The Impact of Price and Exchange Rate Volatility on Nigeria Agricultural Trade

Topics: Foreign exchange market, Inflation, International trade Pages: 61 (19345 words) Published: September 26, 2012
CHAPTER ONE
INTRODUCTION:

1.1 BACKGOUND TO THE STUDY
Since the 1980s, the performances of the agricultural export have decreased dramatically. The agricultural sector, which was the major contributor in Nigerian foreign exchange earnings, experienced a declining trend after economic reforms programmes (SAP). One of the most important ingredients of reforms programmes which have generated a lot of inconclusive controversies is the movement to flexible exchange rate which first occurred in the developed countries in 1973, and much later in the developing countries. The controversy especially for the developing countries is whether flexible exchange rate is actually as beneficial as mostly claimed. Since the move to floating exchange rate system in 1973 the effects of volatility in exchange rate has continued to generate series of responses.

Of all the major macroeconomic variables, the effects of sudden and sharp changes in the price volatility and exchange rate volatility on agricultural trade and investment have increasingly become of particular interest for both researchers and policy makers as it provides a door way for serious macroeconomic stability issues. Uncertainty in the commodity export trade has also been linked with exchange rate and price fluctuations.

Exchange rate volatility is unsystematic movement of domestic currency in terms of foreign ones. Exchange rate volatility brings about risks and uncertainty in international trade and thus discourages trade (IMF, 1984). Exchange rate risk measures the volatility and erratic pattern of exchange rate movements; the more volatile the movements, the higher the risks. Producers of export are not only concerned with the magnitude of the price they receive; they are also bothered by the stability of such prices as it relates to earning a consistent income.

The impact of exchange rate volatility on trade has generated a lot of controversies among scholars. However, there are no clear cut consensuses about the impact of exchange rate volatility on external trade. For example, lastrapes and Koray (1990) indicated a significant depressive effect of exchange risk. George et al., (2008), Clark et al., (2004) and IMF (1984) did not find any robust negative relationship between exchange rate volatility and trade. Abel (1983) showed that if one assumes perfect competition, convex and symmetric costs of adjusting capital, and risk neutrality, investment is a direct function of price (exchange rate) uncertainty. Also, it is claimed that exchange variability is independent of exchange rate regime adopted, contrary to people believe of it relationship with floating exchange rate regime. Exchange rate volatility is attributed to inherent instability in macroeconomic variables of an economy. Some even believe that flexible exchange rate lead to misalignments of major currencies which lead into adjustment problems in the tradable foods sectors and political pressures towards protectionism.

1.2PROBLEM STATEMENT
Changes in income earnings of export producers come as a result of either increase/decrease in international world price of exports or exchange rate volatility. Such price/exchange rate changes, however, may lead to a major decline in future output if they are unpredictable and erratic. Fluctuation – whether positive or negative – is not desirable as it increase risk and uncertainly in international transactions and thus discourages trade. In a sense, trade will be reduced similarly to a reduction following an increase in transportation costs. An IMF (1984) study cites arguments that exchange rate variability would also tend to induce macroeconomic phenomena that are undesirable, for example inflation and protectionism.

The problem of exchange rate volatility in Nigeria emerged immediately after the introduction of Structural Adjustment Programme (SAP), when the economy was deregulated, trade liberalized and exchange rate subjected to market...

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