions of monetary authorities; v) increased accountability of
the central bank for attaining its inflation objectives”. The above description of inflation targeting
is not totally different from others, but only the all inclusive nature of the definition and little bit
of including many variables. However, Bulir (2015) used three key inflation targeting
communication tools – inflation targets, inflation forecasts, and verbal assessments of inflation
factors contained in quarterly inflation reports provided consistent message in five out of six
countries; Chile, the Czech Republic, Hungary, Poland, Thailand and Sweden. However, no single
central Bank, according to him in the sample stands out as an exceptionally good forecaster of
inflation and communication of its policies.
Conceptually, inflation targeting (IT) decreases a monetary policy framework in which central
banks accept and announce certain targets of inflation, over a given period of time, as measure of
policy anchor and are accountable for deviation of actual from set of targets. Three main forms of
inflation targeting have been identified: (I) full fledge IT (FFIT), that is, when a country is ready
to adopt IT as its single nominal anchor upon which macroeconomic stability would be achieved.
This is suitable for countries with robust or sound financial environment, and a central bank, which
is transparent, accountable and highly committed to the attainment of the goal of IT. (ii) Electric
IT (EIT) when a country, for instance pursues IT along with other monetary policy objectives in a
stable financial environment which, however, is less accountable and transparent. (iii) Inflation
targeting lite (ITL), low profile forms of inflation targeting pursued by countries, largely due to
lack of strong or credible macroeconomic environment. ITL countries float their exchange rate and
announce an inflation target, but are not able to maintain the inflation target as the foremost policy
objective. A number of emerging market economies are practitioners of ITL. It is agreed also that
FFIT is not possible in ITL countries because of the following;
i. Lack of sufficiently strong fiscal position and high debt/GDP ratio.
ii. Lack of a fully developed monetary and financial system.

iii. Vulnerability of economic shocks (especially supply shocks) owing to their low degree of
development.
iv. Lack of transparency in the operation and implementation of monetary policy (Englama
and Aliyu, 2015). In practice, all types of monetary policy involve modifying the amount
of base currency (Mo) in circulation.
This process of changing the liquidity of base currency through the open sales and purchases of
(government-issued) debt and credit instruments is called open market operations. Constant market
transactions by the monetary authority modify the supply of currency and this impacts other
variables such as short-term interest rates and exchange rate. The distinction between the various
types of monetary policy lies primarily with the set of instruments and variables that are used by
the monetary authority to achieve their goals.
Countries Experience with Inflation Targeting
Since the early 1990, many emerging economies switched to inflation targeting as their monetary
policy regime. These countries have different economic environments and hence decided to follow
a policy suitable to a specific economic. These countries are categorized into three. First countries
with relatively strong financial market fundamentals, such as a stable macroeconomic
environment, and independent countries moved to inflation targeting with flexible exchange with
specific inflation targets to be achieved over the specified period. The second group is countries
did not have the same environment and switched to inflation targeting with tolerance bands. Third
group of countries had difficulty in maintaining specific target due to a less credible central bank
and adopted a policy of inflation targeting lite. Chile (2012), Peru (2016), and Mexico (2014) used
the “big bang” approach, while Chile followed a gradual converge towards full-fledge (Khalid
2015). Batini and Laxton (2015) compared the performance of emerging economies who adopted
an I.T regimes (IT user) and those who did not (non-I.T users) over the period of 15 years. They
observed high inflation in all sampled countries in the early to mid-1990.Although, inflation tends
to fall in all sampled countries, they observed higher inflation for non-IT users countries with a
range of 3.5% this reflect the success of IT in emerging economies. In a study conducted by Ye,
and Lin (2014) on the effect of inflation targeting in thirteen (13) developing countries, using
variety of propensity score matching methods, their result shows that on the average, inflation
targeting has large and significant effects of lowering both inflation and inflation variability in
these thirteen countries. However, the effect of inflation targeting on lowering inflation is found
to be quite heterogeneous. The performance of a given inflation regimes can be affected by
country’s characteristics such as government fiscal position of exchange rate, its willingness to
meet the precondition of policy adoption and time length.
Also, in the context of a simple empirical model, Aizenman, Hitchison, Noy (2014) have proven
using panel data for 17 emerging markets both IT and non- IT observed that a significant and stable
response running from inflation to policy interest rates in emerging markets that are following
publically announced IT policies. By contrast, Central Banks respond much less to inflation in
non- IT regimes. They allocate for a “Mixed IT Strategy” whereby both inflation and exchange
rates are important determinants of policy interest rates.
The theory regarding the determination of price level, and changes in price level is the quantity
theory of money. This theory in its simplest form postulates a direct proportional relationship
between money supply and price level. According to the theory if money supply were doubled,
prices would increase proportionately.

Several studies after this formulation have shown that money supply is significant in explaining
inflation in both advanced and developing economies. Among such studies are those of Akinifesi,
Owosekun and Odama, Osakwe, Adeyokunu and Ladipo, Moser, Tanzi, Ikhide, and Aigbokhan.
2.1.11 Money Supply
According to Osiegbu, (2015) money is a dynamic instrument on the economy. It acts as an
indispensable lubricant of the economic machine without which production and exchange would
be limited. Money makes savings easier and simplifying lending. By the use of money, it is
possible to mobilize the surpluses of other members of the public and lend them out for
investments. Money in many ways speeds up the economic process. Osiegbu further gave the
classification of money as (a) currency outside the banks which is currency in circulation less vault
cash in banks. (b) demand deposit i.e money in the fixed deposit or current account. (c) M1 which
denotes note currency which could be used as medium of exchange. (d) M2 which denotes M1 plus
fixed and savings account. (e) Quasi money which Osiegbu (2015) posits that it qualified as postal
order, money order, treasury bills, shares, bonds etc. (f) M3 are deposits with companies, mortgage
banks, finance houses etc. M1 and M2 is use for money in circulation for the purpose of this study.
Money is used in virtually all economic transactions, it has a powerful effect on economic activity.
An increase in the supply of money works both through lowering interest rates which spurs
investment and through putting more money in the hands of consumers, making them feel
wealthier and thus stimulating spending. Business firms respond to increased sales by ordering
more raw materials and increasing production (Afolabi, 2016). The spread of business activity
increases the demand for labor and raises the demand for capital goods.
Also in a buoyant economy, stock market prices rise and firms issue equity and debt. If the money
supply continues to expand and prices begin to rise, especially if output growth reaches capacity
limits. As the public begins to expect inflations, lenders insist on higher interest rates to offset on
expected decline in purchasing power over the life of their loans.
Opposite effects occurs when the supply of money falls or when its rate of growth declines.
Economic activity declines either disinflation (reduced inflation) or deflation (falling prices)
results (Anyanwu, 2015).
2.1.12 Interest and Exchange Rates Management in Nigeria
Interest rate management refers to the totality of steps and processes designed and used by the
monetary authorities (the CBN) to determine, sustain or support the level of interest rates in an
economy in ways that engender the achievement of the stated macroeconomic goals of price and
exchange rate stability, rapid and sustainable employment, and generating growth. Interest rate
management also entails anticipating the financial markets and developing appropriate policy
measures to impact the markets using known monetary tools. It needs to also ensure that rates do
not fall to levels where the liquidity trap ensnares the economy. (Liquidity trap - the level of interest
rate below which further reductions will not impact on the level of economic activities/national
income).
Interest rate and foreign exchange rate risks are two significant economic and financial factors that
affect the common stock value. Interest rate, which reflects the price of money, has an effect on
other variables in money and capital markets. The interest rates indirectly affect the valuation of
the stock prices and also its volatility directly creates a shift between the money market and capital
market instruments. Interest rate volatility influences the valuation of the stocks by affecting the
basic values of the firm, such as net interest margin, sales and etc. An increase in interest rates
negatively affects the value of assets by increasing the required rate of return. Furthermore, an
increase in interest rates leads investors to change the structure of his/her investment from capital
markets to fixed-term income securities market. Conversely, a decline in interest rates leads to an
increase in the present value of the future dividends (Hashemzadeh and Taylor, 2014). Interest rate
is considered as one of the most significant determinants of the stock prices (Modigliani and Chon,
2016).
Volatility in the foreign exchange rate is the one of the other major sources of macroeconomic
uncertainty that affects the firms. After the financial liberalization and deregulation after 1970s
and the adoption of the floating exchange rate regime, many countries are exposed to the foreign
exchange rate volatility. Foreign exchange rate volatility influences the value of the firm since the
future cash flows of the firm will change with the fluctuations in the foreign exchange rates.
According to Luehrman (2013) depreciation of a currency of a country affects the competitiveness
of the firms engaged in international competition by leading an increase in the demand for its
export goods. Also, Adler and Dumas (2014) reported that although firms whose operations are
widely domestic may be influenced by the fluctuations in the foreign exchange rates as their input
and output prices may be affected by the currency movements. At the same time, if the country is
import denominated, the weak currency may have a negative impact on the country due to the
increase in the cost of imported goods.
Studies on the determinants of interest rates in Nigeria have been generally scanty. These include
Ndekwu (2014), which examined the relationship between interest rates, bank deposit and
economic growth in Nigeria; Ajakaiye and Omole (2014), which studied the impact of commercial
bank lending rates on inflation in Nigeria; Ogwumike and Omole (2013), which examined the role
of interest rates in domestic resource mobilization; and Omole and Falokun (2012), which
examined how interest rate influences corporate financing strategy. Others include Teriba (2012),
which studied the determinant of the information content of Interest Rate Spread (IRS) in Nigeria;
and Busari (2015), which examined the role of interest rates in economic activities in Nigeria;
Adebiyi and Babatope-Obasa (2014) which examined institutional framework, interest rate policy
and the financing of the Nigerian Manufacturing sub-sector, a paper presented at the 2004 Paper
Forum, Lord Charles Hotel, Somerset West, South Africa. However, in spite of all these studies,
work on interest rate determination in Nigeria is an area that has not received much attention. The
work of Uwatt and Onwioduokit (2016) would have been a good example of this but the study is
flawed in that it covers largely the period of regulation when interest rate was administratively
fixed. While work of Busari, Olayiwola and Olaniyan (2015) would also have been a good example
but the study is also flawed in that it covers the period of deregulation.
This study represents an attempt to bridge the gap of regulation and deregulation.
From international perspective, Omar, (2013) studied the differential impact of real interest rates
and credit availability on private investment: Evidence from Venezuela and maintained that,
according to the financial liberalization theory, we should expect that in economies with very low
or negative real interest rates, a positive shock to interest rates would cause a positive effect on
private investment while the same effect is negative, according to the traditional theory, at higher
rates. Other international studies include Patnaik and Vasudevan (2014), which studied interest
rate determination (India): An Error Correction Model (ECM) and David and Folawewo studied
investigation on macroeconomic and market determinants of banking sector interest rate spreads:
empirical evidence from low and middle income countries with conclusion that despite the
widespread implementation of costly financial sector reform programmes in the developing world,
banking sectors in many developing countries are still characterized by persistently high interest
rate spreads (IRS).

