Journal of Economics and Management

ISSN 1732-1948 Vol. 37 (3) • 2019

Benjamin Ighodalo Ehikioya

ORCID ID: 0000-0003-3824-3609
Department of Financial Studies,
Faculty of Management Sciences
National Open University of Nigeria
[email protected]

The impact of exchange rate volatility on the Nigerian

economic growth: An empirical investigation
Accepted by Editor Ewa Ziemba | Received: September 30, 2018 | Revised: February 8, 2019; May 5,
2019 | Accepted: May 10, 2019.

Abstract

Aim/purpose – Exchange rate volatility has remained a serious issue affecting economic
stability, especially in developing countries. Thus, this study aimed at examining the
impact of exchange rate volatility on economic growth in Nigeria.
Design/methodology/approach – The study employed the Generalized Autoregressive
Conditional Heteroscedasticity (GARCH) model and the system Generalized Method of
Moments (GMM) technique to analyse the time series data from the period January 1980
to December 2017. The study used the Augmented Dickey–Fuller and Philips–Perron
tests to determine the presence of a unit root and the Johansen co-integration test to es-
tablish the relationship among the variables in the study.
Findings – The results of the estimates offer evidence that exchange rate volatility per-
sists throughout the study period, and has a negative and significant effect on the eco-
nomic growth of Nigeria. This result suggests that excessive volatility due to low inflows
is inimical to the growth of the Nigeria economy. The findings of the study demonstrate
a negative and significant relationship between inflation and economic growth. Moreo-
ver, while credit to the private sector and crude oil prices exerts positive and significant
relationship with growth, the relationship between money supply, trade openness and
government expenditure and economic growth is positive but insignificant.
Research implications/limitations – Therefore, it is important for the government to
pursue policies and programs that would help ensure exchange rate stability and boost
local production for both consumption and export. In addition, a holistic program of
economic reforms is important to complement the exchange rate policy and stimulate
economic growth.

Cite as: Ehikioya, B. I. (2019). The impact of exchange rate volatility on the Nigerian economic
growth: An empirical investigation. Journal of Economics & Management, 37(3), 45-68. http://
doi.org/10.22367/jem.2019.37.03
46 Benjamin Ighodalo Ehikioya

Originality/value/contribution – The study shed some light on exchange rate volatility

and confirmed its adverse effect and the importance of a stable environment on econom-
ic growth. In addition, the study introduced crude oil prices as a variable to the study of
exchange rate volatility and economic growth from a developing country perspective.

Keywords: exchange rate volatility, economic growth, GARCH, GMM, developing country.
JEL Classification: C13, F43, O47.

1. Introduction

The exchange rate is an important macroeconomic fundamental that influ-

ences the economy of a country. It is the conversion rate of a currency to another,
and it determines the international competitiveness of a country. In an open
economy, where the demand for foreign currency is higher than the supply of
foreign currency, exchange rate and its volatility on economic activities can have
far-reaching implications on growth (Adewuyi & Akpokodje, 2013; Alagidede
& Ibrahim, 2017; Schnabl, 2009). Nigeria operates a mono-cultural economy
with over 78% of the foreign earnings to the government accruing from the sale
of crude oil at the global market and fluctuations in oil prices could have impli-
cations for the economy. Conversely, the country depends on foreign countries
for imported raw materials, technology and other related products to hone the
economy. The pressure on the foreign exchange due to insufficient foreign earn-
ings to meet the demand has often resulted in the volatility of the exchange rate.
Over time, the Nigeria economy, like other economies, has suffered from the
effect of persistent exchange rate volatility, instability in macroeconomic varia-
bles and the overall poor economic growth. Moreover, compared with the ad-
vanced countries with stable market conditions, emerging markets attached im-
portance to this variable because of the degree of uncertainties that characterises
their markets and the need to have a stable exchange rate to reduce the cost and
risks associated with transactions in foreign exchange.
The interaction between exchange rate volatility and economic growth has
been a subject of intense debate among the policymakers, professionals and oth-
er stakeholders of the economy. This debate is further heightened with countries’
move to a floating exchange rate regime, the liberalisation of the financial mar-
kets beginning in the 1980s and the recent global economic crisis affecting eco-
nomic growth. Moreover, several studies have used an array of methods, control
variables and in a different environment to examine exchange rate volatility and
its effect on economic growth with conflicting results (Eriṣ & Ulaṣan, 2013;
 The impact of exchange rate volatility on the Nigerian economic growth… 47

Kiyota & Urata, 2004; Wong, 2017). According to Schnabl (2009), the mixed
results on the link between exchange rate volatility and economic growth may be
due to country-specific factors such as the level of financial markets develop-
ment, human capital development, governance and institutional structures.
Musyoki, Pokhariyal, & Pundo (2012) documented that the exchange rate vola-
tility is an important determinate of economic growth. This is because high levels
of exchange rate volatility can create uncertainties that would disrupt the smooth
functioning of the markets and other economic activities. In addition, uncertain-
ties resulting from exchange rate volatility could lead to a reduced international
trade; drop in investment and unfair competition that could give an advantage to
foreign firms in terms of product pricing.
The economic growth models posit that stable exchange rates may result in
lower inflation rates, increased trade and investment, which in turn may boost
productivity and economic growth. Despite its effect on economic growth and
the importance of previous studies on this issue, the magnitude of exchange rate
volatility and its real effects on economic growth is still an open question, espe-
cially in developing countries like Nigeria. This is evident in the light of the
recent exchange rate fluctuations in Nigeria, especially from the second half of
2015, which along with other factors led to an economic recession in 2016. Ex-
change rate volatility can occur in economic activities any time and this requires
constant investigation, given the widespread effects on economic activities,
which is of concern to the government, investors, researchers and other agents of
the economy. Additionally, the lack of consistent evidence in emerging markets
on the issue of exchange rate volatility and economic growth means that addi-
tional work is required to answer the pending question about the relationship
between the variables. Thus, the subject of exchange rate volatility in developing
countries still needs extended analysis and further research attention, especially
when considered as an important determinant for pricing products at the global
markets.
Consequently, the principal objective of this paper is to use the Generalized
Autoregressive Conditional Heteroscedasticity (GARCH) to model exchange
rate volatility and the system Generalized Method of Moments (GMM) model to
examine the effect of exchange rate volatility on economic growth in Nigeria. In
particular, this paper attempts to shed some light on this issue and find out
whether there exists exchange rate volatility in Nigeria. If it does exist, what is
the influence on economic growth? The current study postulates that exchange
rate volatility has a significant effect on the Nigerian economic growth. The
48 Benjamin Ighodalo Ehikioya

