PRICE, EXCHANGE RATE VOLATILITY AND NIGERIA AGRICULTURAL TRADE FLOWS- A DYNAMIC ANALYSIS.
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PRICE, EXCHANGE RATE VOLATILITY AND NIGERIA AGRICULTURAL TRADE FLOWS- A DYNAMIC ANALYSIS.
Chapter one
1.1 Introduction
This chapter serves as the framework for future research on price volatility, exchange rates, and Nigerian trade flows. Nigeria’s economy is a middle-income, mixed-economy emerging market with strong financial, legal, communications, transportation, and entertainment industries.
It is rated 31st in the world in terms of GDP (PPP) in 2009, and its emerging, if currently underperforming manufacturing sector is the continent’s second-largest, producing a large amount of goods and services for the West African region.
Previously hampered by years of mismanagement, Nigeria’s economic reforms over the last decade have placed it back on pace to reach its full economic potential.
Nigeria’s GDP at purchasing power parity more than quadrupled from $170.7 billion in 2005 to $374.3 billion in 2010, while estimates of the size of the informal sector (which is not included in official calculations) place the true total closer to $520 billion.
Although much has been made of Nigeria’s status as a major oil exporter, it produces only about 3.3% of the world’s supply, and while it is ranked 15th in production at 2.2 million barrels per day (mbpd), the top three producers, Saudi Arabia, Russia, and the United States, produce 10.7mbpd (16.8%), 9.8mbpd (15.4%), and 8.5mbpd (13.4%), respectively, accounting for 63.6mpd (45.4%) of total global production.
To put oil income into perspective, with an estimated export rate of 1.9 million barrels per day and a projected sales price of $65 per barrel in 2011, Nigeria’s petroleum revenue is expected to be around $52.2 billion.
This represents less than 14% of official GDP numbers. As a result, while the petroleum sector is vital, it is only a small part of the country’s lively and diverse economy.
The mostly subsistence agricultural sector has not kept up with rapid population expansion, and Nigeria, which was once a major net food producer, now imports some of its food goods.
In 2006, Nigeria successfully persuaded the Paris Club to allow it to buy back the majority of its obligations in exchange for a cash payment of approximately $12 billion.
Nigeria’s foreign economic relations revolve around its role in supplying the world economy with oil and natural gas, while the country seeks to diversify its exports, harmonise tariffs in line with the Economic Community of West African States’ (ECOWAS) potential customs union, and encourage inflows of foreign portfolio and direct investments.
In October 2005, Nigeria implemented the ECOWAS Common External Tariff, which reduced the number of tariff bands. Prior to this change, tariffs were Nigeria’s second greatest source of revenue after oil exports.
Thus, this study will look at the relationship between agricultural product prices, exchange rate volatility, and agricultural trade flows.
1.2 Statement of Problem:
Changes in export crop producers’ revenue earnings originate from either an increase or drop in the international global price of exports, or a currency devaluation and associated increase in producer pricing.
However, if such price/exchange rate fluctuations are unpredictable and inconsistent, they can result in a significant drop in future output.
Fluctuations, whether positive or negative, are undesirable because they raise risk and uncertainty in international transactions, discouraging trade. In some ways, trade will suffer in the same way that it would if transportation costs rose.
An IMF (1984) research presents arguments that exchange rate unpredictability tends to create negative macroeconomic phenomena such as inflation and protectionism.
Despite this assumption and others’ findings, more recent research explains why a positive effect is also feasible (de Grauwe, 1988; Caballero and Corbo, 1989).
If firms hedge against currency rate risk, one would not expect a significant negative impact on trade. Hedging against risk can be accomplished through futures or forward markets. Forward markets change the nature of the uncertainty that traders encounter.
A future market is essentially a guaranteed projection of the exchange rate that will prevail at the conclusion of the contract period, which a trader can benefit from by paying a small margin around the forward rates.
Because currency uncertainty can be eliminated from short-term trading transactions by paying this margin, the cost of such uncertainty cannot be more than the cost of obtaining insurance against it.
Unfortunately, there is no future market in Nigeria, thus the idea of hedging through this channel is remote. In fact, most research have not taken hedging options into consideration.
It has been suggested that hedging foreign exchange through futures/forward markets is an imperfect and costly technique of avoiding currency risk.
This is because hedging trades incur a cost. Second, multiple research (Cumby and Obstfeld, 1981; Frenkel, 1981; Hakkio and Rush, 1989) found that the forward rate is a poor predictor of the future spot rate.
Thus, even in the presence of future markets for currency rates and hedging, trade is likely to suffer. The IMF (1984) contends that forward/future markets can be utilised to hedge against nominal exchange rate risk in the short run at a low cost.
Long-term export-oriented activities, on the other hand, would be subject to greater and potentially uncontrollable risks.
As a result, even with hedging, exchange rate volatility, which tends to raise risk and uncertainty in foreign transactions, may have a negative impact on trade and investment flows. This will exacerbate the danger of export supply disruption.
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