2.1.13 What Makes Currencies Fluctuate
A foreign exchange rate is a price or a numerical expression of value of the currency of one country
in terms of that of another country at any given time. Having established the reasons why firms/
banks trade in foreign exchange and the motives for the transaction, it is pertinent to review those
factors which make currencies fluctuate.
Most authorities believes that currencies movement are caused by some or all of the following
factors which influence the demand and supply of each currency in the market.
i. Relative price levels and inflation rate
ii. Relative economic growths
iii. Relative interest rates, especially in the freely traded money market like the Euro currency
market.
iv. Relative change in the money supply in the currency areas (countries) concerned
v. Investment or portfolio preferences of big international investors like the OPEC countries.
vi. Bandwagon affects (if a currency seems to be on the way up, speculators may exaggerate
to trend by buying in the hope of a quick profit)
vii. Intervention by central banks
viii. Interest rate arbitrage.
Any of the above factors can independently or in conjunction with other factors affect the value of
a particular currency. It is also important to stress the various causes take different time spans to
operate.
2.2 Theoretical Framework
2.2.1 Balance of Payment Theory of Exchange Rate
The balance of payments theory of exchange rate holds that the price of foreign money in terms of
domestic money is determined by the free forces of demand and supply on the foreign exchange
market, propounded by Bretton Woods in (1970).
It follows that the external value of a country's currency will depend upon the demand for and
supply of the currency. The theory states that the forces of demand and supply are determined by
various items in the balance of payments of a country.
According to the theory, a deficit in the balance of payments leads to fall or depreciation in the
rate of exchange, while a surplus in the balance of payments strengthens the foreign exchange
reserves, causing an appreciation in the price of home currency in terms of foreign currency. A
deficit balance of payments of a country implies that demand for foreign exchange is exceeding
its supply.
As a result, the price of foreign money in terms of domestic currency must rise, i.e., the exchange
rate of domestic currency must fall. On the other hand, a surplus in the balance of payments of the
country implies a greater demand for home currency in a foreign country than the available supply.
As a result, the price of home currency in terms of foreign money rises, i.e., the rate of exchange
improves.
In short, the balance of payments theory simply holds that the exchange rates are determined by
the balance of payments connoting demand and supply positions of foreign exchange in the
country concerned. As such, the theory is also designated as "Demand-Supply Theory."

The theory asserts that, the rate of exchange is the function of the supply of and demand for foreign
money and not exclusively the function of prices obtaining between two countries as asserted by
the Purchasing Power Parity Theory which does not take into account invisible items.
According to the balance of payments theory, the demand for foreign exchange arises from the
“debit” items in the balance of payments, whereas, the supply of foreign exchange arises from the
"credit" items. Since the theory assumes that the demand for and supply of foreign currency are
determined by the position of the balance of payments, it implies that supply and demand are
determined mainly by factors that are independent of variations in the rate of exchange or the
monetary policy.
According to the theory, given demand-supply schedules, their intersection determines the
equilibrium exchange rate of a currency. It should be noted that the lower the price of a currency,
the greater will be the demand for it, and therefore, the demand curve slopes downward. On the
other hand, the supply curve slopes upward from left to right indicating that a lowering of the value
of price of the currency tends to contract its supply.
DD and SS are the demand and supply curves of a given country's currency. These two curves
intersect at a Point P determining PM or OR as the exchange rate where the quantities demanded
and supplied are equal (OM).
It is the equilibrium rate. When OR is the rate exchange (high), supply exceeds demand, hence it
will be lowered by the excessive supply fore When the rate is lowered, supply will contract and
the demand will expand. This process will continue till both are in equilibrium at the point of
intersection. The reverse will happen when the exchange rate is lower than the equilibrium rate.
It goes without saying that changes in demand or supply or both will accordingly influence
equilibrium rate of exchange. This is how the theory brings the determination of the exchanger
within the purview of the general theory of value (or equilibrium analysis).
Merits of Balance of Payment Theory of Exchange Rate
The main merit of the theory is that it brings the determination of exchange rate problem within
the purview of the general equilibrium analysis.
Secondly, the theory stresses the fact that, there are many predominant forces besides merchandise
items (exports and imports of goods) included in the balance of payments which influence the
supply of and demand for foreign exchange which in turn determine the rate of exchange. Thus,
the theory is more realistic in that the domestic price of a foreign money is seen as a function of
many significant variables, not just purchasing power expressing general price levels.
Furthermore, the greatest practical significance of the theory is that, it shows that disequilibrium
in the balance of payments position can be corrected by marginal adjustments in the exchange rate
by devaluation or revaluation rather than through internal price inflation or deflation as implied by
the mint parity theory.
Criticisms of Balance of Payment Theory of Exchange Rate
1. The fundamental defect of the theory is that it assumes perfect competition, including no
interference with the movement of money from one country to another. This is very unrealistic.
2. According to the theory, there is no causal connection between the rate of exchange and the
internal price level. But, in fact, there should be some such connection, as the balance of payments
position may be influenced by the price-cost structure of the country.
3. The theory advocates that the rate of exchange is the function of the balance of payments. But,
in practice it has also been found that the balance of payments position of a country is very much
affected by the changes in the rate of exchange. Thus, it is equally true that the balance of payments
is the function for the rate of exchange. In this sense, the theory is indeterminate as it confuses as
to what determines what.
4. According to the theory, the optimum value of a currency is the gold content embodied in it.
This is not true for a flat paper standard. Thus, the demand-supply theory fails to explain the basic
value incorporated in currencies.
5. In fact, the balance of payments theory of exchange rate is merely a truism - a self-evident fact
without any causal explanatory significance. Critics argue that if payments must necessarily
balance, there can be no meaning to a decline in the exchange rate during an unfavourable trade
balance; an uncovered balance simply does not exist.
2.2.2 Monetary Model of Foreign Exchange Rate
Dornbusch (1976) developed the monetary model in its sticky-price variant. Frenkel (1976) and
Mussa (1976) introduced the monetary model with flexible prices (Smith and Wickens 1986).
After that the monetary model was further developed and empirically tested by Bilson (1978),
Keran (1979), Frenkel (1976), Officer (1981), Hakkio (1982), Frankel (1982), Smith and Wickens
(1986) among many others.
The flexible-price monetary model (associated with Frenkel and Mussa) assumes that prices of
goods are flexible, and that purchasing power parity (PPP) always holds. The assumption about
PPP implies that the real exchange rate is constant over time (Diamandis, Georgoutsos, and
Kouretas, 1996).
The sticky-price monetary model (associated with Dornbusch, 1976) assumes that prices of goods
are sticky in the short run, and that PPP holds only in the long run but does not hold in the short
run because goods prices adjust slowly relatively to asset prices. This model “allows substantial
overshooting for both the nominal and the real price-adjusted exchange rates beyond their long-
run equilibrium (PPP) levels, since the exchange rates and the interest rate compensate for
sluggishness in the goods prices” (Diamandis, Georgoutsos, and Kouretas, 1996).
Both models also assume stable domestic and foreign money demand functions, perfect capital
mobility, and uncovered interest parity.
While the assumptions of the monetary model rarely hold in the real world (especially in the short
run), this model shows theoretically well-grounded relationship between exchange rate, prices,
money, real incomes, and interest rates.
The basic monetary model can be represented the following way:
s = (m - m*) + α1( y - y *) + α2 ( i - i*) + error (1)
where all small letters denote logarithms. Here is nominal exchange rate, m is money supply, y
denotes real income (or industrial production, or real output), i is nominal interest rate. Asterisk
denotes a foreign country. Some researchers also employ difference in inflation4 (π-π*) and
difference in accumulated trade balances5 (tb-tb*).

2.2.3 Purchasing Power Parity Theory of Exchange Rate
Macroeconomic analysis relies on several different metrics to compare economic productivity and
standards of living between countries and across time. One popular metric is purchasing power
parity (PPP).
Purchasing Power Parity (PPP) is an economic theory that compares different countries' currencies
through a market “basket of goods” approach. According to this concept, two currencies are in
equilibrium or at par when a market basket of goods (taking into account the exchange rate) is
priced the same in both countries.
The formula is calculated thus:
P1
S=
P2
Where:
"S" represents exchange rate of currency 1 to currency 2
"P1" represents the cost of good "x" in currency 1
"P2" represents the cost of good "x" in currency 2
To make a comparison of prices across countries that holds any type of meaning, a wide range of
goods and services must be considered. The amount of data that must be collected, and the
complexity of drawing comparisons makes this process difficult. To facilitate this, the
International Comparisons Program (ICP) was established in 1968 by the University of
Pennsylvania and the United Nations. Purchasing power parities generated by the ICP are based
on a worldwide price survey that compares the prices of hundreds of various goods. This data, in
turn, helps international macroeconomists come up with estimates of global productivity and
growth. Every three years, the World Bank constructs and releases a report that compares various
countries in terms of PPP and U.S. dollars.
Both the International Monetary Fund (IMF) and the Organization for Economic Cooperation and
Development (OECD) use weights based on PPP metrics to make predictions and recommend
economic policy. These actions often impact financial markets in the short run.
2.2.4 Uncovered Interest Rate Parity Theory of Exchange Rate
The uncovered interest rate parity (UIP) is a parity condition stating that the difference in interest
rates between two countries is equal to the expected change in exchange rates between the
countries' currencies. If this parity does not exist, there is an opportunity to make a risk-free profit
using arbitrage techniques.
Assuming foreign exchange equilibrium, interest rate parity implies that the expected return of a
domestic asset will equal the expected return of a foreign asset once adjusted for exchange rates.
There are two types of interest rate parity: covered interest rate parity and uncovered interest rate
parity. When this no-arbitrage condition exists without the use of forward contracts, which are
used to hedge foreign currency risk, it is called uncovered interest rate parity.
The formula for uncovered interest rate parity takes into account the following variables:
E(t + k) / S(t) = the expected rate of change in the exchange rate, which is simply the projected
exchange rate at time (t + k) divided by the spot rate at time t
k = the number of time periods into the future from time t

i (c) = the foreign interest rate
i(d) = the domestic interest rate.
2.2.5 Abstinence or Waiting Theory of Interest Rate
The abstinence theory was propounded by Senior, (1989). According to him, interest is a reward
for abstinence. When an individual saves money out of his/her income and lends it to other
individual, he/she makes sacrifice. The term sacrifice implies that the individual refrains from
consuming his/her whole income that he/she could spent easily. Senior advocated that abstaining
from consumption is unpleasant. Therefore, the lender must be rewarded for this. Thus, as per
Senior, interest can be regarded as the reward for refraining from the use of capital.
Abstinence theory was also criticized by a number of economists. According to the theory, an
individual feels unpleasant when they save as it reduces his/her consumption. However, rich
people do not feel unpleasant while saving because they are able to meet their requirements.
2.2.6 Mark-up Theory of Inflation Rate
Mark-up theory of inflation was proposed by Prof Gardner Ackley. According to him, inflation
cannot occur alone by demand and cost factors, but it is the cumulative effect of demand-pull and
cost-push activities. Demand-pull inflation refers to the inflation that occurs due to excess of
aggregate demand, which further results in the increases in price level. The increase in prices levels
stimulates production, but increases demand for factors of production. Consequently, the cost and
price both increases.