results of the study suggest that exchange rate volatility persists in Nigeria. The
findings indicate that exchange rate volatility is detrimental to Nigerian econom-
ic growth. The result shows that while inflation exerts a negative and significant
influence on economic growth, credit to the private sector and crude oil prices
demonstrates a positive and significant impact on the economic growth of Nige-
ria. The implication of this result is that exchange rate stability is an important
factor along with other macroeconomic variables to achieve economic growth.
The investigation of exchange rate volatility and its effects on economic
growth is an important issue for both the policymakers and other economic
agents of the markets. This paper contributes to the literature in several ways.
Firstly, by employing a GARCH model, which is one of the most efficient and
standard methods to model exchange rate volatility, the current paper provides
a more appropriate framework than the standard deviation technique to examine
this issue. Secondly, this study shed some light on economic growth’s response
to exchange rate volatility for similar emerging and industrial markets as well.
Thirdly, this study and the model used will assist investors and firms to estimate
risk and enhance investment decisions. Fourthly, the understanding of the ex-
change rate volatility and its influence on different macroeconomic variables and
economic growth will assist the policymakers with appropriate policies and pro-
grammes that will help stabilise the exchange rate and stimulate economic
growth. Finally, researchers and other economic agents involved in the financial
markets will benefit from how exchange rate volatility is determined.
The rest of the paper is structured as follows: Section 2 presents the litera-
ture review on the relationship between exchange rate volatility and economic
growth. Section 3 describes the data set and the econometric methodology used.
While Section 4 reports the empirical results of the paper, the final section con-
cludes.

2. Literature review

2.1. Exchange rate volatility and economic growth

Exchange rate volatility and economic growth are two concepts that contin-
ued to attract the attention of scholars in the field of finance and economics.
Previous studies have documented the importance of a stable environment for
economic growth. Economic growth occurs when there is an increase in a coun-
try’s productive capacity for goods and services, measured in terms of GDP
 The impact of exchange rate volatility on the Nigerian economic growth… 49

yearly. At the theoretical level, economic growth has been investigated using the
neoclassical growth theory and the endogenous growth theory. The neoclassical
growth theory pioneered by Solow (1956), argued that steady economic growth
could be attained through progressive efforts in exogenous technical innovation.
However, the endogenous growth theory popularised by Romer (1986) and Lu-
cas (1988) argued that any country can achieve economic growth even without
any exogenous technical progress but through deliberate efforts in endogenous
activities such as external capital accumulation, foreign aid, human capital de-
velopment or through existing product design among others. The endogenous
growth theory hinges its arguments on sound economic policies that support and
promote macroeconomic stability, increased investment and productivity. More-
over, the growth models posit that low inflation rates, low interest rates and trade
openness can enhance productivity and economic growth through access to mar-
kets, transfer of capital goods, technologies and skills (Eriṣ & Ulaṣan, 2013;
López-Villavicencio & Mignon, 2011).
According to Mundell (1961) in Optimal Currency Area (OCA) theory, ex-
change rate and monetary policies are Keynesian instruments that must be inde-
pendent in order to deal effectively with asymmetric shocks in the economy.
This is based on the concepts of trade, shocks and the degree of labour market
mobility. Advancing this theory, McKinnon (1963) argued the economic bene-
fits of fixed exchange rate regimes to include price stability for open economies
that rely on foreign goods for consumption and productivity. Moreover, fixed
exchange rate regimes promote stability in the environment for investment, in-
creased trade and output growth by reducing the level of exchange rate uncer-
tainty, which in turn would help to reduce transaction and other risk-mitigating
costs (Frankel & Rose, 2002). Nevertheless, a flexible exchange rate regime is
argued for its ability to allow an economy to adjust to external shocks resulting
from the differences between the domestic and international prices to offset pro-
duction losses (Mundell, 1961). Furceri & Zdzienicka (2011) opined that coun-
tries promoting a flexible exchange rate regime tend to experience lower produc-
tion losses during periods of financial crises. However, this type of exchange
rate regime is also vulnerable to excessive exchange rate volatility, which may
be inimical to economic growth.
The empirical literature regarding the effects of exchange rate volatility on
economic growth has been unsettled. For example, Azid, Jamil, & Kousar
(2005) employed data from the manufacturing sector and the GARCH model to
examine the impact of exchange rate volatility on economic performance in Pa-
50 Benjamin Ighodalo Ehikioya

