CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Since the collapse of the Bretton Woods fixed exchange rate system in the early 1970s, the effect of exchange rate volatility on trade flows and other macroeconomic variables has attracted sustained attention. The exchange rate is the rate at which one currency exchanges for another. Its volatility is a statistical measure of the tendency of the rate to rise and fall sharply within a short period, and it is central to understanding the behaviour of the foreign exchange market. Whether the rate is nominal or real, volatility creates uncertainty in macroeconomic policy formulation, in investment decisions and in international trade. In their survey of the literature, Auboin and Ruta (2013) conclude that, on average, exchange rate volatility has a negative, though not large, impact on trade, and that the size of the effect depends on factors such as the availability of hedging instruments, the structure of production (for example the prevalence of small firms) and the degree of economic integration.

The role of exports in economic development is widely acknowledged. Exports are the goods and services that a country sends to other countries for sale. They affect the current account positively, and payment for them involves converting one currency into another at the exchange rate. In principle, export activity promotes growth in several ways: it improves the balance of payments, builds production and demand linkages, allows economies of scale in larger international markets, raises efficiency, brings in superior technology embodied in imported capital goods, produces learning effects and improvements in human resources, increases productivity through specialisation and creates employment. Evidence for export-led growth is not uniform across countries, but the rapid export growth of East Asian economies has often been used to support the argument that carefully managed openness to trade is a mechanism for rapid growth. For Nigeria, recent evidence is mixed. Ogunyomi-Oluyomi, Akinyomi and Olamade (2023), using data from 1970 to 2021, found that oil exports had a negative and non-oil exports a positive effect on economic growth, and that the export-led growth hypothesis was not supported by the causality tests. Adekunle (2025), by contrast, found that both oil and non-oil exports enhance growth and that there is bidirectional causality between exports and growth, and he stressed the need for diversification.

Exchange rate volatility has acquired particular importance in research on international trade and investment. Because of the central role of the exchange rate in an economy, and its importance to investment and trade, the Nigerian government has increasingly felt the effect of volatility on its efforts to achieve macroeconomic objectives. Variables that are often said to be influenced by exchange rate volatility include trade flows, foreign direct investment, the risk of currency crisis, the cost of debt servicing and commodity prices. Volatility refers to erratic fluctuation, whether the domestic currency is appreciating or depreciating, and large unpredictable swings can lead to a decline in future output. The exchange rate is therefore an important relative price, because it influences the external competitiveness of the domestic economy.

Trading on the foreign exchange market involves mainly the US dollar, because of the depth of the dollar market and the lower transaction cost associated with it. A Nigerian importer who wishes to buy yen to pay a Japanese exporter, for example, would sell naira for dollars and then use the dollars to buy yen. Because Nigeria depends on imports, exchange rate volatility has a considerable influence on its macroeconomic performance, and appreciation and depreciation of the currency feed directly or indirectly into the volatility of other macroeconomic variables. Gbadebo (2023), using quarterly data from 2000 to 2022, found that exchange rate volatility has a negative and significant short-run effect on Nigeria's trade and causes a significant decline in real exports and imports in the long run.

Research on exchange rate management remains of interest to economists, particularly in developing countries such as Nigeria, despite a large body of literature. This is because the exchange rate is an important relative price that connects domestic and world markets for goods, assets and services and also signals a country's competitiveness relative to the rest of the world. Nigeria's export base also remains narrow. Mati et al. (2024), in a study of nine ECOWAS countries' exports to the Eurozone, found that volatility affects these exports asymmetrically, that Nigeria's exports to the Eurozone are dominated by inferior goods, and that Nigeria should therefore diversify its economy.

A study that determines the influence of exchange rate volatility on exports is therefore important, especially for a developing country such as Nigeria. To obtain the maximum benefit from exports, Nigeria needs incentives and measures that support exports, including careful management of the exchange rate.

1.2 Statement of the Problem

Although a growing body of literature addresses the impact of exchange rate volatility on exports and trade in general, the empirical evidence remains ambiguous both within and across developed and developing countries. Auboin and Ruta (2013) report that the average effect is negative but modest and depends on several features of the economy. Many studies support the hypothesis that greater exchange rate volatility reduces trade flows, because in most international transactions sales are denominated in the currency of either the exporter or the importer, so that unanticipated movements in the exchange rate affect profits. Other studies report that volatility has no significant effect, or even a positive one, which may reflect differences in methodology or in the economies studied, and the debate remains unresolved.

The Nigerian evidence illustrates this. Duru et al. (2022), using quarterly data from 2005 to 2020 and a range of GARCH-type measures of volatility, found that volatility had a negative but statistically insignificant effect on exports. Rasaki and Oyedepo (2023), using linear and non-linear ARDL models on quarterly data from 1995 to 2020, found that volatility has only a significant short-run effect on exports, with no asymmetric effect. Okogor, Orubu and Ezi (2023), looking at exports to Nigeria's top five destinations from 1995 to 2020, found that volatility is a strong determinant of real exports in both the short and the long run. Gbadebo (2023) found a significant negative effect of volatility on real exports in the long run.

