Asymmetric Effect of Oil Price Shocks on Exchange Rate Volatility and Domestic Investment in Nigeria

Asymmetric Effect of Oil Price Shocks on Exchange Rate Volatility and Domestic Investment in Nigeria

INTRODUCTION

The abundance of natural resources, particularly crude oil, has been described as a blessing to many nations since its presence is said to spur economic growth. However, the consequences of oil price increase different amongst countries. All things being equal, oil price increase should be considered positive in oil exporting countries and negative in oil importing countries, while the reverse should be expected when the oil price decreases. Researchers have exposited on the channels through which oil price increase affects the economy [1]. Transmission mechanisms through which oil prices impact on real economic activity include both supply and demand channels. The supply side effects are related to the fact that crude oil is a basic input to production, and consequently an increase in oil price leads to a rise in production costs that induces firms to lower output. The demand-side effect of oil prices changes affects basically consumption and investment. These authors noted that consumption is affected indirectly through its positive relationship with disposable income. The magnitude of this effect is in turn stronger the more the shock is perceived to be long-lasting. Moreover, oil prices have an adverse impact on investment by increasing firms’ costs. [2].The wake of oil price increase supply suffers as production costs rise. Given substitution between production factors, relative price changes result in a reallocation of the means of production. However, these intersectoral reallocations also generate costs (training expenses, irreversible investments, etc.) Thus, the actual impact on investment essentially depends on the expectations about the stability of oil price changes, which tend to vary over time. On the demand side, oil price shocks drive up the general level of prices, which translates into lower real disposable incomes and thus reduces demand [3]. Consumption and investment is said to be affected due changes in the demand side. Consumption is affected indirectly through its positive relationship with disposable income while investment is adversely affected indirectly because such increase in oil price also affects firms’ input prices and thereby increasing their costs. Oil price changes also influence foreign exchange markets and generate stock exchange panics, higher interest rate, produce inflation and eventually lead to monetary and financial instability. The Nigerian economy is constantly exposed to oil price shocks since oil contributes over 90% of the total revenue. The dependency of the country on crude oil revenue is amplified by the usual budgetary estimate based on forecast from the expected crude oil prices. Shortfall on oil revenue occasioned by fluctuations in international oil prices had often led to deficit in the country’s budget. Such deficits are usually financed by either external or internal borrowings or through downward adjustments in sectoral budgetary allocation. However one may look at it, shortfalls from oil receipts have negative impact on the country’s economic growth. The significant effect of oil price shocks is explained by the “Dutch Disease” syndrome, a relationship that explains the decline in manufacturing sector despite increase in the exploitation of natural resources [4]. Oil price shocks have become a very important impediment to the development of growing economies. The dependence on natural resources (oil) revenues makes the national economy vulnerable to market prices.

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