EFFECT OF INTEREST RATE ON EXCHANGE RATE MANAGEMENT IN NIGERIA

EFFECT OF INTEREST RATE ON EXCHANGE RATE MANAGEMENT IN NIGERIA

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ABSTRACT

Despite the fact that in Nigeria Monetary Policy (Interest rate policy) has been a policy tool

for managing the exchange rate, Nigeria has continued to witness depreciating value of its

domestic currency in recent times. This cannot be disconnected to the fact that the monetary

policy has proved ineffective in managing exchange rate over the period under study. Thus,

this study buttress other factors which can possibly enhance the interest rate defense of a

currency in Nigeria. These factors; level of capital account openness, and level of corporate

debt have not been given emphasis in the literature in terms of studies conducted using

Nigerian data on how the exchange rate in Nigeria can be effectively managed or defended

using Nigerian data. Therefore, this study examines the effect of interest rate on exchange

rate management in Nigeria in the context of capital account liberalisation and corporate debt

level. In doing so, this study utilized annual time series data sourced from CBN and WDI

from 1981 to 2015 to estimate a Vector Error Correction Model (VECM). The long-run

findings show appreciation of the domestic currency, implying that high level of corporate

debt and capital account openness alone are notenough to induce capital outflows and hence,

depreciate the domestic currency as interest rate rises. However in the short-run increase in

interest rate induces depreciation of the domestic currency even though less if the capital

account is liberalised and also more if there is high level of corporate debt. Therefore, sequel

to the findings of this studyit is recommended that,interest rate policies that aim at increasing

the value of the domestic currency must focus on liberalising the capital account as well as

ensuring lower leverage ratio (low debt level) in the corporate sector while interest rate is

increased to attract investors.

CHAPTER ONE

Introduction 1.1 Background of the study

The integration of financial markets and high capital mobility made possible by the

increasing globalization of world economies has exposed economies, especially developing

ones, to the volatility of capital flows which often leads to severe financial crise


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