CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Foreign exchange markets exist because nations want to maintain their sovereign right and identities as nations, by administering and controlling their own currencies. There would have been no foreign exchange market if all countries of the world had and transacted with a single currency. Hence, Ickes (2006) opines that foreign exchange markets exist because economies employ national currencies. The need for foreign exchange initially emanated from international trade which requires settlement in currencies that are legal tender in the countries of both the importer and the exporter (RMB, 2012). As Rime (2003) observes, prior to the advent of telecommunications technology, trading in foreign exchange could be described as a centralized call market. According to him, trading in foreign exchange can be traced back to ancient times when foreign exchange trading was a way to circumvent the ban on usury. King, et al; (2011) assert that it would be hard to overstate the importance of foreign exchange market to the economy: they affect output and employment through real exchange rate; they affect inflation through the cost of imports and commodity prices; they affect international capital flows through the risk and return of different assets.
However, one unique aspect of this international market is that, there is no central market place for currency exchange rate. It is conducted electronically over the counter (OTC), which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange. Ifionu and Ogbuagu (2007) assert that foreign exchange market is a mechanism for the determination of an appropriate exchange rate for the naira in order to reduce the pressure on foreign exchange resources and stabilize the balance of payment. This over the counter market is composed of hundreds of banks and other dealers in foreign currencies that buy and sell deposits of foreign currency (Baye & Jansen, 2006).
Exchange rate is an important variable as its appreciation or depreciation affects the performance of other macroeconomic variables in any economy (Hashim and Zarma, 1996). However, Khan et al (2012) posits that exchange rate is one of the most important policy variables in an open economy, as it affects the macroeconomic variables like; trade, capital flows, foreign direct investment, international reserves, GDP and remittances. An exchange rate is not only important for the business circle, but it can also significantly influence the growth process of a small open economy (Peter, 2007). Exchange rate comprises both nominal foreign exchange and real exchange rate. Tyres et al;(2006) defines nominal exchange rates as the number of units of foreign exchange that might be obtained in return for unit of the domestic currency. It is the price of one country’s currency in terms of another (Unugboro, 2007). Whereas real exchange rate is one of the indicators of international competitiveness of a country and is generally understood to mean various levels of relative price/cost expressed in a certain currency. In other words, it is a relative price of tradables to non-tradables (Musa and Watundu, 2009). Tyres et al; (2006) assert that real exchange rate is the number of baskets of foreign produced goods and services for which a corresponding basket of domestically produced goods and services could be traded. Barry (2007) observed that real exchange rate is a relative price and that, as such, it is not under direct control of the authorities, but it can be influenced by policy.
Theoretically, there exists a positive correlation between exchange rate and economic growth of a country. The purchasing power parity of foreign exchange rate determination, which is base on the law of one price, expresses the change in the exchange rate as a function of the difference between the change in world price and the change in domestic price (Mcperson and Ravoski, 2000). According to Balassa Samuelson hypothesis (1964), strong economic growth should, in general, be accompanied by a real appreciation of exchange rate, as cited in Miyajima (2005). Auwal and Hamzat, (2010) posit that scholars have modified the purchasing power parity approach to take Balassa Samuelson Conjecture in to consideration. The conjecture point to the fact that prices of non-tradable tend to increase relative to the price of tradables with the growth of an economy. Ito, et al; (1999) observe that if differential productivity growth rates between the non-tradable and tradable sectors are the source of both high income growth and inflation differentials between the two sectors, there should exist a positive correlation between change in the non-tadable sector price ratio and income growth. Haddad and Pancaro (2010) stated that a stable exchange rate is a necessary condition for developing countries to achieve sustained economic growth. A stable and sustainable real exchange rate should be thought of as a facilitating condition where keeping it at appropriate levels and avoiding excessive volatility enable a country to exploit its capacity for growth and development (Barry, 2007). Akpan (2008) asserts that, stability in exchange rate leads to enhancements of economic growth and sustained development.
However, movement in exchange rate can have both negative and positive effect on international transactions. Dani and Rodrik (2008) postulate that avoiding significant overvaluation of currency (a low real exchange rate) is one of the most robust imperatives that can be gleaned from the diverse experience with economic growth around the world. Abbas et al; (2011) assert that foreign exchange uncertainty affects economy from demand side through export, import and demand of money, and from supply side through cost of imported intermediate goods. The depreciation of the real exchange rate enhances the international competitiveness of domestic goods, boosts net export and eventually enlarges gross domestic product (Thapa, 2001). Ping and Hua (2011) observe that if a real exchange rate appreciation exerts positive effect on economic growth by acting pressure on efficiency improvement and technological progress via workers motivation, education and capital intensity, it exerts negative effects by deteriorating international competitiveness in tradable sector and by destructing employment. While depreciation of the real exchange rate encourages internal competitiveness of domestic goods and raises export in the former, it increases the cost of production and redistribution income against the poor in the latter (Akinkunmi, 2007). Ildiko (2008) opines that sustained exchange rate overvaluation could constitute a warning signal of adjustment of relative prices and possible decline in the aggregate growth rate of the economy. In addition, Corsetti et al; (2006) concludes that productivity shocks in the non-tradable sector would lead to a real exchange rate and terms of trade depreciation, irrespective of the effect on these variables of shocks to tradable productivity.
| Project details | Contents |
|---|---|
| Number of Pages | 127 pages |
| Chapter one | Introduction |
| Chapter two | Literature review |
| Chapter three | methodology |
| Chapter four | Data analysis |
| Chapter five | Summary,discussion & recommendations |
| Reference | Reference |
| Questionnaire | Questionnaire |
| Appendix | Appendix |
| Chapter summary | 1 to 5 chapters |
| Available document | PDF and MS-word format |
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