An analysis of foreign exchange reserve holdings and macroeconomic stability in nigeria

Thesis Overview

<p> This study stems the depletion of Nigeria’s Reserves in recent times and the possible implications of this fluctuation of the Foreign Exchange Reserves on the macroeconomic stability of Nigeria in tandem with factors like holding of Reserves in excess and the desirability or otherwise of holding Reserves as embedded in the nation’s Reserve Management Strategy. The study used quarterly data ranging from the first quarter of 1981 to the first quarter of 2015. A Reserve demand function was developed using a simultaneous equation model to provide a theoretic cover of the interdependence between Real GDP and Foreign Exchange Reserves while VAR Models were used to estimate the implications of Reserves on some macroeconomic indicators which included Inflation Rate, Exchange Rate and Investment. Cointegration tests reveal that there was no long-run relationship amongst the variables in their respective models. It was found that the opportunity cost of holding Reserves though negatively affecting Reserve holdings was not significant, while other factors like the Capital and Current Account Vulnerability, Trade Openness, lagged value of Nominal Exchange Rate all significantly determine Foreign Exchange Reserves in Nigeria. The IMF condition and Guidotti-Greenspan condition for Reserves Adequacy were significant determinants of Reserve holdings. Inflation in Nigeria was found to respond negatively to fluctuations from the Reserves while Exchange Rate and Investment were found to positively respond to shocks from the Reserves. Conclusions drawn were that the decision to hold Reserves is not motivated by the return on Reserves; Reserves is sensitive to both Capital and Current Account instability, thus the need to account for both the Short Term Debts as well as the 3 months of Import cover and that Exchange Rate management is a predominant cause of the depletion of Reserves in Nigeria. Recommendations rendered were that intertemporal expenditure using a present value analysis should be considered so as to account for the opportunity cost of horlding Reserves, the Federal Government should review her Exchange Rate policy in order to allow the other reasons for the demand of Reserves prevail, since Reserves was found to be held in excess, the excess should be spent in improving the investment climate of the economy in order to balance the complementarity expected of the economy’s size and Reserves accumulation and finally the economy should be diversified to reduce the burden imposed on the Reserves by Oil price shocks. <br></p>