In some cases, wages also increase without rise in the excess demand of products. This results in
fall in supply at increased level of prices as to compensate the increase in wages with the prices of
products. The shortage of products in the market would result in the further increase of prices.
Therefore, Prof. Gardner has provided a model of mark-up inflation in which both the factors,
demand cost, are determined. Increase in demand results in the increase of prices of products as
the customers spend more on products.
On the other the goods are sold to businesses instead of customers, then the cost of production
increases. As a result, the prices of products also increase. Similarly, a rise in wages results in
increase in cost of production, which would further increase the prices of products.
So according to Prof Gardner, inflation occurs due to excess of demand or increases in wage rates;
therefore, both monetary and fiscal policies should be used to control inflation. Though, these two
policies are not adequate to control inflation.
2.2.7 The Classical School Theory of Money
For the classical argument, money is insignificant referring to finance as that which suffered
obscurity in the hands of the classical economist. Money was passive and neutral as a causative
factor in the economy Niebyl (1946) and Wallace (2005). The substance of the classical argument
was captured by Mills (1848) who posited that there cannot in short, be intrinsically a more
insignificant phenomenon in the economy of society than money.
2.2.8 The Keynesian Position Theory of Money
The incoming of the Keynesian mainstream however gave more recognition and affection to the
going need of money than the classical. In the era, dominates by this school of mainstream taught,
money was ascribed some measures of importance and so was finance. The work of Keynes titled,
the General theory of money is a case in point which gave impetus to the development of money.
Keynes era created awareness and recognition to something more than money. According to
Ezirim (2005), the sum of the Keynesian argument is that money exerts an indirect influence on
the economy through the vehicle of interest rates thus money started gaining some recognition as
a causative factor in the economy.
2.3 Empirical Framework
In the past, many researchers have explored the relationship between foreign exchange rate and
manufacturing employment. Different methodologies employed have resulted in different results
some contradictory to past evidences where some in support as the case may be. The empirical
results of these studies however were ambiguous and mixed (Campa and Goldberg, 2017)
therefore, a conclusive remark as not been reached. This is not surprising as output effect of
exchange rates (which is expected to be highly correlated with employment) (Changes in
employment are linked to changes in output via a production function) is transmitted via the trade
balance and the foreign trade multiplier. Because the conclusions of the theoretical models of the
trade effect of exchange rate movement are ambiguous, this abates the possibility of concluding a
significant systematic relationship between the exchange rate and employment. Most of the
empirical works on the subject of this study concentrated more on the disaggregated level.
The concern has mostly been with the manufacturing sub-sector where most of the work done
has concentrated on a particular country. The presumed relationship in these studies is negative
that is an appreciation of the currency is expected to lead to a decrease in employment and vice
versa. Some empirical studies established that exchange rate fluctuations have significant negative
effect on employment (Alexandre et al., 2012; Demir, 2012; Frenkel, 1976; Nucci and Pozzolo,
2014; Goldberg and Tracy, 2012; Burgess and Knetter, 2016; Revenga, 2012; Branson and Love,
2013). Some studies on the other hand, found weaker implications of exchange rates for
employment but more pronounced effects for wages (Campa and Goldberg, 2017; Goldberg and
Tracy, 2012). Some studies established positive relationship between exchange rate and general
employment (Ngandu, 2013).
Opaluwa, Umeh and Ameh (2012) examined the impact of exchange rate fluctuations on the
Nigerian manufacturing sector during a twenty (20) year period (1986 – 2005). The variables used
are: MGDP = f (MER, MFPI, EXR), where MGDP is manufacturing gross domestic product, MER
is manufacturing employment rate, MFPI is manufacturing foreign private investment and EXR
is exchange rate. The argument is that fluctuations in exchange rate adversely affect output of the
manufacturing sector. This is because Nigerian manufacturing is highly dependent on import of
inputs and capital goods. These are paid for in foreign exchange whose rate of exchange is
unstable. Thus, this apparent fluctuation is bound to adversely affect activities in the sector that is
dependent on external sources for its productive inputs. The methodology adopted for the study is
empirical. The econometric tool of regression was used for the analysis. The result of the
regression analysis shows that coefficients of the variables carried both positive and negative
signs. The study actually shows adverse effect and is all statistically significant in the final
analysis.
Lawal, (2016) studied the effect of exchange rate fluctuations on manufacturing sector output from
1986 to 2014, a period of 28 years. Data sourced from Central Bank of Nigeria (CBN) statistical
Bulletin and World Development Indicators (WDI) on manufacturing output, Consumer Price
Index (CPI), Government Capital Expenditure (GCE) and Real Effective Exchange Rate (EXC)
were analyzed through the multiple regression analysis using Autoregressive Distribution Lag
(ARDL) to examine the effect of exchange rate fluctuations on manufacturing sector. Using ARDL
it was discovered that exchange rate fluctuations have long run and short run relationship on
manufacturing sector output. The result showed that exchange rate has a positive relationship on
manufacturing sector output but not significant. However, from the empirical analysis it was
discovered that exchange rate is positively related to manufacturing sector output.
Ehinomen and Oladipo (2012) studied exchange rate management and the manufacturing
sector performance in the Nigerian economy. Variables like manufacturing GDP, manufacturing
direct investment, exchange rate, inflation rate, real interest rate were used Ordinary Least Square
(OLS) multiple regression analysis was employed using E-view. The study covered the periods of
1986-2010 with the use of time-series data. The empirical result of this study shows that
depreciation which forms part of the structural adjustment policy (SAP) 1986, and which
dominated the period under review has no significant relationship with the manufacturing’s sector
productivity. It was found that in Nigeria, exchange rate appreciation has a significant relationship
with domestic output. And that exchange rate appreciation will promote growth in the
manufacturing sector. It was also ascertained from the estimated regression line that there is a
positive relationship between the manufacturing gross domestic product and inflation.
While study like Adewuyi (2015) has even established that trade policy variables have no
significant effect on the manufacturing wage and employment in Nigeria during the SAP reform
period.
According to Alexandre et al. (2012) in their study of 20 manufacturing sectors in Portugal
between 1988 and 2006, they established the role of degree of openness and the technology level
as factors that mediate the impact of exchange rate movements on labour market developments.
According to their estimations whereas employment in high-technology sectors seems to be
relatively immune to changes in the real exchange rates these appear to have sizable and significant
effects on highly open low- technology sectors. In order to assess the roles of openness and
technology in the sensitivity of employment to exchange rate movements they computed exchange
rate elasticities of employment for different degrees of trade openness. They found out that the
interaction between the exchange rate and openness is statistically significant and positive. The
analysis of job flows according to the study suggests that the impact of exchange rates on these
sectors occurs through employment destruction. This result seems to support the result of a study
titled Job Creation, Job Destruction and the Real Exchange Rate by Klein, Schun, and Triest,
(2013) where it was established that the effect of the exchange rate on employment is magnified
by trade openness. In their study, they measured industry openness using a 5 years moving average
of the ratio of total trade to total market sales.
Frenkel (1976) presents a study with two main issues. The first one is the relationship between
the Real Exchange Rate (RER) and employment in Argentina, Brazil, Chile and Mexico. The
second one is the viability of macroeconomic policies intended to preserve a stable and
competitive RER. The results show that both GDP and RER have an expected negative effect on
the change in the national unemployment rates in the period covered (1980-2003). This result is
also consistent with the findings of Ros (2004). All coefficients are highly significant (at 1%). On
average in the 4 countries, a 10% increase in GDP is associated with a 14.9% unemployment rate
fall, a 10% appreciation (depreciation) of the RER is associated with a 5.6% increase (fall) in the
unemployment rate with a 2 years lag.

