Exchange Rate Variability in Nigeria: Drivers and Remedial Monetary Policy

In this study, we examine the drivers of persistent exchange rate depreciation in Nigeria and suggest remedial monetary policy actions based on inference from the results. Using time series data from January 2008 to June 2023, the following potential drivers were examined: price level differential, interest rate differential, terms of trade, stock market performance, oil price and central bank forex supply to the FX market. While the Naira/USD exchange rate is a daily observation data, potential drivers are majorly available on a monthly basis. On this note, we employ the GARCH variant of the Mixed Data Sampling (GARCH-MIDAS) technique. For robustness purposes, we employ conduct modelling with fixed window and rolling window data sampling techniques. Notable model selection criteria such as the Akaike Information Criterion (AIC), Bayesian Information Criterion (BIC) and Logarithmic Likelihood (LogL) are utilized to determine the optimal model. Our results reveal that foreign exchange market inefficiency, high inflation, low interest rate, dwindling oil price, adverse stock market performance, and low CBN FX supply to the forex market are major drivers of exchange rate variability in Nigeria. The results are robust to alternative data sampling techniques. Additional results of this study suggest that improvement in macroeconomic performance and adverse financial market performance can reduce the long-term volatility persistence of the exchange rate in Nigeria. Based on intuition from these findings, remedial monetary policy actions proposed by this study include improvement in forex market efficiency, promotion of productivity and export of tradeable goods and services, reduction in macroeconomic uncertainties, and policy consistency in exchange rate and macroeconomic management. In addition, we conclude that monetary authorities need not introduce hostile financial market policies to reduce exchange rate variability; rather, they should embark on policies to enhance macroeconomic performance.