kistan. The results of their study suggest a positive but insignificant impact of
exchange rate fluctuations on manufacturing output performance. Musyoki et al.
(2012) used the monthly frequency data, the GARCH model to capture the real
exchange rate volatility and Generalized Method Moments (GMM) to examine
the impact of the real exchange rate volatility on the Kenya’s economic growth
for the period January 1993 to December 2009. They reported persistent volatili-
ty throughout the study period and the negative influence of real exchange rate
volatility on the Kenyan economic growth. Similarly, Vieira & MacDonald
(2016) employed the annual data from 2000 to 2011 and the system GMM to
investigate the effects of the real effective exchange rate volatility on export
flows in 106 developed and emerging countries. Their empirical investigation
reveals that exchange rate volatility has a negative relationship with exports. In
a related study, Mukhtar & Malik (2010) used the time series data from 1960 to
2007 as well as cointegration and vector error correction model (VECM) to ex-
amine the effect of real exchange rate on the growth of three South Asian coun-
tries (India, Pakistan and Sri Lanka). The results of their estimation show that
real exchange rate volatility exerts a significant negative effect on exports in
both the short run and long run.
In Nigeria, Akpan & Atan (2012) furthered the study on this issue using the
GMM to investigate the effects of exchange rate movements on economic
growth in Nigeria. They argued that there was no evidence to suggest a strong
direct link between exchange rate and output growth. Instead, monetary varia-
bles have been responsible for Nigeria economic growth. Similarly, Danmola
(2013) used the ordinary least square (OLS) regression technique and the
Granger causality test to analyse the impact of exchange rate variability on eco-
nomic growth proxy as GDP in Nigeria for the period 1980-2010. The study
found that exchange rate variability showed a significant positive relationship
with economic growth. Apollos, Emmanuel & Olusegun (2015) adopted the
OLS technique and data for the period 1986-2013 to investigate the relationship
between the GDP and exchange rate, imports, exports and the inflation rate in
Nigeria. The result of their study revealed a significant positive relationship
between the GDP and the explanatory variables like the exchange rate and ex-
ports. In a related study, Isola, Oluwafunke, Victor, & Asaleye (2016) employed
the autoregressive distributed lag (ARDL) model to investigate the linkage be-
tween exchange rate volatility and economic growth in Nigeria from 2003-2013
and the results indicate that there is no relationship between the variables in the
long run. One concern with some of the studies that used the OLS model is that
they failed to account for the panel effects of the data used and the issue with the
endogeneity of the variables in the study.
 The impact of exchange rate volatility on the Nigerian economic growth… 51

2.2. The Nigerian exchange rate history from 1980

Nigeria has gone through different exchange rate regimes in a bid to stabi-
lise the economy. The exchange rate plays an important role in the economy
given its effect on the prices of goods and services, allocation of resources and
investment decisions. Since the mid-1980, the country moved from the fixed
regimes and adopted the flexible exchange rate regimes though with periodic
intervention by the regulatory authorities. In the opinion of Okoroafor & Adeniji
(2017), no exchange rate could be allowed to float completely or be determined
by the market forces without the periodic intervention of the regulatory authority
in order to achieve some strategic objective of macroeconomic stability and
growth. Following the creation of the Nigeria entity as an independent nation in
1960, the exchange rate policy has undergone a substantial transformation as
part of the effort by the government to position the economy on the path of
growth. For instance, between 1960 and August 1986, Nigeria adopted the direct
exchange rate control mechanism to manage foreign exchange rate along with
other macroeconomic variables in order to stabilize the economy and stimulate
growth. This system of direct exchange rate control was possible because of the
boom in agricultural produce and a sharp rise in the prices of crude oil at the
international market. However, the 1982 foreign exchange crisis that increased
the demand for foreign exchange at a time when the supply dwindled due to
a drop in foreign earnings necessitated the exchange controls and the develop-
ment of parallel foreign exchange markets to stabilise the economy. During this
period, particularly between 1981 and 1986, the Naira depreciated against the
dollar from N0.61 to N2.02.
Since the adoption of the Structural Adjustment Policy (SAP) in 1986, dif-
ferent foreign exchange markets have been introduced. The government in 1986
introduced the Second-tier Foreign Exchange Market (SFEM) and the Unified
Official Market (UOM) in 1987 to balance the economy. However, in 1990, the
Naira depreciated further to N7.90. To stabilise the exchange rate, the govern-
ment in 1994 embarked on exchange rate reform and pegged the Naira exchange
rate against the Dollar at N21.89. The fallout of that reform compelled the gov-
ernment to liberalise the Foreign Exchange Market in 1995 with the introduction
of the Autonomous Foreign Exchange Market (AFEM). The foreign market was
further liberalised and the Inter-bank Foreign Exchange Market (IFEM) was
announced in October 1999. During this same period, further deregulation saw
the Naira exchange for N86.32 against the dollar. Furthermore, in a bid to re-
52 Benjamin Ighodalo Ehikioya

spond to the upward demand in foreign exchange and the consistent drop in the
country foreign reserve, the government in 2002 deregulated the foreign ex-
change market and introduced the Dutch Auction System (DAS). During this
period, the Naira traded against the dollar for N120.97 in 2002 and N135.5 in
2004. Meanwhile, the Wholesale Dutch Auction System (WDAS) was intro-
duced in 2006.
Interestingly, the government’s efforts to stabilise the exchange rate paid
off when the Naira appreciated to N132.15 in 2005 and N118.57 in 2008. How-
ever, this period was short-lived due to the global financial crisis that saw the
Naira depreciating to N150.01 against the dollar in 2009. The government’s
attempts to manage the exchange rate were aimed at finding an enduring solu-
tion to the foreign exchange crisis in the country, occasioned by the dwindling
foreign exchange earnings, particularly from oil revenue. Nevertheless, the actions
of the present civilian administration have again thwarted the whole essence of
that effort with more challenging foreign exchange crisis. For instance, between
the middle of 2015 when the present administration led by President Muhamadu
Buhari came into power and the second quarter of 2017, the domestic economy
witnessed an unprecedented adverse exchange rate volatility against the US dol-
lar. During this period, the hostile business environment due to inconsistencies
in government policies and programs resulted in the withdrawal of foreign cur-
rencies from the economy by foreign investors who were not certain about their
future in Nigeria. This situation, coupled with the fall in foreign inflows from oil
revenue, created a shortfall in foreign currencies in relation to demand. To ad-
dress this imbalance, the government embarked on the devaluation of the Naira
against the dollar and the exchange rate moved from N180 in mid-2015 to N254
in 2016 and N350 in 2017 as the official rate.