Nucci and Pozzolo (2014) in their study use firm level panel data drawn from two high-quality
sources to study the relationship between exchange rate fluctuations and labour inputs in Italy.
The results of the study confirm that exchange rate fluctuations have a significant effect on
employment and hours worked. The coefficient measuring the effect of exchange rate variations
through changes in the proceeds from foreign sales is negative and significantly different from
zero; the estimated coefficient measuring the effect through the change in the cost of imported
inputs is positive and it also statistically significant. Therefore, exchange rate depreciation causes
an expansion in the number of hours worked in the subsequent year through the revenue side and
a contraction through the cost side. Moreover, the effect stemming from the revenue side increases
in absolute value with the share of foreign sales in total revenues while the effect on the cost side
is increasing in the share of the firm’s expenditure on foreign inputs in total costs. It is also
established from the study that the effects of exchange rate fluctuations on labour inputs also
depend on the degree of monopoly power of the firm. Nucci and Pozzolo (2014) also note that
there are at least five ways in which firms with some degree of market power can adjust in response
to a change in the exchange rate. Besides adjusting employment such firms can adjust output
prices, wages and investment. This underscores the fact that intervening variables mediate the
effect of changes in exchange rates on employment. According to Revenga (2012) both
employment and real wages in US manufacturing industries are significantly affected by the real
exchange rate fluctuations however, the implication of real exchange rates for real wages is less
than for employment but still significant. In her viewpoint, the possible explanation for this result
may be in the characteristic of mobility across industries that labour possesses.
As Hall (2015) points out, the behaviour of the labour market is inclined to both wage
stickiness and an efficient link between recruitment and job-seekers which probably explains the
weak effect of real exchange rate movements on real wages.
In addition, exchange rate volatility can directly affect firms’ employment decisions through
its effects on sales, profits and investment risk and planning of firms (Federer, 2013; Aizenman
and Marion, 2012). It can also discourage international trade (assuming risk-averse investors) by
raising the risk in international transactions (Kenen and Rodrik, 2016; Qian and Varangis, 2014).
On the other hand, some studies found weaker implications of exchange rates for employment but
more pronounced effects for wages.
Goldberg and Tracy (2012) study the effect of changes in the US$ exchange rate using labour
market data disaggregated both by industry and state. They found that local industries differ
significantly in their earnings, hours worked and employment responses to exchange rates. The
effects of changes in the exchange rate also differed significantly between different regions of the
US as in the study by Branson and Love (2013). Wages were significantly affected by the dollar
exchange rate in eight of the twenty manufacturing industries studied.
Employment was found to be negatively related to changes in the exchange rate in twelve of
the industries. On average, dollar appreciations were associated with employment declines for
both high and low profit margin industrial groupings.
The greater the export orientation of the industry the greater the negative effect on
employment. Some of these effects were offset by the positive effect on the prices of imported
inputs. Ngandu (2013) in his research titled Exchange Rates and Employment where he studied
the South African economy also specifically pay attention to exchange rate and employment using
the Computable General Equilibriun Technique. He claimed that whereas a partial equilibrium
analysis that only focuses on the manufacturing sector might conclude that appreciation has a
negative impact on employment taking into consideration the economy-wide impacts there can be
an overall positive impact on employment from an appreciation. The four worst-affected sectors
in terms of employment according to Ngandu include transport equipment, leather products,
chemical products and footwear. The sectors that respond positively to the exchange rate include
business services other producers other mining and medical and other services.
According to King-George (2013), the effect of exchange rate fluctuations on the Nigeria
manufacturing Sector was set to find out the effect of exchange rate on the Nigeria manufacturing
Sector. Hypothesis was stated to guide the study. To evaluate this hypothesis, annual time series
data on manufacturing gross domestic product a proxy for economic growth, exchange rate, private
foreign investment and manufacturing employment rate were collected from the year, 1986 to
2010. A multiple linear regressions were adopted employing Ordinary Least Square (OLS)
techniques. This analysis yielded some interesting results. From the results it was observed that
exchange rate has no significant effect on economic growth of Nigeria. Also the dependent variable
(Manufacturing Gross Domestic Product) can be controlled by, exchange rate, private foreign
investment and manufacturing employment rate.
Olufayo and Fagile (2014), their research examined the impact of exchange rate volatility on the
performance of Nigeria export sectors, separating the sectors into oil and non-oil sector. They
adopted the econometrics method of Seemingly Unrelated Regression (SUR) and in testing the
volatility of the exchange rate; they adopted GARCH (generalized autoregressive
conditional heteroskedasticity) and examine the effect of floating exchange rate policy on the
volatility of the nominal exchange rate. Using the GARCH model, they discovered that there exists
volatility in the exchange rate of the country.
Their study established the negative relationship between the volatility of exchange rate and export
performance of oil and non-oil sectors using time series data of 1980 to 2011, though it is
statistically not significant and also they discovered the significant effect of the floating exchange
rate regime in Nigeria, thus, the introduction of floating exchange rate induces instability in the
country exchange rate, this is in agreement with the submission of many scholars, who asserted
that the shift from fixed exchange rate to floating exchange rate brought about uncertainty in the
exchange rate. More so, the negative relationship between the exchange rate volatility and exports
in Nigeria called for drive towards domestication of the country’s resources, through inward
looking policy that would encourage the local utilization of the country abundant resources and
also diversification of the country’s exports base.
2.4 Literature gap
The study on impact of foreign exchange rate on manufacturing sector in Nigeria is an aspect that
was abandoned in the past but receiving little attention of recent. Focus from the onset was on the
impact of exchange rate on the economic growth but recently studies like Opaluwa, et al (2012);
Ehinomen and Oladipo (2012); Lawal, (2016). This study also intends to focus on the impact of
foreign exchange rate on manufacturing firms in Nigeria, covering a period of twenty seven years
(1990-2016), using fifteen (15) manufacturing firms quoted in the Nigeria stock exchange. In
addition most study on this area used manufacturing Gross domestic product as a performance
measure but this study intends to use returns on equity as a better performance measure also the
study intends to disaggregate exchange rate into real effective exchange rate and parallel exchange
rate.
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
Methodology is the science of method and procedure used in any given analysis or activity. It is a
set of principles, which are adopted to specify how to reach a particular conclusion or achieve a
given objective. Acording to Ndiyo (2005), research methodology enables researchers to focus
their thought and action on their investigation and improve or maximize their chances of reasoned
conclusion, as objectively as possibe. Ololube (2016) defined research methodology as the process
of arriving at dependable solutions to problems through the planned and systematic collection,
analysis, and interpretation of data. It is the most important tool for advancing knowledge,
promoting progress, and enabling man to relate more effectively to his environment, accomplish
his purposes and resolve his conflicts.
Hence, this chapter will explain the methods used by the researcher in the study. This will enable
the researcher to draw inference concerning the impact of exchange rates on nigerian economy.
3.2 Research Design
For any research activiy to be of any significance to the reading audience, it is desirable that such
research should be properly designed. According to Asika (2000), research design means the
structuring of investigation aimed at identifying variables and their relaionship to one another.
Also, Ndiyo (2005) opined that research design is the conceptual framework within which an
investigation is conducted.
The study choose ex-post facto research design because the study intends to establish cause and
effect relationship, also the researcher has no control over the variables of interest and therefore
cannot manipulate them.
3.3 Population and Sample Size
The sampling frame which is the list of all the thirty seven (37) manufacturing firms quoted in the
Nigeria stock exchange makes up the population of the study. Thus, the sample size of fifteen (15)
manufacturing firms out of the population was used, which are: Flour Mills Nigeria Plc (Lagos
State), Dangote Cement Plc. (Lagos State), Berger Paints Plc. (Lagos State), Beta Glass Plc.
(Lagos State), Premier Paints Plc. (Ogun State), Cutix Plc. (Anambra State), Portland Paints &
Products Nigeria Plc. (Lagos State), Meyer Plc. (Lagos State), Honeywell Flour Mill Plc. (Lagos),
7-UP Bottling Company (Lagos), Cadbury Nigeria Plc. (Lagos), Guinness Nigeria Plc. (Lagos),
Nestle Nigeria Plc. (Lagos), Golden Guinea Brewery Plc. (Lagos), and VitaFoam Nigeria Plc.
(Lagos).
3.4 Sampling Technique
The study employed the judgmental sampling technique to choose the sampling period 1990-2016.
The judgmental sampling technique will be applied because the period the data is to be collected
is available. The researcher considered only the number of years on which data have been made
available in the firms under study.
3.5 Method of Data Collection
In the course of this research work, secondary data was used. Secondary data were obtained from
annual report and account of the firms under study and also Central bank of Nigeria Statistical
Bulletin (2016). Other secondary sources of data include textbooks, journals, newspapers, etc.
3.6 Techniques of Data Analysis
In order to estimate the regression model, the software the researcher used in the analysis is E-
view version 7.0. Chris Brooks (2010) opined that the E-view is encourages and justified for such
time series regression analysis because it is more robust, highly technical and highly efficient. The
procedure involves specifying the dependent and independent variables. In this process, we shall
obtain the values of constant (slope), coefficient of regression and the error term. In addition Caner
and Kilian (2012) noted that the estimation will show the t-statistics and the p-values for the
coefficient which result in either rejecting or accepting the hypotheses at a specific level of
significance. The p-value is the probability of getting a result that is at least as extreme as the
critical value.
3.6.1 Model Specification
To achieve the objectives of the study, we build the ideas of our reasoning by construction of
econometrics process. Model specification is a process of constructing logical thinking abstraction
of eonomic reality. Model specification entails establishing the coefficient(s) of regression for a
sample and making inference on the population. The linear regression equation is stated as follows:
ROE= f(REER, PER, INTR, INFR, DOP, MSP) ................................ (1)
The econometric model is expressed below:
ROE = β0 + β1REER + β2PER + β3INTR + β4IINFR + β5MSP + μ ........ (2)
Where:
ROE = Returns on Equity, (dependent variable)
REER = Real Effective Exchange rate
PER = Parallel Exchange Rate
INTR = Interest Rate Independent Variables
INFR = Inflation rate
MSP = Money Supply
μ = Stochastic Disturbance (Error Term)
f = Functional Relationship
Bo = Intercept of relationship in the model/ constant
B1 – B5 = coefficients of each of the independent variables
By log linearizing, the model becomes;
Log(ROE)=β0+β1log(REER) + β2log(PER) + β3log(INTR) + β4log(INFR) + β5log(MSP) +μ
Apriori Expectations
REER > 0
The expectation of the result is proposed as real effective exchange rate will have positive impact
on returns on equity of manufacturing firms in Nigeria.
PER > 0
The expectation of the result is proposed as parallel exchange rate will have positive impact on
returns on equity of manufacturing firms in Nigeria.
INTR < 0
The expectation of the result is proposed as interest rate will have negative impact on returns on
equity of manufacturing firms in Nigeria.
INFR < 0
The expectation of the result is proposed as inflation rate will have negative impact on returns on
equity of manufacturing firms in Nigeria.
MSP > 0
The expectation of the result is proposed as money supply (MSP) will have positive impact on
returns on equity of deposit money banks in Nigeria.
3.7 Summary
This chapter examines the materials and methods used in this chapter. This includes research
design, population and sample size, sampling techniques, data collection methods and techniques
for data collections.

