The Exchange Rate Determination in Nigeria: The Purchasing Power Parity Option

Abstract

Exchange rate determination in Nigeria has gone through many changes since 1986. The increasing demand for foreign exchange and the inability of the exchange control system to determine a realistic exchange rate for the Naira prompted the switch over to floating rate system in 1986. However, in spite of this reform, a realistic exchange rate has not been found for naira and presently naira is undervalued. This study tested the validity of the purchasing power parity (PPP) either as a compliment or an option to the present floating exchange rate system. The study used ordinary least square multiple regression method and time series secondary data for the data analysis. The time series secondary data used for the study were tested for stationarity and co-integration and were processed by an E-view for windows econometric packages. The multiple regression results confirmed the validity of purchasing power parity (PPP) as the better option for the determination of exchange rate and the realistic value of naira. The study suggested the need for the Central Bank of Nigeria to dump the floating exchange rate system and opt for the purchasing power parity (PPP) system of exchange rate determination.

Key Words: Floating Exchange Rate, Fixed Exchange Rate, Purchasing Power Parity (PPP), Structural Adjustment Programmes (SAP), Foreign Exchange Market (FEM).