Institutional Environment and the Quest for Stable Exchange Rate in Nigeria
Abstract
This research empirically investigates the influence of Nigeria's institutional environment on exchange rate stability using annual data from 1981 to 2023. The study uses co-integration analysis to find a co-movement between exchange rate volatility and the institutional environment measures (measured by political risk and the unpredictability of revenue sources), with the expansion of the financial sector and adjustments to exchange rate policy serving as control variables. Political risk and the unpredictability of revenue sources have a positive and substantial short- and long-term impact on Nigeria's exchange rate volatility. The results suggest that exchange rate policy only has a negative and significant impact on exchange rate volatility over the long period, while financial sector expansion has a positive but insignificant influence in both periods. The causation test reveals a unidirectional correlation between the volatility of revenue sources and the volatility of currency rates, even though there is a bidirectional association between exchange rate volatility and both political risk and revenue source volatility. This suggests that the institutional environment is endogenous to the volatility of Nigeria's currency rate. The findings suggest that restructuring Nigeria's political system and diversifying its economy away from its reliance on oil could stabilize currency rate volatility and mitigate the effects of demand fluctuations and global oil price fluctuations
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