3. Data and methodology

3.1. Measuring exchange rate volatility

The determination of exchange rate volatility remains a controversial issue

due to the choice of the exchange rate and the absence of a unique method in the
literature. For example, while Servén (2002) argued the choice of real exchange
rate to compute volatility, other studies such as Barguellil, Ben-Salha, & Zmami
(2018) believe that the choice of nominal or real exchange rates does not signifi-
cantly influence the results of the computed volatility. The Nigeria economic
 The impact of exchange rate volatility on the Nigerian economic growth… 53

environment is very dynamic with frequent movements of the Consumer Price

Index due to fluctuations in the exchange rate. This means that a movement in
the currency of Nigeria trading partner will affect the value of the Naira with
implications. The prices of crude oil, which is the major source of foreign earn-
ings for the country, fluctuate regularly with effects on the prices of products in
the markets. Thus, to account for the effects of inflation in the determination of
exchange rate volatility, this study employed the real exchange rate measured as
follows:
RERt = NERt ⎛⎜ t ⎞
P
⎟ (1)
⎝ PN t ⎠

Where NER is the nominal exchange rate to convert the Naira to US$1, PN
is the inflationary price level in Nigeria, P is the price level of the US as a trad-
ing partner and t is the transaction time.
Different models such as the Generalized Autoregressive Conditional Het-
eroscedasticity (GARCH) model, developed by Bollerslev (1986) and the stand-
ard deviation, among others, have been used in the literature to compute ex-
change rate volatility (Siregar & Rajan, 2004). However, following the studies
of Adewuyi & Akpokodje (2013), Alagidede & Ibrahim (2017), Musyoki et al.
(2012), this study employs the GARCH model to measure the real exchange rate
volatility, which is the variable of interest. The GARCH model is an extension
of the Autoregressive Conditional Heteroscedasticity (ARCH) model developed
by Engle (1982), which adopts the variance of a time series. The merit of the
GARCH model stems from its ability to differentiate and recognise information
that generates the exchange rate in a random process. Like the standard deviation
approach that is deficient in its failure to recognise the interesting patterns such
as time-varying and clustering properties in asset volatility, the GARCH model
is a robust model that is capable of dealing with the volatility associated with
financial data characterised by skewed distribution and the problem of hetero-
scedasticity. Moreover, apart from the skewed distribution, the standard devia-
tion measure of exchange rate volatility is characterised with the inability to use
all the relevant information to estimate the effects of volatility (Pagan & Ullah,
1988). In addition, the GARCH model allows for the differentiation and recogni-
tion of information that generates the exchange rate in a random process (Azid et
al., 2005). The GARCH model to obtain the monthly exchange rate volatility
time series for this study is specified as follows:
EVOLt = α o + β1γ t −1 + β2 γ t − 2 + εt (2)
54 Benjamin Ighodalo Ehikioya

εt / θt −1 ∼ N(0,σt2 )
p q
σ t2 = α + ∑i =1
λ i ε t2− i + ∑
j =1
ϕ j σ t2− j (3)

Where α o is the mean, σ 2 is a conditional variance of εt , and α, λ , and φ

are non-negative. Equation (3) takes into consideration the conditional variance
explained by past shocks or volatility, ε t2−i (ARCH term) and the variance of the
past period forecast error, σ t2− j (GARCH term). Equation (3) is stationary where
p q

∑ λi + ∑ ϕi < 1 . As part of the pre-estimation checks, the study employed the

i =1 j =1

Augmented Dickey–Fuller (ADF) and Philips–Perron (PP) tests to analyse the

properties of the time series data and determine the level of stationarity of the
variables. In other words, the ADF and PP were used to determine whether the
variables are integrated of order zero 1(0) or order one 1(1). The Johansen co-
-integration estimation technique was used to test for the periodicity effect and
establish if there is any long-run relationship among the variables in the study.

3.2. Model specification

To investigate the impact of exchange rate volatility on economic growth,

there are several dependent variables such as the trade, investment, exports, em-
ployment and current account balance among others that could be used to meas-
ure the growth rate of any economy (Azid et al., 2005; Kiyota & Urata, 2004;
Pagan & Ullah, 1988; Servén, 2002). Moreover, several explanatory variables
have been documented in the literature to have a relationship with economic
growth (Sala-i-Martin, Doppelhofer, & Miller, 2004). Consistent with the
growth literature, this study employs the real GDP per capita as a proxy for eco-
nomic growth and the exchange rate volatility as the explanatory variable
(Katusiime, Agbola, & Shamsuddin, 2016). The control variables used in this
study are inflation (INF), financial development proxy as credit to private sector
(CPS), trade openness (TOPON), money supply (MS), human capital develop-
ment (HCD), government expenditure (GEXP), crude oil prices (COP) and
dummy variable for exchange rate regimes (DUMR). The choice of variables
follows the theoretical and empirical literature on this issue. Additionally, the
variable selection is based on data availability and the need to have balanced
 The impact of exchange rate volatility on the Nigerian economic growth… 55

observations for all the variables. The choice of real GDP per capita, which em-
beds other growth variables, will help avoid or deal with the likely problem of
interdependences between variables. To estimate the effects of the exchange rate
volatility of the Naira on economic growth, the study employed the following
model:
Y = f ( REVOL, INFL, CPS , TOPEN , MS , HCD, GEXP, COP, DUMR)t (4)

Equation (4) can further be expressed in the econometric model as:

Yt = β 0 + β1 REVOLt + β 2 INFLt + β 3 CSPt + β 4 TOPEN t
(5)
+ β 5 MS t + β 6 HCDt + β 7 GEXPt + β 8 COPt + β 9 DUMRt + ε t
Where β 0 is the constant, β1 to β 5 are the coefficients of the endogenous vari-
ables and ɛ is the stochastic disturbance term. Equation (5) can further be ex-
pressed by introducing the natural log and that gives us equation (6) below.
InYt = β0 + β1 InREVOLt + β2 InINFLt + β3 InCSPt + β4 InTOPENt
(6)
+β5 InMSt + β6 InHCDt + β7 InGEXPt + β8 InCOPt + β9 InDUMRt + ε t
Since the data are time series datasets, the lagged values of the data can be intro-
duced as possible instruments because lagged values are less likely to be influ-
enced by current shocks. Thus, equation (6) was redefined as
ΔInYt = β0 + β1ΔInREVOLt + β2ΔInINFLt + β3ΔInCSPt + β4ΔInTOPENt + β5ΔInMSt
(7)
+β6ΔInHCDt + β7ΔInGEXPt + β8ΔInCOPt + β9ΔInDUMRt + εt
Where In is the log and ∆ is the lag of the logged variable. Table 1 presents the
definition and measurement of variables.