CHAPTER FOUR
RESULTS AND DISCUSSION
4.1 INTRODUCTION
This chapter focuses on presentation and analysis of data sourced from CBN Statistical Bulletin
2016. The data represents each of the samples, and the analysis hinges on the relationship among
the variables and their effects constructed in the model specified in chapter three. This chapter will
contain presentation and discussion of data, analysis of data, analysis of data technique and
discussion of findings.
4.2 Data Presentation
Table 4.2.1: Data for the Independent Variables
Independent Variables
YEAR REER PER INTR INFR MSP
% % % % %
1990 16.55 7.72 17.5 14.43 2
1991 16.88 6.32 16.5 15.14 22.4
1992 17.09 3.74 26.8 16.03 32.9
1993 17.23 2.97 25.5 17.07 12.9
1994 18.98 2.96 20.01 18.02 32.7
1995 19.02 0.74 29.8 18.3 37.4
1996 19.07 30.17 18.32 23.7 63.3
1997 19.22 28.83 21 26.20 53.8
1998 19.88 28.32 20.18 28.50 34.5
1999 53.76 73.91 19.74 30.20 19.4
2000 58.25 73.21 13.54 32.30 16.2
2001 70.58 81.30 18.29 38.30 16
2002 85.13 88.95 21.32 43.30 22.3
2003 106.68 100.63 17.98 49.30 33.1
2004 126.69 107.07 18.29 56.70 48.1
2005 143.78 106.58 24.85 66.90 26.4
2006 148.33 105.02 20.71 72.40 18.8
2007 155.75 106.41 19.18 76.30 13.5
2008 90.31 79.69 17.95 85.10 20.7
2009 97.44 94.30 17.26 95.80 22.6
2010 93.39 96.74 16.94 109.80 36.4
2011 89.82 103.30 15.14 120.70 64.4
2012 79.58 98.09 18.99 135.50 53.4
2013 74.20 95.64 17.59 147.00 14.5
2014 69.51 94.05 16.02 159.80 10
2015 70.83 102.00 16.79 173.10 13.1
2016 78.70 131.30 16.72 200.30 17.4
Source: Central Bank of Nigeria Statistical Bulletin (CBN), (2016).
Table 4.2.2: Data for the (Dependent Variable) Returns on Equity (ROE %)
Dependent Variable
YEAR Flour Dangote Berger Beta Glass Premier Cutix Portland
Mills Cement Paints Paints Plc. Paints
1991 0.536 0.071 0.024 0.136 0.239 0.171 0.309
1992 0.521 0.095 0.015 0.399 0.268 0.356 0.234
1993 0.462 0.113 0.001 0.431 0.223 0.477 0.045
1994 0.345 0.208 0.279 0.239 0.231 0.435 0.453
1995 0.324 0.007 0.308 0.268 0.264 0.042 0.235
1996 0.213 0.007 0.399 0.223 0.278 0.028 0.435
1997 0.326 0.024 0.431 0.231 0.013 0.030 0.456
1998 0.423 0.015 0.483 0.264 0.005 0.060 0.214
1999 1.435 0.001 0.457 0.278 0.027 0.045 0.277
2000 0.067 0.005 0.234 0.389 0.032 0.090 0.291
2001 0.252 0.123 0.324 0.220 0.001 0.123 0.282
2002 0.010 0.324 0.324 0.199 0.034 0.026 0.248
2003 0.008 0.195 0.004 0.042 0.075 0.082 0.222
2004 0.015 0.153 0.005 0.028 0.007 0.054 1.272
2005 0.002 0.126 0.123 0.030 0.389 0.043 0.355
2006 0.214 0.342 0.324 0.069 0.324 0.045 0.466
2007 0.093 0.437 0.324 0.060 0.453 0.067 0.622
2008 0.123 0.007 0.374 0.045 0.435 0.324 0.595
2009 0.070 0.007 0.279 0.037 0.156 0.037 0.528
2010 0.073 0.234 0.308 0.034 0.273 0.034 0.425
2011 0.150 0.345 0.477 0.453 0.013 0.096 0.413
2012 0.106 0.109 0.435 0.234 0.005 0.103 0.127
2013 0.927 0.521 0.214 0.324 0.027 0.150 0.206
2014 0.738 0.462 0.234 0.211 0.034 0.090 0.309
2015 0.653 0.345 0.345 0.334 0.096 0.123 0.234
2016 0.692 0.324 0.109 0.421 0.205 0.026 0.341
Dependent Variable
YEAR Meyer Honeywell 7-UP Cadbury Guinness Nestle Golden VitaFoam
Plc Flour Bottling Plc Nig. Nig. Guinea
1991 1.272 0.231 0.001 0.001 0.435 0.536 0.213 0.037
1992 0.355 0.264 0.000 0.001 0.456 0.521 0.191 0.034
1993 0.466 0.278 0.000 0.004 0.214 0.462 0.198 0.096
1994 0.622 0.273 0.001 0.003 0.291 0.345 0.196 0.103
1995 0.324 0.013 0.001 0.023 0.282 0.324 0.176 0.150
1996 0.374 0.027 0.004 0.008 0.248 0.213 0.177 0.090
1997 0.308 0.032 0.003 0.001 0.222 0.213 0.108 0.123
1998 0.399 0.001 0.003 0.018 1.272 0.213 0.069 0.026
1999 0.239 0.034 0.023 0.013 0.355 1.435 0.220 0.054
2000 0.268 0.075 0.134 0.093 0.466 0.927 0.199 0.043
2001 0.268 0.007 0.034 0.123 0.622 0.738 0.205 0.456
2002 0.233 0.389 0.324 0.070 0.595 0.653 0.171 0.667
2003 0.231 0.324 0.000 0.073 0.528 0.536 0.356 0.120
2004 0.264 0.453 0.000 0.150 0.425 0.191 0.477 0.096
2005 0.278 0.435 0.000 0.106 0.413 0.198 0.435 0.068
2006 0.289 0.156 0.001 0.927 0.127 0.196 0.234 0.217
2007 0.324 0.273 0.000 0.738 0.206 0.176 0.345 0.218
2008 0.453 0.013 0.008 0.653 0.309 0.177 0.109 0.413
2009 0.483 0.005 0.001 0.536 0.234 0.214 0.263 0.289
2010 0.457 0.027 0.018 0.521 0.341 0.234 0.136 0.243
2011 0.234 0.067 0.013 0.462 0.909 0.345 0.108 0.288
2012 0.324 0.253 0.014 0.345 1.272 0.109 0.069 0.243
2013 0.324 0.010 0.010 0.324 0.355 0.521 0.220 0.291
2014 0.329 0.008 0.010 0.213 0.466 0.462 0.199 0.358
2015 0.268 0.002 0.127 0.213 0.622 0.345 0.042 0.289
2016 0.223 0.015 0.435 0.326 0.653 0.324 0.028 0.622
Source: Annual Report of Firms under Study (2016).
4.3 Discussion of Data
Table 4.2.1 above is the data for all the independent variables under study (REER, PER, INTR,
INF and MSP) during the period 1990 – 2016. REER recorded 16.55 in 1990, further increased to
58.25 in year 2000, in 2006, it drastically increased to 148.33 and fell to 79.58 in 2012, finally
reduced to 78.70 in 2016. PER recorded 7.72 in 1990, increased to 77.21 in year 2000, furthermore
drastically increased to 105.02 in 2016. Inflation rate (INF) started low in 1990 14.43 and as time
went on, it recorded a gradual increase till 2016 as it recorded 72.40. money supply recorded a
high fluctuating rate all through the period under study, it also fell in 2016 to 18.8.
Returns on equity was the proxy used to measure manufacturing performance in Nigeria, for the
purpose of this study the average returns on equity of all the manufacturing firms under study
were used.
4.4 Analysis of Data Techniques
4.4.1 Ordinary Least Square (OLS)
Table 4.2.2: Ordinary Least Square (OLS) Result
Dependent Variable: ROE

Method: Least Squares
Date: 12/02/17 Time: 03:52
Sample: 1990 2016
Included observations: 27
Variable Coefficient Std. Error t-Statistic Prob.
C 10240.53 861.9526 11.88062 0.0000

REER 27564.29 12311.18 2.238964 0.0361
PER 43.57128 10.08997 4.318279 0.0003
INTR -5.957460 2.587455 -2.302440 0.0316
INF 193.0052 19.86838 9.714190 0.0000
MSP 5.488378 2.119677 2.589252 0.0171
R-squared 0.987175 Mean dependent var 37276.75

Adjusted R-squared 0.984122 S.D. dependent var 17800.00
S.E. of regression 2242.962 Akaike info criterion 18.46211
Sum squared resid 1.06E+08 Schwarz criterion 18.75008
Log likelihood -243.2385 Hannan-Quinn criter. 18.54774
F-statistic 323.2912 Durbin-Watson stat 2.231710
Prob(F-statistic) 0.000000
Estimation Command:
=========================
LS ROE C REER PER INTR INF MSP
Estimation Equation:
=========================
ROE = C(1) + C(2)*REER + C(3)*PER + C(4)*INTR + C(5)*INF + C(6)*MSP
Substituted Coefficients:
=========================
ROE = 10240.5321566 + 27564.2905494*REER + 43.5712842006*PER - 5.95746035112*INTR +
193.005165612*INF + 5.48837788877*MSP
Source: Author’s Computation using E-view 7.0 (2017)
Table 4.2.2 shows the result for ordinary least square. Real effective exchange rate (REER) is
positive in the coefficient column which connotes that a unit increase in real effective exchange
rate can lead to 10240 increase in returns on equity of manufacturing firms in Nigeria. Parallel
exchange rate (PER) is positive in the coefficient column and signifies that a unit increase in
parallel exchange rate can lead to 43.5% increase in returns on equity of manufacturing firms in
Nigeria. Interest rate (INTR) is negative also a unit increase in interest rate can lead to -5.95%
decrease in returns on equity. Inflation rate (INF) and money supply (MSP) are positive and a unit
increase in them can lead to 193.00 and 5.48 increase in returns on equity of manufacturing firms
in Nigeria respectively.
All the independent variables have significant impact on returns on equity of manufacturing
firms in Nigeria.
4.4.2 Diagnostic Test
Table 4.2.3: Normality test

9
Series: Residuals
8 Sample 1990 2016
Observations 27
7
6 Mean 1.53e-12
Median -142.3301
5 Maximum 5600.274
Minimum -3297.777
4 Std. Dev. 2015.788
Skewness 0.580746
3 Kurtosis 3.571169
2
Jarque-Bera 1.884710
1 Probability 0.389709
0
-4000 -2000 0 2000 4000 6000
The series distribution is normal as the p-value associated with JB- Jarque Bera statistics is 0.389
which is greater that the critical value of 0.05.
Table 4.2.4: Serial Correlation Test
Breusch-Godfrey Serial Correlation LM Test:
F-statistic 3.727732 Prob. F(2,19) 0.1431

Obs*R-squared 7.608920 Prob. Chi-Square(2) 0.1223
The p-value of the f-statistics is 0.143 which is greater that the critical value of 5%, we conclude
by accepting H0 that there is no presence of serial correlation.
Table 4.2.5: Heteroskedasticity Test
Heteroskedasticity Test: Breusch-Pagan-Godfrey

Scaled explained SS 4.672373 Prob. Chi-Square(5) 0.4572

The p-value of the observed R-squared is 0.305 which is greater than the critical value of 5%,
meaning that we accept null hypothesis that the residuals are not heteroscedastic in nature.
Table 4.2.6: Stability Test
Ramsey RESET Test

Equation: UNTITLED
Specification: ROE C REER PER INTR INF MSP
Omitted Variables: Squares of fitted values
Value df Probability
t-statistic 3.662975 20 0.0015
F-statistic 13.41739 (1, 20) 0.0015
Likelihood ratio 13.86029 1 0.0002
The p-value of the f-stat of ramsey reset test is 0.001 which is less than critical value of 5%, we
conclude by accepting H1 that the series are not in functional form and it is not structurally stable.
4.4.3 Unit Root Test
Table 4.2.7: Unit root test for ROE
Null Hypothesis: D(ROE,2) has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=6)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.412934 0.0206

Test critical values: 1% level -3.737853
5% level -2.991878
10% level -2.635542
The Augmented Dicker Fuller test (ADF) at second difference I(2) for ROE is -3.412 > -2.991 at
0.05 level of significance, this shows no unit root and that the series is stationary.
Table 4.2.8: Unit root test for REER
Null Hypothesis: D(REER,2) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.020686
10% level -2.650413
The Augmented Dicker Fuller test (ADF) at second difference I(2) for REER is -5.6404 > -3.020
at 0.05 level of significance, this shows no unit root and that the series is stationary.
Table 4.2.9: Unit root test for PER
Null Hypothesis: D(PER) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.986225
10% level -2.632604
The Augmented Dicker Fuller test (ADF) at first difference I(1) for PER is -4.372 > -2.986 at 0.05
level of significance, this shows no unit root and that the series is stationary.
Table 4.2.10: Unit root test for INTR
Null Hypothesis: D(INTR) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.986225
10% level -2.632604
The Augmented Dicker Fuller test (ADF) at first difference I(1) for INTR is -4.391 > -2.986 at
Table 4.2.11: Unit root test for INF
Null Hypothesis: D(INF) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.986225
10% level -2.632604

