ISSN 2348-1218 (print) International Journal of Interdisciplinary Research and Innovations ISSN 2348-1226 (online) Vol. 8, Issue 4, pp: (132-136), Month: October - December 2020, Available at: www.researchpublish.com
INTEREST RATE AND EXTERNAL RESERVES OF NIGERIA: A COINTEGRATION APPROACH Malgit Amos Akims Accounting and Finance Department School of Business, Kenyatta University, Nairobi Kenya Email: malgitakims@gmail.com
Abstract: The study sought to evaluate the effect of interest rate on external reserves of Nigeria. This study which originates from the master’s thesis of the author is based on a cointegration approach. The analysis was based on time series data spanning from 1981 to 2014. The findings of the study show that real interest rate is significant in determining external reserves. Therefore, the Government of Nigeria should employ measures that will ensure moderate inflation that is price stability. Strenthening of monetary policies should be the focus of the Central Bank as it plays a major role in the accumilation of external reserves. Keywords: Interest Rate, External Reserves, Interest Rate Parity Theory, Liquidity Preference Theory.
1. INTRODUCTION In Africa, commodity price such as international oil price hikes have allowed external reserves accumulation among exporting countries, while on the other hand draining the external reserves among importing countries. However, the recent fall in international oil price has led to the depletion of reserves for oil exporting countries. Evidently, Egypt devalued its national currency three times in 2015 as a result of the dwindling reserves. Egypt’s reserves depleted by 10 percent in September, 2015, which is the highest since January, 2012 (Namatalla, 2015). Similarly, Libya spent more than 25 percent of its external reserves in 2014 to offset the sharp decrease in oil revenues and keep the country running. This sharp decrease in oil revenue is attributed to the fall in international oil price. Libya’s reserves totaled US$76.6 billion at the end of 2014, a decrease from the US$105.9 billion in the previous year (Bloomberg, 2015). The rationale for holding reserves varies from one country to another; however, the most common reason for holding reserves is to back monetary policy (Sajal, 2012). Nigeria like other developing countries relies on external reserves for import cover, and also for exchange rate stability (Central Bank of Nigeria, 2015). Total external reserves for Nigeria was used in this study. Total external reserves constitute monetary gold holdings, Special Drawing Rights, holdings of foreign exchange, and external reserves of IMF member countries, under the management of Central Banks, which are expressed in US dollars (World Bank, 2014). Also, the monetary authorities use external reserves as a store of value to build up additional wealth which can be consumed in the future. This is done by segregating the external reserves into a wealth tranche and liquidity tranche for speculative purposes. The wealth tranche includes long term securities such as bonds and equities, which are controlled alongside a special benchmark that lays emphasis on return maximization (CBN, 2015). Interest rate being a short term monetary policy tool is used by the monetary authority of a country to influence the level of foreign reserves of a nation (Bird & Rajan, 2003). Higher interest rates increase the value of a given economy’s currency. An interest rate above the average world rate will attract foreign capital into the domestic market, and as this continuous, the value of the country’s currency increases. Conversely, lower interest rates tend to be unattractive for
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