Table 1. Description of variables

Variable Definition
1 2
Y Real GDP per capita, a proxy for economic growth and measured as the ratio of total
GPD to the total population
REVOL Real exchange rate volatility, measured using the GARCH (1, 1) model as presented
in equation 2
INFL The inflation rate, measured as the annual percentage change in the consumer price
index
CPS Domestic credit to the private sector, a proxy for financial development, and it is
measured as domestic credits to the private sector over the GDP
TOPEN Trade openness, defined as the sum of exports and imports to GDP
MS Money supply is measured as the total money liability of commercial and merchant
banks to the GDP
56 Benjamin Ighodalo Ehikioya

Table 1 cont.
1 2
HCD Human capital development, measured as the ratio of annual total expenditure on
education to GDP
GEXP Government expenditure and it is measured as the ratio of government total expenditure
to GDP
COP Crude Oil Prices, measured as the annual average price of oil in US dollars per barrel
DUMR A dummy variable for fixed and flexible exchange rate regimes taking the value of the
period is fixed, 0 otherwise

The impact of exchange rate volatility on economic growth may occur

through the aggregate demand channel. Excessive exchange rate volatility may
reduce the international competitiveness and the aggregate demand for domestic
goods due to an increase in inflation, interest rate and risk. According to the
endogenous growth models, increase in consumer prices of goods and services
due to volatility would reduce the purchasing power and the demand for prod-
ucts, which in turn would discourage economic growth (Kiyota & Urata, 2004;
Wong, 2017). Moreover, exchange rate volatility may affect growth through the
influence on investments and the expectations about the present and future re-
turns from the market, which could affect growth (López-Villavicencio & Mi-
gnon, 2011). This is partly because an increase in exchange rate volatility lead-
ing to abnormal behaviour of other economic fundamentals such as the interest
rates and money supply could mean a rise in the level of risks associated with
the financial markets. This trend could result in the scarcity of funds in the fi-
nancial markets and a rise in the cost of funds since investors may move their
investment to less risky assets or may be unwilling to take up any investment in
financial assets. Additionally, exchange rate volatility may impair or affect eco-
nomic growth when there is the ‘overshooting’ behaviour of the exchange rate
due to the response or behaviour of the financial markets and non-financial mar-
kets to external shocks (Frankel & Rose, 2002; Musyoki et al., 2012).
According to economic theory, the government can raise aggregate demand
and boost economic growth through an increase in expenditure on infrastructure,
technology and human capital development. However, increases in government
expenditure may be counter-productive on economic growth because of the
crowding out effects on private sector investment. Exchange rate volatility can
deter government expenditure due to a reduction in inflows and in the value of
the reserves, which may affect the welfare effects and consumer spending be-
haviour, ceteris paribus. The level of financial development and its ability to
support the economy through savings mobilisation and risk management will
determine the level of economic growth. The study introduces crude oil prices
 The impact of exchange rate volatility on the Nigerian economic growth… 57

(COP) to moderate the effect of exchange rate volatility on growth. Crude Oil
prices are an important factor in the Nigeria economy due to its influence on
foreign earnings and reserves. It expects the increase or decrease in crude oil
prices to have a positive or negative influence on growth. This is because a de-
crease or increase in oil prices will reduce or increase foreign exchange earnings,
discourage or improve investment in infrastructure and resource allocation.
Thus, it is important to examine the dynamic relationship between this variable
and economic growth in Nigeria. Finally, the study introduced a dummy variable
to account for the period of fixed and flexible exchange rate regimes.
To establish the impact of the exchange rate volatility of the Naira on eco-
nomic growth, this study employed the two-step system GMM technique devel-
oped by Blundell & Bond (1998). The choice for this model is to deal with the
drawbacks and inaccuracy associated with the difference GMM estimator devel-
oped by Arellano & Bond (1991) and in small samples. In addition, the system
GMM will help to take into consideration the time dimension of the dataset. This
is in tandem with the previous empirical growth studies (Aghion, Bacchetta,
Rancière, & Rogoff, 2009). Compared with the estimation using non-conditional
standard deviation technique, which imposes a known restriction on the empiri-
cal analysis of exchange rate volatility on growth, the system GMM estimation
technique will help avoid the likelihood of any biased results that may be due to
the correlation between the endogenous variables and the error term in the study.
In other words, the system GMM estimation technique will help overcome any
issues about potential endogeneity and produce unbiased results even in the face
of any potential lagged dependent variables among the explanatory variables.
This is possible because of the ability of the system GMM to consider all varia-
bles as endogenous. To test the validity of the instruments in the model, the
study used Hansen’s test of over-identification of restrictions that evaluate the
entire set of moment conditions.