The Augmented Dicker Fuller test (ADF) at first difference I(1) for INF is -3.357 > -2.986 at 0.05
level of significance, this shows no unit root and that the series is stationary.
Table 4.2.12: Unit root test for MSP
Null Hypothesis: D(MSP,2) has a unit root
Exogenous: Constant
t-Statistic Prob.*
5% level -3.029970
10% level -2.655194
The Augmented Dicker Fuller test (ADF) at second difference I(2) for MSP is -3.549 > -3.029 at
Table 4.2.13: Granger Causality Test
Diagnostic Check F-stat Prob. Conclusion

REER and ROE 10.1294 0.0009 REER granger cause ROE
ROE and REER 7.62524 0.0035 ROE granger cause REER
PER and ROE 0.63600 0.5398 PER does not granger cause ROE
ROE and PER 1.99297 0.1625 ROE does not granger cause PER
INTR and ROE 6.63804 0.0062 INTR granger cause ROE
ROE and INTR 2.95789 0.0749 ROE does not granger cause INTR
INF and ROE 0.81969 0.0062 INF granger cause ROE
ROE and INF 8.85650 0.0487 ROE granger cause INF
Prob. Value < 0.05, Sig. at 5% for granger causality test, vice versa.
Table 4.2.14: Johansen Co integration

Date: 12/02/17 Time: 04:10
Sample (adjusted): 1991 2016
Included observations: 26 after adjustments
Trend assumption: Linear deterministic trend
Series: ROE REER PER INTR INF MSP
Lags interval (in first differences):
Unrestricted Cointegration Rank Test (Trace)
Hypothesized Trace 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.851317 111.9662 95.75366 0.0024

At most 1 0.643477 62.41173 69.81889 0.1689
At most 2 0.428389 35.59648 47.85613 0.4169
At most 3 0.402802 21.05478 29.79707 0.3542
At most 4 0.232283 7.651592 15.49471 0.5034
At most 5 0.029514 0.778919 3.841466 0.3775
Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values
The co integration result shows that the trace statistics of ROE (None *) is greater than 5% critical
value, while the trace statistics of real effective exchange rate (REER) (At most 1), parallel
exchange rate (PER) (At most 2), interest rate (At most 3), inflation rate (At most 4) and money
supply (At most 5) are less than 5% critical value.
4.5 Discussion of Findings
Ho1: There is no significant relationship between real effective exchange rate (REER) and return
on equity (ROE) of manufacturing firms in Nigeria.
The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of real effective
exchange rate (REER) is 0.0361 which is less than 0.05 significant level, thereby the null
hypothesis is rejected and the alternate hypothesis is accepted and signifies that real effective
exchange rate (REER) have significant impact on return on equity of manufacturing firms in
Nigeria. The economic implication of rejecting the null hypothesis connote the existence of
international competitiveness, further the existence of trade flows, incentives for reallocation
between tradable and the non-tradable sectors.
Ho2: There is no significant relationship between parallel exchange rate (PER) and return on
equity (ROE) of manufacturing firms in Nigeria.
The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of parallel
exchange rate (PER) is 0.000 which is less than 0.05 significant level, thereby the null hypothesis
is rejected and the alternate hypothesis is accepted and signifies that parallel exchange rate (PER)
have significant impact on return on equity of manufacturing firms in Nigeria.

Ho3: Interest rate (INTR) does not have any significant impact on return on equity (ROE) of
The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of interest rate
(INTR) is 0.0316 which is less than 0.05 significant level, thereby the null hypothesis is rejected
and the alternate hypothesis is accepted and signifies that interest rate (INTR) have significant
impact on return on equity of manufacturing firms in Nigeria.
The economic implication of rejecting the null hypothesis connote the existence of credit to
manufacturing sector, which will in turn improve the capital structure of manufacturing firms in
Nigeria and will foster high performance.
Ho4: Inflation rate (INFR) does not have any significant impact on return on equity (ROE) of
The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of inflation rate
(INFR) is 0.000 which is less than 0.05 significant level, thereby the null hypothesis is rejected
and the alternate hypothesis is accepted and signifies that inflation rate (INFR) have significant
impact on return on equity of manufacturing firms in Nigeria. The economic implication of
rejecting the null hypothesis connote the stable price level of goods of services.
Ho5: There is no significant relationship between money supply (MSP) and return on equity
The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of parallel
exchange rate (PER) is 0.000 which is less than 0.05 significant level, thereby the null hypothesis
is rejected and the alternate hypothesis is accepted and signifies that money supply (MSP) have
significant impact on return on equity of manufacturing firms in Nigeria.
Holistically the result reveals that all the independent variables under study have significant impact
on returns on equity of manufacturing firms in Nigeria because their p-values are all less than 5%
significant level.
The model has high explanatory and predictive power as suggested by the R-squared and adjusted
R-squared respectively. The R2 is 0.987 and AdjR2 is 0.984, this further shows that (REER, PER,
INTR, INF and MSP) have 98% positive impact to ROE of manufacturing firms in Nigeria, more
so (AdjstR2) is 0.984 which suggest that 98% of the independent variables could be explained by
the changes in returns on equity and the remaining 2% could not be explained due to some error
in the financial system.
The Durbin Watson test is 2.231 which revealed no presence of serial correlation and good for
prediction. Globally, the p-value of the F-stat is 0.000 < 0.05 which suggest that the whole
independent variables (REER, PER, INTR, INF and MSP) are statistically significant.
The diagnostic test was applied to confirm the assumptions of the ordinary least square (OLS)
result, it emphasizes on four major test which are normality, serial correlation, heteroskedasticity
and stability test. Table 4.2.3 shows the normality test and suggest that the series distribution is
normal as the p-value is 0.389 which is greater than 5% significant level, we accept H0 which states
that the residuals are normally distributed and it is desirable and further connote that the influence
of other omitted and neglected variables is small and at best random. While table 4.2.4 is serial
correlation test and shows that the p-value of the f-statistics is 0.122 which is greater that the
critical value of 5%, we conclude by accepting H0 that there is no presence of serial correlation
which is desirable and implies that the variables are independently distributed.
Table 4.2.5 unveils the result for heteroskedasticity test, the p-value of the observed R-squared is
0.305 which is greater than the critical value of 5%, therefore we accept null hypothesis that the
residuals are not heteroscedastic meaning residuals are homoscedastic and it’s desirable. Also the
p-value of the f-stat in functionality test is 0.001 which implies that the series is not in functional
form.
Unit root is a useful test in diagnostic procedure for time series data. It is used to find out the
stationarity behavior of variables. The Augmented Dicker Fuller (ADF) test for unit root varies
between first difference 1(1) and second difference I(2). ROE is -3.412 > 2.991 at 5% significant
level, this shows no unit root and that the series is stationary. REER is -5.640 > 3.020 at 5%
significant level, this shows no unit root and that the series is stationary. PER is -4.372 > 2.986 at
5% significant level, this shows no unit root and that the series is stationary. INTR is -4.391 >
2.986 at 5% significant level, this shows no unit root and that the series is stationary. INF is -3.357
> 2.986 at 5% significant level, this shows no unit root and that the series is stationary. MSP is -
3.549 > 3.029 at 0.05 significant level, this shows no unit root and that the series is stationary. The
result for unit root suggests that there is no presence of unit root as the ADF values are greater
than the critical value at 5%. Hence, the variables are stationary which informs granger causality
and co integration test.
Causality test is employed at this stage to know the causal relationship between the variables under
study, the basis for conducting this test is to enable us know whether the independent variables
can actually cause variations in the dependent variable or vice versa. From the results in table
4.2.13, the p-value of REER and ROE is 0.0009 which implies that REER granger cause ROE and
the p-value of ROE and REER is 0.0035 which also signify that ROE in return granger cause
REER which further implies that there is a long run effect and dual causality exist between REER
and ROE.
The p-value of PER and ROE is 0.539 which connote that PER does not granger cause ROE while
ROE and PER is 0.162 which connotes that ROE does not also granger cause PER and signify a
short run and unidirectional effect.
The p-value of INTR and ROE is 0.006 which connote that INTR granger cause ROE while ROE
and INTR is 0.074 which connote that ROE does not granger cause INTR and signify a short run
and unidirectional effect.
The p-value of INF and ROE is 0.4548 which connote that INF does not granger cause ROE while
ROE and INF is 0.0018 which connote that ROE granger cause INF and signify a short run and
unidirectional effect.
The p-value of MSP and ROE is 0.0062 which connote that MSP granger cause ROE while ROE
and MSP is 0.0487 which connote that ROE granger cause MSP and shows long run effect and
dual causality exist between MSP and ROE.
Ezirim, (2012) stated that Johansen co-integration test steps in to determine the number of co
integrating equation and also investigating presence or absence of spurious regression through the
measure of presence or absence of full rank. The Johansen co-integration result shows that the
trace statistics of ROE (None *) is greater than 5% critical value, this is enough evidence to accept
H1 and conclude that ROE is co-integrated at (None *). While the trace statistics of real effective
exchange rate (At most 1), parallel exchange rate (At most 2), interest rate (At most 3), inflation
rate (At most 4) and money supply (At most 5) are less than 5% critical value, this is enough
evidence to reject H1 and conclude that the variables are not co-integrated. Also the probability
associated with the trace statistic for (At most 1) - (At most 5) are greater than 5% which connote
non-existence of long term relationship between the dependent variable and independent variables.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary
The desire of every developing country like Nigeria is to ensure rapid industrialization. It is logical
to say that industrialization if correctly harnessed can transform and stabilize a country
structurally.
In the bid to achieve macroeconomic stability, Nigeria’s monetary authorities have adopted various
exchange rate arrangements over the years. It shifted from a fixed regime in the 1960s to a pegged
arrangement between the 1970s and the mid-1980s, and finally, to the various types of the floating
regime since 1986, following the adoption of the Structural Adjustment Programme (SAP). The
fixed exchange rate regime induced an overvaluation of the naira and was supported by exchange
control regulations that engendered significant distortions in the economy.
5.2 Conclusion
Based on the discussion of findings, the following are the conclusion:
i. The Ordinary least square test conclude that real effective exchange rate (REER) parallel
exchange rate, interest rate, inflation and money supply have significant impact on returns
on equity of manufacturing firms in Nigeria. We reject the null hypothesis H0 and conclude
that foreign exchange rate have significant impact on performance of manufacturing sector
in Nigeria.
ii. The diagnostic test suggests we accept H0 that the series distribution is normal, which is
desirable. For serial correlation test, we accept H0 that the residuals are not serially
correlated and it connotes that each of the observation are independent of one another. In
Heteroskedasticity test we accept the null hypothesis H0 that the residuals are
homoscedastic which signify that they are of equal variance and desirable.
iii. For unit root test, all the variables were stationary at second difference 1(2) except for
parallel exchange rate, interest rate and inflation rate which were stationary at first
difference 1(1).
iv. There exist a dual causality relationship between REER and ROE and MSP and ROE while
a uni-directional granger causality relationship exist among PER and ROE, INTR and
ROE, INF and ROE.
The study is consistent with the works of Ehinomen and Oladipo (2012), Frenkel (1976) also
contradicts the study of Opaluwa, Umeh and Ameh (2012), Lawal, (2016).
5.3 Recommendations
1. Excess provisions for inflation should be cut to barest minimal level to avert the ideal of
external borrowing which most consequently result in external debt and interest rate
services.
2. The monetary authority should continue to initiate policies that will stabilize exchange rate
and remove negative effect of exchange rate fluctuations on Nigeria’s manufacturing
performance.
3. Since manufacturing sector depends much on foreign inputs, and for the importation of
these foreign inputs not be continuous, efforts should be geared towards improving the
level of technological advancement, increasing agricultural production, and developing
local raw materials in the country.

