THE DETERMINANTS OF FOREIGN EXCHANGE MARKET PRESSURE IN NIGERIA: 1995 – 2016
1.1 Background to the Study
Excessive Foreign Exchange Market Pressure (FEMP) could be considered as detrimental to domestic economic performance in any developing country, including Nigeria. This is because of its consequences on the value and stability of the exchange rate as it affects every aspect of economic activities through both domestic and foreign transactions. FEMP involves the simultaneous movement in exchange rate and foreign reserves, especially in developing economies where the government has to intervene in the foreign exchange market to abate the pressure either through purchase or sales of foreign exchange reserves depending on the prevailing condition.
The maintenance of a stable exchange rate system is very important in any economy as
fluctuations in the foreign exchange market could offset all other markets’ performance (such as the money market and capital market) where it serves as a key determinant. Similarly, unstable exchange rate regime could have significant adverse effects on the level of foreign reserves, which is an important policy instrument, especially when operating the fixed, pegged ormanaged-float exchange rate regime. Thus, an inordinate foreign exchange market pressure could have inauspicious effects on foreign reserves (continuous depletion) and may finally lead to currency crises through speculative attacks, as was experienced in the chain of currency crisis of Mexico 1994, Asian 1997 and Argentina 2001 (Eichengreen, Rose, & Wyplosz, 1996).
External supply and demand shocks could be another important cause of foreign exchange market pressure. For instance, a significant fall in the price of key export commodity could significantly reduce the supply of its foreign exchange in the face of constant or rising demand for foreign exchange. It is still argued that when this occur, and concurrently happens in the cause of a prevailing foreign exchange market pressure, the response of monetary authoritiesplays a decisive role in determining the reaction of foreign capital. The typical reaction is to temporarily devalue the domestic currency and raise interest rate as a way to sustain market confidence. Where the devaluation fails to occur,investors may pull out leading to capital outflow and subsequently accruing more pressure to the already crisis-ridden foreign exchange
Other external factors such as foreign policies could also have impact on the foreign exchange market (Aizenman & Binici, 2015). Following the globalization and strong market integration between the developing, emerging and the industrial economies, shocks in the industrialized economies could spillover to the developing economies through some channels such as interest rate and exchange rate (Aizenman & Binici, 2015). This is conceived during the global financial crises where one of its major upshots was the heavy pressure on the exchange rate as well as drastic depletion foreign reserves due to capital flight.
Statement of Problem
With what is envisage as identification problem of the factors responsible for exchange market pressure in Nigeria, there has been a persistent demand pressure in the foreign exchange market through the instability in exchange rate overtime. This has also lead to difficulty in sustenance of a realistic exchange rate and effective performance of the foreign exchange market in Nigeria.
Conversely, in the past decades, Nigeria has practiced various exchange rate regimes such as pegged, floating, fixed, managed float and has switched to a pseudo-flexible kind of exchange rate, but the management of exchange market pressure remains largely unsuccessful. Changes in the demand for foreign currencies relative to autonomous supply have determined the level of foreign exchange market pressure in the official and parallel market. Rising demand relative to supply causes the foreign exchange market pressure to move towards disequilibrium of depreciating market pressure. This is often douse by Central Bank of Nigeria’s timely interventions in the foreign exchange market. The CBN’s willingness to intervene in the foreign exchange markets amidst mounting pressure still depends, in part, on the level of its foreign
exchange reserves access, which in turn, depends on oil exports proceeds.
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