3.3. Data source

This study employed secondary data to examine exchange rate volatility

and its impact on economic growth in Nigeria. The study period is from January
1980 to December 2017 with 456 monthly time series observations. The choice
of the study period was influenced by data availability for the relevant variables
and the Nigeria experience of exchange rate instability against the dollar and
other major currencies, especially after the suspension of the exchange rate con-
58 Benjamin Ighodalo Ehikioya

trol measure in 1986. Prior to the mid-1980s, Nigeria witnessed a shortfall in

foreign revenue from crude oil and agricultural produce that could not service
the expected foreign exchange demand. Following this development, from Sep-
tember 1986 down to 1999, the country witnessed the managed float regime with
different exchange rates. Towards the end of the study period, that is, 2016, Nige-
ria witnessed the worse and the most volatile exchange rate regime that crashed
the purchasing power of the Naira and plugged the economy into recession. The
study employed data sourced from the Central Bank of Nigeria (CBN) Statistical
Bulletin and Annual Reports of various issues, National Bureau of Statistics
(NBS) and the World Development Indicators database of the World Bank.

4. Empirical results and discussion

4.1. Preliminary analysis

The study proceeds with the preliminary analysis of the variables in the
study. Tables A1 and A2 in the Appendix depict the descriptive statistics and the
correlation matrix of the variables in the model. The study carried out the esti-
mation of the unit root of the variables to establish their behaviour over time. As
presented in Table A3 in the Appendix, the results of the unit root test using
Augmented Dickey–Fuller (ADF) and Philips–Perron (PP) tests show that the
variables are stationary in their first difference. In addition, the results of the
Johansen cointegration tests, given the order of integration of the variables in the
study, are presented in Table A4 in the Appendix. The results of the Johnson co-
-integration tests in trace and Max–Eigen statistics show the existence of cointe-
gration among the variables, which means there is evidence to support the exist-
ence of a long-run relationship between exchange rate volatility and other variables
in the model.

4.2. Estimation of real exchange rate volatility

The study employed the ARCH test to examine the ARCH effect in the vari-
ables. Table 2 shows the results of the heteroscedasticity test for the returns
series and it is statistically significant at a 5% level with the observed R-squared
of 6.0118 and a p-value of 0.0031. This implies the presence of an ARCH effect
in the variables since the p-value is less than the required 5%. This result sug-
 The impact of exchange rate volatility on the Nigerian economic growth… 59

gests the influence of the previous period exchange rate volatility on the current
exchange rate volatility with respect to the US dollars, and thus confirms the
appropriateness of a GARCH model to explain exchange rate volatility. The
results of the estimation of exchange rate volatility using the GARCH (1, 1)
model are presented in Table 3. The result shows that the coefficients of ARCH
and GARCH term are positive and significant at 5% level. The result of the
GARCH (1, 1) test suggests the persistence of shocks in the volatility of the
variables, which implies that the volatility is highly persistent over the periods in
consideration. It implies that the periods of high (low) exchange rate shocks tend
to be followed by periods of high (low) exchange rate shocks for a prolonged period.

Table 2. ARCH Lagrange Multiplier (LM) Test

Heteroskedasticity Test: ARCH

F-statistic 4.1042 Prob. F(1,0173) 0.0046

Obs*R-squared 6.0118 Prob. Chi-Square(1) 0.0031

Table 3. Estimation of exchange rate volatility with ARCH/GARCH Model

Variable Coefficient Std. Error z-Statistic Prob.
Mean equation

C 0.6150 0.2047 3.0042 0.0041

Variance equation

C 4.0312 1.3250 3.0424 0.0411

ARCH(-1)^2 0.6320 0.4653* 1.3583 0.0120
GARCH(-1) 3.2189 0.6384* 5.0422 0.0014

Note: *, **, and *** denote statistical significance at 1%, 5%, and 10% levels, respectively.

4.3. Effect of exchange rate volatility on economic growth

The study employed the system GMM model to examine the effect of ex-
change rate volatility on economic growth and the results are presented in Table 5.
The robustness of the study outcome for policymakers, investors and other
stakeholders of the economy is reinforced with the diagnostic checks of the
model specification using Ramsey RESET test, normality using the Jarque–Bera
test, serial correlation using the Breusch–Godfrey test and the heteroscedasticity
using the White test. As reported in Table 4, the result of the model functional
form shows t-stat = 1.4103; p-value = 0.5110 and it is significant at the 5% level,
60 Benjamin Ighodalo Ehikioya

which suggests that the null hypothesis that the model has no omitted variables
accepted. The results show that the residuals are normally distributed (t-stat =
= 2.8931; p-value = 0.3615). The LM tests results of t-stat = 4.0114; p-value =
= 0.1503) and White tests results of t-stat = 3.4835; p-value = 0.0083 indicate
the acceptance of the null hypotheses that there is no serial correlation and het-
eroscedasticity problems in the study. In Table 5, the R2 of 0.6790 suggests that
the model is fitted and 68% of the variation in economic growth is explained by
the variation of the independent variables. The result of the F-value of 6.8435
with a corresponding p-value of 0.0015 indicates the overall suitability of the
variables employed. The validity of the set of instruments in the model is re-
vealed in the result of the Hansen J – statistics of 0.6802 with a high p-value of
0.3446, which indicates that the instruments are not correlated with the residuals.

Table 4. Diagnostic checks

Estimate Technique t-stat Prob
Serial correlation Breusch–Godfrey Lagrange Multiplier test of residual
4.0114 0.1503
serial correlation
Functional form Ramsey RESET test for omitted variables/functional form 1.4103 0.5110
Normality Jarque–Bera normality test based on a test of skewness
and kurtosis of residuals 2.8931 0.3615
Conditional White’s test for heteroscedasticity based on the regression
heteroscedasticity of squared residuals on squared fitted values 3.4835 0.0083

Table 5. System GMM estimation of exchange rate volatility on growth

Variable 1 2
Coefficient Std. Error Prob. Coefficient Std. Error Prob.
C 4.0091 1.9742 0.0752 1.4845 3.7421 0.8728
Δ REVOL −0.4842** 0.4820 0.0000
Δ INFL −0.2273** 1.2298 0.0014 −0.1407* 1.4892 0.0021
Δ CPS 0.1293* 4.3221 0.0046 0.1461* 2.1839 0.0133
Δ TOPEN 1.0483 1.0338 0.2033 0.2942 0.2113 0.5431
Δ MS 1.4999 0.3421 0.4190 1.2340 1.3641 0.3001
Δ HCD 0.3720 3.8473 0.2010 0.3478 1.4393 0.0324