4. The government should ensure stable electricity, good roads, water, telecommunication
etc. And more importantly as regards this study, the exchange rate appreciation is what the
Government should intensify efforts to achieve in Nigeria.
5. Furthermore a technological policy aimed at developing a local engineering industry is
advocated. By so doing, the link between agriculture and the manufacturing sector will be
established, leading to expansion of export base which would attract more foreign
exchange into the country. This could culminate into high external reserves build up and
reduce adverse pressure on inflation rate and money supply.
6. The monetary authority (the Central Bank of Nigeria) should monitor deposit money banks
to ensure unethical practices (high interest rate) are not condoled.
5.4 Contribution to Knowledge
The result of this research has been able to empirically establish the following:
1. The study used disaggregated approach (real effective exchange rate and parallel exchange
rate) to determine the impact of foreign exchange rate on performance of manufacturing
sector in Nigeria.
2. The research work provided a predictive power for foreign exchange rate and
manufacturing sector performance in Nigeria using: ROE = 10240.5321566 +
27564.2905494*REER + 43.5712842006*PER + 5.95746035112*INTR +
193.005165612*INF + 5.48837788877*MSP.
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APPENDIX
Ordinary Least Square (OLS) Result

Date: 12/02/17 Time: 03:52
Sample: 1990 2016
C 10240.53 861.9526 11.88062 0.0000

REER 27564.29 12311.18 2.238964 0.0361
PER 43.57128 10.08997 4.318279 0.0003
INTR -5.957460 2.587455 -2.302440 0.0316
INF 193.0052 19.86838 9.714190 0.0000
MSP 5.488378 2.119677 2.589252 0.0171

Estimation Command:
=========================
LS ROE C REER PER INTR INF MSP
Estimation Equation:
=========================
ROE = C(1) + C(2)*REER + C(3)*PER + C(4)*INTR + C(5)*INF + C(6)*MSP
Substituted Coefficients:
=========================
ROE = 10240.5321566 + 27564.2905494*REER + 43.5712842006*PER - 5.95746035112*INTR +
193.005165612*INF + 5.48837788877*MSP
Diagnostic Test
Normality test
9
Series: Residuals
8 Sample 1990 2016
Observations 27
7
6 Mean 1.53e-12
Median -142.3301
5 Maximum 5600.274
Minimum -3297.777
4 Std. Dev. 2015.788
Skewness 0.580746
3 Kurtosis 3.571169
2
Jarque-Bera 1.884710
1 Probability 0.389709
0
-4000 -2000 0 2000 4000 6000
SERIAL CORRELATION TEST
Breusch-Godfrey Serial Correlation LM Test:
F-statistic 3.727732 Prob. F(2,19) 0.!431

Test Equation:
Dependent Variable: RESID
Date: 12/02/17 Time: 03:56
Sample: 1990 2016
Presample missing value lagged residuals set to zero.
C 25.80579 773.9502 0.033343 0.9737

REER -4993.444 11335.59 -0.440510 0.6645
PER 0.117461 10.50282 0.011184 0.9912
INTR 0.706153 2.378242 0.296922 0.7697
INF 7.141061 20.27898 0.352141 0.7286
MSP -0.502123 1.953485 -0.257039 0.7999
RESID(-1) 0.609011 0.224552 2.712122 0.0138
RESID(-2) -0.337735 0.262473 -1.286739 0.2136
R-squared 0.281812 Mean dependent var 1.53E-12

Sum squared resid 75875474 Schwarz criterion 18.66319
HETEROSKEDASTICITY TEST
Heteroskedasticity Test: Breusch-Pagan-Godfrey

Scaled explained SS 4.672373 Prob. Chi-Square(5) 0.4572
Test Equation:
Dependent Variable: RESID^2
Date: 12/02/17 Time: 03:57
Sample: 1990 2016
C 6744716. 2410705. 2.797819 0.0108

REER -49404951 34431850 -1.434862 0.1661
PER 23816.16 28219.57 0.843959 0.4082
INTR 8726.086 7236.583 1.205830 0.2413
INF 3541.078 55567.78 0.063725 0.9498
MSP -7894.172 5928.302 -1.331608 0.1973
R-squared 0.222516 Mean dependent var 3912906.

Adjusted R-squared 0.037401 S.D. dependent var 6393814.
S.E. of regression 6273106. Akaike info criterion 34.33457
STABILITY TEST
Ramsey RESET Test

Equation: UNTITLED
Specification: ROE C REER PER INTR INF MSP
Omitted Variables: Squares of fitted values
Value df Probability
t-statistic 3.662975 20 0.0015
F-statistic 13.41739 (1, 20) 0.0015
Likelihood ratio 13.86029 1 0.0002
F-test summary:
Mean
Sum of Sq. df Squares
Test SSR 42418828 1 42418828
Restricted SSR 1.06E+08 21 5030879.
Unrestricted SSR 63229636 20 3161482.
Unrestricted SSR 63229636 20 3161482.
LR test summary:
Value df
Restricted LogL -243.2385 21
Unrestricted LogL -236.3084 20
Unrestricted Test Equation:

Date: 12/02/17 Time: 03:58
Sample: 1990 2016
C 14126.04 1261.777 11.19535 0.0000

REER 14248.20 10414.48 1.368114 0.1865
PER 23.24433 9.735095 2.387684 0.0269
INTR -2.623800 2.243985 -1.169259 0.2560
INF 39.58321 44.74797 0.884581 0.3869
MSP 2.835106 1.829801 1.549407 0.1370
FITTED^2 7.38E-06 2.01E-06 3.662975 0.0015

UNIT ROOT
ROE (2ND DIFF)
Null Hypothesis: D(ROE,2) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.991878
10% level -2.635542
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation

Dependent Variable: D(ROE,3)
Date: 12/02/17 Time: 04:00
D(ROE(-1),2) -0.864760 0.253377 -3.412934 0.0025

C -72.01395 227.5809 -0.316432 0.7547
R-squared 0.346174 Mean dependent var -143.2742

REER (2ND DIFF)
Null Hypothesis: D(REER,2) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.020686
10% level -2.650413

Dependent Variable: D(REER,3)
Date: 12/02/17 Time: 04:01
D(REER(-1),2) -16.04176 2.844068 -5.640428 0.0001

D(REER(-1),3) 13.21722 2.493813 5.300006 0.0001
D(REER(-2),3) 10.43846 2.014151 5.182558 0.0001
D(REER(-3),3) 6.804071 1.314813 5.174934 0.0001
D(REER(-4),3) 2.588917 0.677847 3.819325 0.0019
C 0.014853 0.026695 0.556394 0.5867

S.D. dependent var 0.214410 S.E. of regression 0.116774
Akaike info criterion -1.213823 Sum squared resid 0.190907
Schwarz criterion -0.915104 Log likelihood 18.13823
Hannan-Quinn criter. -1.155510 F-statistic 10.01095
Durbin-Watson stat 1.494409
PER (1ST DIFF)
Null Hypothesis: D(PER) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.986225
10% level -2.632604

Dependent Variable: D(PER,2)
Date: 12/02/17 Time: 04:03
D(PER(-1)) -0.981832 0.224552 -4.372414 0.0002

C 10.66841 7.311027 1.459222 0.1580

S.D. dependent var 43.91895 S.E. of regression 33.15307
Akaike info criterion 9.916766 Sum squared resid 25279.90
Schwarz criterion 10.01428 Log likelihood -121.9596
Hannan-Quinn criter. 9.943811 F-statistic 19.11800
Durbin-Watson stat 1.630837
INTR (1ST DIFF)

Null Hypothesis: D(INTR) has a unit root
Exogenous: Constant
t-Statistic Prob.*

5% level -2.986225
10% level -2.632604

Dependent Variable: D(INTR,2)
Date: 12/02/17 Time: 04:04
D(INTR(-1)) -0.940077 0.214060 -4.391648 0.0002

C 135.0146 212.2076 0.636238 0.5309

INF (1ST DIFF)
Null Hypothesis: D(INF) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.986225
10% level -2.632604

Dependent Variable: D(INF,2)
Date: 12/02/17 Time: 04:06
D(INF(-1)) -0.716799 0.213508 -3.357253 0.0027

C 5.614945 2.778590 2.020789 0.0551

Sum squared resid 3287.835 Schwarz criterion 7.974496
MSP (2ND DIFF)
Null Hypothesis: D(MSP,2) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.029970
10% level -2.655194

Warning: Probabilities and critical values calculated for 20 observations
and may not be accurate for a sample size of 19

Dependent Variable: D(MSP,3)
Date: 12/02/17 Time: 04:07
D(MSP(-1),2) -4.795732 1.350997 -3.549772 0.0040

D(MSP(-1),3) 3.429101 1.248784 2.745953 0.0177
D(MSP(-2),3) 2.730244 1.064698 2.564336 0.0248
D(MSP(-3),3) 2.279400 0.835046 2.729670 0.0183
D(MSP(-4),3) 1.154309 0.563968 2.046764 0.0632
D(MSP(-5),3) 1.097111 0.326697 3.358188 0.0057
C -145.8399 227.9924 -0.639670 0.5344

GRANGER CAUSALITY
Pairwise Granger Causality Tests

Date: 12/02/17 Time: 04:09
Sample: 1990 2016
Lags: 2
Null Hypothesis: Obs F-Statistic Prob.
REER does not Granger Cause ROE 25 10.1294 0.0009

ROE does not Granger Cause REER 7.62524 0.0035
PER does not Granger Cause ROE 25 0.63600 0.5398

ROE does not Granger Cause PER 1.99297 0.1625
INTR does not Granger Cause ROE 25 6.63804 0.0062

ROE does not Granger Cause INTR 2.95789 0.0749
INF does not Granger Cause ROE 25 0.81969 0.4548

ROE does not Granger Cause INF 8.85650 0.0018
MSP does not Granger Cause ROE 25 6.63545 0.0062

ROE does not Granger Cause MSP 3.52919 0.0487
PER does not Granger Cause REER 25 2.95673 0.0750

