Crude Oil, Exchange Rate and the Convergence of Foreign Reserves: A VECM of Nigeria’s Monetary Policy Tools
Abstract
Nigeria’s high level dependence on crude oil for its foreign exchange earnings makes its capital account vulnerable to the crude oil price fluctuations. In addition to this, are the high import bills which also contributed to the fluctuations in the total external reserves level over the years. This Paper focus on the interaction among selected monetary variables-crude oil price, exchange rate and external reserves over the period of 1970-2014, using long-run VECM and the short run Granger Causality/Block Exogeneity Wald tests. VEC test indicates a self-adjusting mechanism for correcting any deviation of the variables from equilibrium. It insinuated that external reserves will converge back to steady state in 5 years, Crude oil price in approximately 4 years, while foreign exchange rate will return to its steady state in 96 years. This is due to Nigeria’s over-dependent on imported products, foreign medical tourism, and the effect of declining oil price, stock market speculation and capital flight. In order to correct the disequilibrium of the external reserves, cointegrating long run equation shows that a 1% increase in crude oil price will lead to 1.8% increase in external reserves.
Keywords: Foreign exchange reserves, Price volatility, Steady state.
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