Δ GEXP 0.4208 4.0222 0.3623 1.4733 0.6836 0.1435

Δ COP 0.1709** 0.9842 0.0361 0.2239** 1.8411 0.0010

Δ DUMR 2.9928 1.2084 0.6384 3.2222 2.6372 0.5737

R-squared 0.6790 0.8220
Adjusted R-squared 0.6102 0.6444
F-statistic 6.8435 4.0282
Prob(F-statistic) 0.0015 0.0000
Durbin–Watson stat 1.9920 2.0111
Hansen’s J-statistic 0.6802 0.6408
Prob (J-statistic) 0.3446 0.3048

Note: *, **, and *** denote statistical significance at 1%, 5%, and 10% levels, respectively.
 The impact of exchange rate volatility on the Nigerian economic growth… 61

Table 5, Model 1 presents the results of the study with all the variables in
the model. The result indicates that exchange rate volatility exerts a negative
impact on economic growth in Nigeria. This result is statistically significant at
5% level and suggests that a 1% increase in the volatility of the Naira exchange
rate in favour of the US dollar will lead to a 48% decrease in the economic
growth of Nigeria. This finding is consistent with previous studies such as
Musyoki et al. (2012) and Schnabl (2009) on the connection between exchange
rate volatility and economic growth. As expected, inflation is found to have
a negative influence on economic growth, which suggests that a 1% increase in
inflation will significantly reduce economic growth by 23%. The result of this
study demonstrates a positive and significant influence of the credit to the pri-
vate sector and crude oil prices on economic growth. Specifically, the results,
which are statistically significant at 5% level, indicate that a 1% increase in
credit to the private sector and crude oil prices will enhance economic growth by
13% and 17%, respectively. Moreover, endogenous variables such as trade
openness, money supply, government expenditure and human capital develop-
ment exert positive, but insignificant influence on economic growth. In Table 5,
Model 2, the study excluded real exchange rate volatility to observe the perform-
ance of other variables on economic growth. The sign of the coefficients of the
variables remains in the same direction, though human capital development ex-
hibited a significant relationship with economic growth.

4.4. Discussion of results

This study found a negative and significant relationship between exchange

rate volatility and the economic growth of Nigeria. The study demonstrates that
the exchange rate is one of the factors responsible for the Nigeria sluggish and
unstable economic growth. The adverse effect of exchange rate volatility on
economic growth might be due to the over-reliance of the Nigerian economy on
a mono-product (crude oil) that is largely dependent on the global market forces.
This result suggests the influence of other foreign exchange market players such
as the bureau de change and other informal players. In addition, this result points
to the nature of the Nigerian economy as an import-dependent economy with
high consumption of foreign exchange and the resultant negative effect on eco-
nomic growth. The persistent exchange rate volatility is a clear manifestation of
the government’s inability to build an external reserve that is adequate to supply
the required foreign exchange to manage the level of volatility from time to
62 Benjamin Ighodalo Ehikioya

time. Moreover, while inflation revealed a negative and significant relationship

with economic growth, credit to the private sector and crude oil prices demon-
strates a positive and significant influence on the economic growth of Nigeria.
All the other endogenous variables such as trade openness, money supply, gov-
ernment expenditure and human capital development exert a positive, but insig-
nificant influence on economic growth.
In line with the theoretical and empirical literature, the negative effect of
exchange rate volatility on economic growth may be explained through its ef-
fects of uncertainty and instability on economic variables such as inflation and
investment. The implication of this is that as a mono-cultural product economy,
higher exchange rate volatility due to a drop in oil revenue inflows may lead to
a higher inflation rate that may affect the demand and consumption pattern,
which in turn would lead to low investment. Moreover, higher exchange rate
volatility may lead to low investment because of low credit to the private sector,
high level of risks, higher interest rates and the demand for more collateral by
the financial markets. The unwillingness of economic agents to lend to the in-
vestment sector due to volatility can hinder economic growth (Eriṣ & Ulaṣan,
2013). These relationships may have been responsible for the recent recession
and poor economic growth in Nigeria. Given that the economic growth is influ-
enced by changes in the explanatory variables, the significance placed on ex-
change rate volatility and other macroeconomic variables by the stakeholders of
the economy is likely to continue in the mix of a dynamic and structural envi-
ronment and the dwindling revenue inflows in Nigeria. The result demonstrates
and confirms that the Nigerian economy seems to lack the required stability to
enhance economic growth due to volatility.
The findings of this current study offer evidence to support the existing lit-
erature in the same direction. For example, Alagidede & Ibrahim (2017) em-
ployed the annual data from 1980 to 2013 and the vector autoregression model
to investigate the connection between exchange rate volatility and economic
growth in Ghana. The results of their study show a co-integrating relationship
between the real exchange rate and real income. Moreover, they documented
that the real exchange rate has a negative and significant relationship with eco-
nomic growth, which means undue exchange rate volatility will reduce econom-
ic growth in Ghana. Nevertheless, the findings of the current study differ with
the results of Katusiime et al. (2016). The study by Katusiime et al. (2016) used
the autoregressive distributed lag model to investigate the effect of exchange rate
volatility on economic growth in Uganda. The study covers a period 1960-2011
 The impact of exchange rate volatility on the Nigerian economic growth… 63

with 52 yearly observations. They employed the GARCH model to compute the
monthly nominal exchange rate volatility and White’s heteroscedasticity test to
examine the presence of heteroscedasticity. They found that exchange rate vola-
tility has a positive influence on economic growth in Uganda. Specifically, they
reported that a 1% increase in exchange rate volatility would lead to a 0.3% and
0.5-1.3% increase in economic growth in the short run and long run, respectively.
Consequent the results of the current study, it is important for the govern-
ment through the monetary authority to pursue policies and programs that would
ensure the stability of the exchange rate for economic growth. This study
demonstrates the need for the government and other stakeholders of the econo-
my to create the enabling environment through the proper mix of macroeconom-
ic variables capable of affecting each other positively. It is also important for the
country to shift from the over-reliance on a single product and pursue a program
of economic diversification to boost foreign earnings. The Nigerian government
is encouraged to promote financial market development to reduce the cost and
risks in financial assets and encourage investment that will improve productivity
and economic growth. The provision of the required infrastructure, enhanced
human capital development and overall improvement of the enabling environ-
ment are important to encourage the export base expansion of the economy.
These measures will help reduce the level of exchange rate volatility and guaran-
tee the country a stable economic growth.