REER does not Granger Cause PER 3.79915 0.0399
INTR does not Granger Cause REER 25 2.78495 0.0857

REER does not Granger Cause INTR 2.52690 0.1051
INF does not Granger Cause REER 25 3.58158 0.0468

REER does not Granger Cause INF 0.64444 0.5355
MSP does not Granger Cause REER 25 2.76512 0.0870

REER does not Granger Cause MSP 1.00001 0.3855
INTR does not Granger Cause PER 25 0.75496 0.4830

PER does not Granger Cause INTR 3.00417 0.0723
INF does not Granger Cause PER 25 0.30023 0.7439

PER does not Granger Cause INF 2.05895 0.1538
MSP does not Granger Cause PER 25 0.74948 0.4854

PER does not Granger Cause MSP 0.33877 0.7167
INF does not Granger Cause INTR 25 0.60496 0.5558

INTR does not Granger Cause INF 0.12105 0.8866
MSP does not Granger Cause INTR 25 0.15770 0.8552

INTR does not Granger Cause MSP 0.46930 0.6322
MSP does not Granger Cause INF 25 0.12208 0.8857

INF does not Granger Cause MSP 1.08790 0.3560
JOHANSEN CO INTEGRATION
Date: 12/02/17 Time: 04:10

Trend assumption: Linear deterministic trend
Series: ROE REER PER INTR INF MSP
Lags interval (in first differences):
Unrestricted Cointegration Rank Test (Trace)
Hypothesized Trace 0.05

None * 0.851317 111.9662 95.75366 0.0024

At most 1 0.643477 62.41173 69.81889 0.1689
At most 2 0.428389 35.59648 47.85613 0.4169
At most 3 0.402802 21.05478 29.79707 0.3542
At most 4 0.232283 7.651592 15.49471 0.5034
At most 5 0.029514 0.778919 3.841466 0.3775
Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)
Hypothesized Max-Eigen 0.05

None * 0.851317 49.55445 40.07757 0.0032

At most 1 0.643477 26.81525 33.87687 0.2734
At most 2 0.428389 14.54170 27.58434 0.7835
At most 3 0.402802 13.40319 21.13162 0.4158
At most 4 0.232283 6.872673 14.26460 0.5043
At most 5 0.029514 0.778919 3.841466 0.3775
Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I):
ROE REER PER INTR INF

0.000117 -3.179585 -0.015709 0.004972 -0.010369
-0.000172 24.81845 -0.002029 -0.009409 0.011958
0.000250 10.39149 -0.011028 -1.29E-05 -0.054042
-0.000358 13.20515 0.011900 0.001582 0.090800
-0.000105 -3.630290 0.021986 0.002909 -0.006972
-0.000170 12.51623 0.003049 0.027230 0.015898
Unrestricted Adjustment Coefficients (alpha):
D(ROE) -1161.400 382.8715 -153.5210 -287.0882

D(REER) -0.002297 -0.095266 0.031352 0.035190
D(PER) 1.695513 17.71689 2.885885 3.295560
D(INTR) -18.99024 49.56848 272.3293 183.7264
D(INF) -3.670176 -3.491241 4.900848 -3.546710
D(MSP) 21.69835 533.5217 69.12880 -37.96305
1 Cointegrating Equation(s): Log likelihood -793.8709
Normalized cointegrating coefficients (standard error in parentheses)

1.000000 -27265.10 -134.7059 42.63162 -88.91620
(20863.9) (16.9638) (21.0186) (33.7033)
Adjustment coefficients (standard error in parentheses)

D(ROE) -0.135439
(0.02324)
D(REER) -2.68E-07
(3.5E-06)
D(PER) 0.000198
(0.00074)
D(INTR) -0.002215
(0.02371)
D(INF) -0.000428
(0.00026)
D(MSP) 0.002530
(0.02641)

1.000000 0.000000 -168.7999 39.81066 -93.41373
(18.1618) (26.5756) (40.5683)
0.000000 1.000000 -0.001250 -0.000103 -0.000165
(0.00019) (0.00028) (0.00043)

D(ROE) -0.201230 13195.04
(0.03807) (4586.54)
D(REER) 1.61E-05 -2.357039
(4.7E-06) (0.56562)
D(PER) -0.002847 434.3146
(0.00109) (131.278)
D(INTR) -0.010732 1290.594
(0.04218) (5081.69)
D(INF) 0.000172 -74.97755
(0.00045) (53.7137)
D(MSP) -0.089148 13172.19
(0.04125) (4969.48)

1.000000 0.000000 0.000000 5.833642 -204.1994
(27.8191) (31.2181)
0.000000 1.000000 0.000000 -0.000355 -0.000986
(0.00023) (0.00026)
0.000000 0.000000 1.000000 -0.201286 -0.656314
(0.25721) (0.28864)

D(ROE) -0.239601 11599.73 19.16073
(0.05869) (4893.24) (3.48576)
D(REER) 2.39E-05 -2.031248 -0.000116
(7.0E-06) (0.58740) (0.00042)
D(PER) -0.002125 464.3033 -0.094403
(0.00169) (141.251) (0.10062)
D(INTR) 0.057333 4120.501 -2.805419
(0.06348) (5292.38) (3.77010)
D(INF) 0.001397 -24.05043 0.010693
(0.00062) (51.4605) (0.03666)
D(MSP) -0.071870 13890.54 -2.185577
(0.06438) (5367.41) (3.82355)

1.000000 0.000000 0.000000 0.000000 -225.0795
(27.0287)
0.000000 1.000000 0.000000 0.000000 0.000286
(0.00046)
0.000000 0.000000 1.000000 0.000000 0.064141
(0.38605)
0.000000 0.000000 0.000000 1.000000 3.579260
(0.93221)

D(ROE) -0.136789 7808.689 15.74450 -9.828379
(0.08261) (5148.99) (3.87348) (1.83790)
D(REER) 1.13E-05 -1.566555 0.000302 0.000940
(9.9E-06) (0.61655) (0.00046) (0.00022)
D(PER) -0.003306 507.8216 -0.055187 -0.153089
(0.00250) (155.821) (0.11722) (0.05562)
D(INTR) -0.008463 6546.636 -0.619152 -0.273740
(0.09270) (5778.00) (4.34668) (2.06243)
D(INF) 0.002667 -70.88528 -0.031512 0.008929
(0.00085) (52.9258) (0.03982) (0.01889)
D(MSP) -0.058274 13389.23 -2.637321 -4.972805
(0.09573) (5966.43) (4.48843) (2.12968)

1.000000 0.000000 0.000000 0.000000 0.000000
0.000000 1.000000 0.000000 0.000000 0.000000

0.000000 0.000000 1.000000 0.000000 0.000000
0.000000 0.000000 0.000000 1.000000 0.000000
0.000000 0.000000 0.000000 0.000000 1.000000

D(ROE) -0.125890 8184.748 13.46703 -10.12968
(0.08389) (5146.32) (5.35395) (1.88925)
D(REER) 1.02E-05 -1.606241 0.000543 0.000972
(1.0E-05) (0.61730) (0.00064) (0.00023)
D(PER) -0.002669 529.7715 -0.188119 -0.170675
(0.00248) (152.410) (0.15856) (0.05595)
D(INTR) -0.050597 5092.839 8.185262 0.891062
(0.08582) (5264.16) (5.47655) (1.93251)
D(INF) 0.002660 -71.11276 -0.030134 0.009111
(0.00087) (53.3069) (0.05546) (0.01957)
D(MSP) -0.102034 11879.33 6.506892 -3.763048
(0.08850) (5428.81) (5.64783) (1.99295)

Impact of Foreign Exchange Rate On Performamce of Manufacturing Sector in Nigeria

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Impact of Foreign Exchange Rate On Performamce of Manufacturing Sector in Nigeria

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IMPACT OF FOREIGN EXCHANGE RATE ON

PERFORMAMCE OF MANUFACTURING SECTOR IN

OLABODE, ESTHER AFOLAKEMI

BEING A DISSERTATION SUBMITTED TO THE POST GRADUATE SCHOOL,

SUPERVISOR: DR. OSUJI, C. C.

presented wholly or in part for the award of other degrees.

OLABODE ESTHER AFOLAKEMI

rate on performance of manufacturing sector in Nigeria is the original work of the

fulfillment of the award of Master of Science (M.Sc) Degree in Banking and

Dr. C.C Osuji Date

Dr. C.C. Osuji Date

Prof. (Mrs.) R.N. Okoh Date

(Dean Faculty of Management Science)

External Examiner Date

towards the successful completion of this academic programme.

Special thanks to the Dean of Faculty of Management Sciences Prof. (Mrs.) R. N

technical knowledge and confidence throughout this programme. To Dr. Victor

Ehiedu, Dr. Andrew O. Agbada, Mr. A. Erijakpor, Mr. I. Eferakaya, Mr. E.

(non-teaching staff) in the Department of Accounting, Banking & Finance, Delta

Table of Contents vii

List of Figures xii

CHAPTER ONE: INTRODUCTION

1.1 Background to the study 1

1.2 Statement of the Problem 5

1.3 Research Questions 5

1.4 Objectives of the Study 6

1.5 Statement of Hypotheses 6

1.6 Scope of the Study 7

1.7 Significance of the Study 7

1.8 Limitations of the Study 8

1.10 Organization of the Study 9

CHAPTER TWO: LITERATURE REVIEW

2.1 Conceptual Framework 11

2.1.1 An Overview of Manufacturing Sector Performance in Nigeria 11

2.1.2 An Overview of Foreign Exchange Rate Policy in Nigeria 15

2.1.3 Determinants of Nigeria’s Foreign Exchange Rate Volatility 18

2.1.4 Effect of Exchange Rate Fluctuations on Export 19

2.1.5 Manufacturing Sector Export in Nigeria 21

2.1.6 The Effect of Exchange Rate Changes on Business 24

2.1.7 Exchange Rate 25

2.1.8 Real Effective Exchange Rate (REER) 29

2.1.9 Interest Rate 30

2.1.10 Inflation Rate 32

2.1.11 Money Supply 39

2.1.12 Interest and Exchange Rates Management in Nigeria 40

2.1.13 What Makes Currencies Fluctuate 43

2.2.1 Balance of Payment Theory of Exchange Rate 44

2.2.2 Monetary Model of Foreign Exchange Rate 48

2.2.3 Purchasing Power Parity Theory of Exchange Rate 49

2.2.4 Uncovered Interest Rate Parity Theory of Exchange Rate 50

2.2.5 Abstinence or Waiting Theory of Interest Rate 51

2.2.6 Mark-up Theory of Inflation Rate 51

2.2.7 The Classical School Theory of Money 52

2.2.8 The Keynesian Position Theory of Money 52

2.3 Empirical Framework 53

2.4 Literature Gap 60

CHAPTER THREE: RESEARCH METHODOLOGY

3.2 Research Design 61

3.3 Population and Sample Size 62