OIL EXPORT DEPENDENCE AND EXCHANGE RATE BEHAVIOUR IN NIGERIA

Abstract

The behaviour of Nigeria’s currency exchange rates has been tied to the vagaries of oil export’s proceeds. Despite export diversification efforts to reduce the level of Oil Export Dependence (OED), the country’s nominal and real exchange rates remain unstable. Nigeria’s OED rose from an average of 19.13% in the 1960s to 97.35% in the 1990s, before dropping to 83.89% in 2019. The Nominal Exchange Rate (NER) depreciated from N0.71/US$ in the 1960s to N306.92/US$ in 2019, while the Real Exchange Rate (RER) of 137 basis points (bpts) in the 1960s appreciated to 97.24bpts in the 1980s, and became 134.52bpts in 2019. Extant literature investigated the effect of OED on Nigeria’s NER without considering the managed floating exchange rate (MFER) system and the varied exchange rates stabilising potential of non-oil sectors (NOS), thus overstating the effect. This study was, therefore, designed to investigate the effect of OED on the behaviour of Nigeria’s exchange rates from 1960 to 2019. The Mundell-Fleming-Dornbusch framework provided the basis. The Structural Vector Autoregressive with block exogeneity (SVARX) model was employed to capture both external (oil export) and exogenous (non-oil export) components of OED. The model produced contemporaneous, short-term(h=2), and medium-term(h=4) horizons effects of OED. The study accounted for external reserves, which moderates monetary authorities’ commitment to defend NER, thus making RER more responsive under MFER system. The exchange rates stabilising potential of NOS were examined by simulating the effect of export diversification to three main NOS (agriculture, manufacturing, and solid minerals) on OED and exchange rates. The variables included OED (oil export percentage of total merchandise export), NER (domestic price per unit of foreign currency), and RER (foreign price relative to domestic price of a common basket of goods). The data were obtained from the Central Bank of Nigeria Statistical Bulletin. All estimates were validated at α≤0.05. The OED shock had insignificant negative contemporaneous effect on NER (-0.07;α=0.61) and RER (-0.01;α=0.52). In the short to medium-term horizons, OED had insignificant effect on NER (h2=0.01;α=0.72, h4=0.03,α=0.21), but a significant negative effect on RER (h2=- 0.05;α=0.00, h4=-0.07,α=0.00). This implied that a lower OED had no immediate impact on NER and RER. However, it caused RER to depreciate in the short to medium term. This result was explained by the dominance of oil export in OED, as the reduction in OED over the sampled period was caused by a lower oil export rather than a higher non-oil export. The simulation of export diversification with the dominance of non-oil export in OED showed that higher export of manufactured goods and solid minerals reduced the level of OED, increased external reserves, and stabilized NER better than higher export of agricultural goods. Whereas, a higher export of agricultural goods caused RER appreciation, unlike the other sectors. Non-oil export was insufficient to generate the reduction in oil export dependence necessary to enhance stable nominal and real exchange rates. Higher commitment to export diversification, particularly in the solid minerals and manufacturing sectors, is required to stabilise exchange rates in Nigeria.