5. Conclusions

This study aimed at examining exchange rate volatility and its effect on
economic growth in Nigeria. The study employed the GARCH model and the
system GMM estimation technique to analyse data for the period 1980-2017.
The study offered evidence that exchange rate volatility persists throughout the
study period, which suggests that periods of high (low) exchange rate shocks
tend to be followed by periods of high (low) exchange rate shocks for a pro-
longed period. The result of the empirical analysis shows that exchange rate
volatility negatively and significantly influences the economic growth of Nigeria.
This result is in tandem with previous studies as reported by Alagidede & Ibrahim
(2017). The implication of this result is that the Nigerian economy is susceptible
to exchange rate volatility. The result also implies that exchange rate volatility is
an important influencing factor, which needs to be weighed in making decisions.
The study presents empirical evidence that crude oil prices, inflation, govern-
64 Benjamin Ighodalo Ehikioya

ment expenditure, trade openness and domestic credit to private sector exert
influence on the economic growth of Nigeria.
This study contributes to the literature by showing the power of exchange
rate volatility on economies such as Nigeria. The current study is limited to the
selected variables based on data availability in Nigeria. Accordingly, further
studies on the issues discussed taking into consideration other control variables
based on the theoretical and empirical literature are important. Finally, given the
limited number of studies that deal with the issues discussed here using the Ni-
gerian economy, this study may provide the foundation for empirical research
work into the connection between exchange rate volatility and economic growth
taking into account the characteristics of a developing country.

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 The impact of exchange rate volatility on the Nigerian economic growth… 67

Appendix

Table A1. Results of unit root analysis

ADF PP
Variable I(d)
Level First Diff. I(d) Level First Diff.
RGDP –1.083 –3.819*** I(1) –2.104 –4.144*** I(1)
REVOL –3.537** –8.011*** I(1) –3.633*** –22.082** I(1)
INFL –1.285 –4.111*** I(1) –2.647 –15.284*** I(1)
CPS –2.041 –4.748** I(1) –0.025 –7.011*** I(1)
TOPEN –2.173 –6.301** I(1) –2.153 –5.753*** I(1)
MS 0.873 –3.047 I(1) –1.637 –9.463*** I(1)
HCD –1.546 –3.303** I(1) –2.291 –8.029*** I(1)
GEXP –0.172 –5.863*** I(1) –0.180 –9.653*** I(1)
COP –2.001 –6.301*** I(1) –1.677 –5.793*** I(1)
Note: Akaike Information Criterion (AIC) is employed to automatically select appropriate.
lags. *, **, and *** denote statistical significance at 1%, 5%, and 10% levels, respectively.

Table A2. Johansen co-integration test result

Trace Maximum Eigenvalue
Hypothesized Eigen 0.05 Max- 0.05
No. of CE(s) value Trace
Critical Prob.** Eigen Critical Prob.**
Statistic
Value Statistic Value
None* 0.958 114.637 85.947 0.012 98.106 64.955 0.031
At most 1 0.720 97.653 76.002 0.001 68.192 53.193 0.001
At most 2 0.539 78.842 57.645 0.053 53.347 42.013 0.030
At most 3 0.330 54.221 32.004 0.010 38.463 32.748 0.033
At most 4 0.270 36.712 35.264 0.230 22.478 25.103 0.117
At most 5 0.181 5.028 3.948 0.027 5.994 3.746 0.022
lags. *, **, and *** denote statistical significance at 1%, 5%, and 10% levels, respectively.

Table A3. Summary statistics of variables

Variable Obs. Mean Max Min Std. Dev. Skewness Kurtosis
RGDP 38 1306.92 2396.76 94.73 93.16 1.18 3.79
REVOL 38 25.17 82.46 0.04 22.52 2.13 9.14
INFL 38 24.08 72.80 5.42 18.93 1.94 7.01
CPS 38 18.38 38.41 1.05 11.94 2.12 5.84
TOPEN 38 75.95 354.03 17.43 41.88 –1.09 4.26
MS 38 15.49 35.62 09.47 6.17 0.40 2.17
HCD 38 5.21 7.90 2.30 1.93 0.09 1.58
GEXP 38 21.35 52.85 15.46 12.07 1.93 7.32
COP 38 43.37 114.21 11.26 29.8 1.58 6.39
DUMR 38 0.03 1 0 0.10 0.85 3.08
68 Benjamin Ighodalo Ehikioya

Table A4. Correlation analysis

Variable RGDP REVOL INFL CPS TOPEN MS HCD GEXP COP DUMR
RGDP 1.000
REVOL –0.645 1.000
INFL –0.552 –0.314 1.000
CPS 0.374 –0.495 –0.264 1.000
TOPEN 0.301 –0.542 –0.141 0.534 1.000
MS 0.226 –0.606 –0.113 0.219 0.335 1.000
HCD 0.311 –0.491 0.219 0.473 0.311 0.342 1.000
GEXP 0.219 –0.407 –0.302 0.530 0.366 0.294 0.322 1.000
COP 0.528 –0.108 0.141 0.103 0.125 0.011 0.219 0.312 1.000
DUMR 0.195 –0.201 0.174 0.129 0.412 0.163 0.122 0.300 0.103 1.000