Whether firms can protect themselves against exchange rate risk is an important part of the argument. If firms hedge, one would not expect to find a strong negative effect of volatility on trade. Hedging is possible through forward and futures markets, which in effect offer a guaranteed rate at the end of the contract in return for a small margin. However, hedging is costly and imperfect, particularly for small firms, and long-term export activities remain exposed to risks that short-term instruments do not cover. Auboin and Ruta (2013) emphasise that the existence of hedging instruments and the prevalence of small firms are among the factors that determine how far volatility damages trade. Exporters care not only about the level of the prices they receive but also about the stability of those prices, since stability determines whether they can earn a consistent income. Volatility that raises risk and uncertainty in international transactions can therefore reduce trade and investment flows and the supply of exports even when some hedging is available.

It is also important to look at the influence of exchange rate volatility on Nigeria's exports as a whole. Recent studies have tended to concentrate on one angle or another, such as trade flows in general (Rasaki & Oyedepo, 2023), exports to particular destinations (Okogor et al., 2023; Mati et al., 2024) or exports measured against volatility only in the short run (Duru et al., 2022). Few of them examine together the direction of causality between exports and volatility, the existence of a long-run equilibrium relationship and the direction of change in exports, over a long period that includes the recent episodes of sharp exchange rate adjustment. This study addresses that gap.

1.3 Research Questions

This research seeks to answer the following questions:

1. Is the causal relationship between exports and exchange rate volatility in Nigeria unidirectional or bidirectional?
2. Do Nigeria's exports and exchange rate volatility converge to a long-term equilibrium?
3. What is the direction of change in exports due to exchange rate volatility in Nigeria?

1.4 Research Objectives

The broad objective of this study is to determine the response of exports to exchange rate volatility in Nigeria. Following the problems highlighted above and the research questions, the specific objectives are to:

1. determine the direction of causality between exports and exchange rate volatility in Nigeria;
2. determine whether Nigeria's exports and exchange rate volatility converge to a long-term equilibrium; and
3. capture the direction of change in exports due to exchange rate volatility in Nigeria.

1.5 Research Hypotheses

Based on the objectives, the following hypotheses, stated in null form, will guide the study:

H₀₁: There is no causal relationship, in either direction, between exports and exchange rate volatility in Nigeria.

H₀₂: Exports and exchange rate volatility in Nigeria do not converge to a long-term equilibrium.

H₀₃: Nigeria's exports do not change significantly in response to exchange rate volatility.

1.6 Policy Relevance of the Study

The findings are expected to help Nigerian policy makers make informed decisions on the conduct of exchange rate policy with a view to stimulating exports in the Nigerian economy. They will also bear on decisions about diversification, since the recommendations of recent studies point to the need to broaden Nigeria's export base (Adekunle, 2025; Mati et al., 2024).

In addition, the results may serve as a vehicle through which Nigerian exporters can argue their case with government for an export-friendly macroeconomic environment, and they may help exporters plan their export activities more effectively.

1.7 Scope of the Study

The study is specific to Nigeria and covers the period 1970 to 2024, a sample of 55 annual observations. Time series data on exports and the exchange rate for this period will be collected and analysed. The analysis is limited to determining how exchange rate volatility influences exports in Nigeria.

References

Adekunle, O. (2025). International trade and economic growth in an oil-dependent country: Case of Nigeria. Management, 23, 147–174. https://doi.org/10.26493/1854-6935.23.147-174

Auboin, M., & Ruta, M. (2013). The relationship between exchange rates and international trade: A literature review. World Trade Review, 12(3), 577–605. https://doi.org/10.1017/S1474745613000025

Duru, I. U., Eze, M. A., Saleh, A. S., Uzoechina, B. I., Ebenyi, G. O., & Chukwuka, E. (2022). Exchange rate volatility and exports: The Nigerian scenario. Asian Journal of Empirical Research, 12(1), 11–28.

Gbadebo, A. D. (2023). Does exchange rates swings affect trade? Evidence from an emerging open economy. International Journal of Economics and Financial Issues, 13(1). https://doi.org/10.32479/ijefi.13929

Mati, S., Ismael, G. Y., Masoud, S., Hamad, K. Q., Mohammed, A. A., & Hussaini, M. (2024). Revisiting ECOWAS-Eurozone exports in the light of asymmetry. Cogent Economics & Finance, 12(1). https://doi.org/10.1080/23322039.2024.2309812

Ogunyomi-Oluyomi, O. O., Akinyomi, O. J., & Olamade, O. O. (2023). Validity of export-led growth hypothesis in the Nigeria oil and non-oil exports: Evidence from ARDL and causality test approaches. Acta Universitatis Danubius. Œconomica, 19(4), 125–143.

Okogor, C., Orubu, C. O., & Ezi, C. T. (2023). Exchange rate volatility and its impact on Nigeria's exports: An autoregressive distributed lag (ARDL) analysis. Acta Universitatis Danubius. Œconomica, 19(5), 152–175.

Rasaki, M. G., & Oyedepo, E. O. (2023). Asymmetric effects of exchange rate volatility on trade flows in Nigeria. Journal of Enterprise and Development, 5(3). https://doi.org/10.20414/jed.v5i3.7192