Exchange
rate is the ratio at which the currency of one country can be changed for the
currency of another country. Exchange rate are required to facilitate international
trade including purchasing goods, services or capital from a country using that
country’s currency. It is based on demand and supply for currency, for example,
a high demand for Canadian goods allows the price that other countries must pay
for the Canadian dollar to increase or set the exchange rate higher.
Also
the international foreign exchange market is highly speculative. There are
flows of “hot” (meaning highly mobile) money from one country to anther seeking
high interest rate, capital profit or political security which a country reduce
its exchange party. Its currency is worth less in relation currencies of other
countries. The adjustment seeks to establish relative currency value at levels
which reflect relative commodity or services, values and so at which import and
export trade trends to stabilize. But the value prospect of an adjustment is
enough to set off speculation which make. Devaluation or revaluation inevitable
regardless of the trading merits of he case.
In
exchange rate policies, the extent to which the policy instruments adopted by
respective government were responsible for the worsening of economics depends
in part on the fiscal and monetary instruments and their implications for the
government budget deficit and inflation.
According
to Nwosu (2005:26) one of the major policies of the structural adjustment
programs in Nigeria is in policy formulations particularly as it relates to
(SFEM) second-tier foreign exchange market and (IFEM). Inter-banking foreign
exchange market. He states that when SFEM was introduced in September 1986 as a
key measures in the structural adjustment some of the objectives are:
(1)
To effect gradual
reduction of the degree of the naira is over valuation.
(2)
To effect
efficient rationing of scarce foreign exchange among competing national users.
(3)
To discourage
high import dependence.
(4)
To effect
systematic corrections of the structural distortion in the domestic economy.
(5)
To provide a cash
and carry platform for the procurement of foreign exchange. He concluded by asking
whether the FEM policy has not succeeded in devaluating the currency for beyond
that is economically positive.
According
to Olukala (2006:12) writing on Nigeria exchange rate system traced the
historical perspective. The series of events that culminated in Nigerian’s
journey to (SFEM). He identified eight cycles in the study of Nigerian foreign
exchange history, party with the pound starling.
The
gold continent appeal, the (1971-1974) pegging against a basket approach, the
use of the currencies, the import weighed basket approach, the use of currency
intervention system (the u.s dollar as currency of intervention). The crawling
peg, the second-tier foreign exchange market (SFEM).
Also,
in the exchange rate system, there are three major things that are involved in
it. They are:
The working of the gold standard, the case of ‘pure’
floating foreign exchange range and fluctuating from day to day according to
market demand and supply. (this is quite like the case of wheat, which is
available at a market price that fluctuates from day to day depending upon
competitive supply and demand). In today’s managed exchange rate system which
involves a mixture o some currencies that float or (fluctuate) freely along
with others that are pegged to the dollar or are floating together.
The country’s exchange rate maintained, Parity with
the pound sterling from 1959 until the devaluation of the sterling in November
1967.
In
the purchasing power parity theory, which was used after the first World War to
demonstrate that the fall in the exchange values of the German, polish, Naira
and other currencies, was due mainly to inflation in those countries. This was
quite true, because is equilibrium situation and price in country ‘A’ rise, say
a hundred fold, while the remain stable in country ‘B’ people ‘B’ will want 100
times as many units of ‘A’s currency as before in exchange for ‘I’ unit of
theirs, for 100 units of ‘A’s currency now buys only as much as I unit bought
before. So if ‘Bs price have say doubled, then the unit of their currency as
before, and so on, in general they should expect changes in the exchange value
of different currencies (as compared with a previous position of equilibrium)
to reflect the changes in their price levels.
Pegged
exchange rate system was devised in 1994 in the Bretton wood conference. The
plan was designed to provide the exchange rate stability considered to be
conducive to the post, world war II growth of international trade. This system
says that the exchange rate between two countries could not be held constant
forever but would be made for valid reason under controlled condition.
Under
the pegged rate system, each currency was defined in terms of gold or the U.S
dollar (united state). Each nation was required to maintain (to peg) the market
value of its currency with plus or minus (+) one percent of the defined (the
par) value. The American dollar was defined in terms of gold at a rate of
$1=1/35 ounce of gold and other currencies were defined in terms of the dollar.
The U.S maintained the pegged value of the dollar by buying and selling gold at
the fixed price of $35 per ounce of gold. If the Nigerian Naira is pegged at N=$1, the naira can change within given
unit of naira plus one percent for upper band and minus one percent for the
lower band will be $0.99 =N1. These
pegging up and pegging down involve the maintenance of fixed exchange rate.