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A SECTORAL ANALYSIS OF CRUDE OIL PRICE, EXCHANGE RATE AND STOCK PRICES IN NIGERIA, (2009-2016)

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CHAPTER ONE

INTRODUCTION

  • Background to the Study

Nigerian economy has relied heavily on importation of goods from foreign countries and has depended on crude oil generated revenue for over three decades. Crude oil revenue is the largest contributor to the Gross Domestic Topic (GDP) in Nigeria, (CBN, 2015). The Nigerian government makes use of the international crude oil price as a benchmark price in budgetary preparations in the country. This implies that an oil exporting economy will experience boom when there is an increase in crude oil production and the crude oil market price exceeds the benchmark price set by government while the economy may some form of recession or sluggishness in the economy when the price falls below benchmark price Clifford K. (March 10, 2017). Such frictions may reflect in the form of inability of the government to fund the national budgets due to a reduction in foreign exchange earnings (Adaramola 2015) the recent situation in Nigeria during the periods that recorded low crude oil price, many states in the country were unable to pay salaries, exchange rate depreciated further and many people lost their jobs (Alechenu 2016, March 25).

Historical data collected from the CBN has shown that crude oil price began falling persistently since November 2013 and got to its lowest price in February 2016. The implications of this fall price reflected in the form of decline in revenue in Nigeria and as a result, most states could not afford to pay salaries and reduction in accumulated foreign exchange which is to be used for importation of consumer and capital goods Gabriel (June 15, 2015). This scarcity of foreign exchange led to a further depreciation in the National currency (Alechenu J. 2016, March 25).The Naira was fast approaching N500 to $1 and finally exceeded N500 to $1 in the parallel market between January and February 2017 (NAN, 2017, February 3). The naira was also traded for N617 and N527 for one Pound Sterling and Euro respectively. However, the naira is currently appreciating in the parallel market in Nigeria (NAN, 2017, February 3). Thus, this suggests that the implications of crude oil volatility and exchange rate volatility on the economy cannot be overlooked. This study investigated how crude oil price shocks and exchange rate affects sectoral stock prices in Nigeria.

The stock market is a place where most elements that gear the development of a nation’s economy operate with one another and it plays a prominent role in shaping a country’s economic and political development. It plays a major role in financial intermediation in both developed and developing countries by channeling idle funds from surplus to deficit units in the economy. This is because as the economy of a nation develops, more resources are needed to meet the need for its rapid expansion. The stock market serves as a channel through which savings are mobilized and efficiently allocated to achieve economic growth (Alile, 1984). Long term capital resources are pooled through issuing of shares and stocks by industries in dire need of finance for expansion purposes. Thus, the overall development of the economy is a function of how well the stock market performs. This is why empirical evidences from developed economies as well as some emerging markets have proved that the development of the stock market is sacrosanct to economic growth (Asaolu & Ogunmuyiwa, 2010).

Stock prices are generally believed to be determined by some fundamental macroeconomic variables such as interest rates, money supply inflation, exchange rate and Gross Domestic Topic (GDP), hence, Change in the prices of stock can be linked to some macroeconomic behavior of both advanced countries and developing countries (Muradoglu, 2000). The relationship between exchange rate and stock price could be negative or positive, depending on whether the economy is export-or import-dominant, respectively. For an export dominant country, an increase in exchange rate would result in a decline in the country’s export competitiveness, thus has a negative impact on the domestic stock prices. For an import dominant country, on the other hand, an appreciation of exchange rate would reduce input costs, thus generates a positive effect on the domestic stock prices (Narayan & Narayan, 2010).

Variations in exchange rates affect the competitiveness of firms who borrow in foreign currencies to finance their operations and this is because changes in exchange rates affect the earnings as well as its cost of funds and hence its stock prices (Dornbusch & Fischer, 1980). An appreciation of the local currency makes exports less attractive and thus bring about a reduction in foreign demand and the total revenues for the firms and thus, bringing about a fall in the value of the exporting firm and its stock prices (Gavin, 1989).

The relationship between stock prices and macroeconomic variables is well illustrated by the theoretical stock valuation models which shows that the current prices of any equity share is approximately equal to the present value of all future cash flows discounted; hence, any macroeconomic variable that affect the cash flow and the required rate of return will certainly have significant effect on the share value as well (Adaramola, 2012). Hence, since macroeconomic fundamentals such as exchange rate and oil price volatilities can affect the cash flow or required rate of return, then it will equally have an effect on stock prices. Changes in exchange rates can significantly affect the competitiveness of firms as variations in exchange rate affects the value of the earnings as well as the cost of its funds and this is because many companies borrow in foreign currencies to finance their operations and hence its stock price (Dornbusch & Fischer, 1980).

Oil prices can act as the transmission channel through which the real exchange rate affects the stock market and as such, inferences about the long-run relationship of variables and the causality structure may not reflect the true impact of exchange rate on stock price without an inclusion of oil price as an explanatory variable (Narayan & Narayan, 2010). When Oil is considered as an input to production process, an increase in oil price will give rise to increased production costs which causes productivity to decline (Narayan & Narayan, 2010).

There is large number of available literature that studied relationship between crude oil price, exchange rate and stock prices in Nigeria and some of which includes Adaramola, (2012); Adebiyi, Adenuga, Abang and Omanukwe  (2014); Akinlo, (2014); Akomafe, Jonathan and Danladi, (2014); Abdulrasheed, (2014); Asaolu and Ilo (2012); Augustine, (2015) and Osuala & Ebieri, (2015).The findings of these studies were mixed. Abdulrasheed, (2014); Asaolu & Ilo, (2012); Augustine, (2015) showed that the relationship between Oil price, Exchange rate and stock price is positive while few others including Akinlo, (2014); Osuala and Ebieri, (2015) found a negative relationship between oil price and stock prices in Nigeria. Regarding causality, Adaramola, (2012) found a unidirectional causality from oil to stock market. Akomafe, et. al, (2014) found evidence of unidirectional causality from oil price to three different industrial sectors (banking sector stocks, construction sector stocks and oil & gas sector stock). Abdulrasheed, (2013) found no evidence of causality from exchange rate to stock price while Akinlo, (2014) showed that the causality flows from stock market to exchange rate not the reverse.  The observed mixed finding implies the need for further investigations in to the nature of relationship and the direction of relationship between exchange rate, oil price and stock prices in Nigeria. This study has its main focused in understanding the nature of the relationship between oil price, exchange rate and sectoral stock price indices (NSE Banking index; NSE Consumer goods index and NSE Oil & Gas index) in Nigeria.

  • Statement of the Problem

The source of government revenue in Nigeria has been from the oil sector for more than three decades, using the price of the product in international market as the bench mark price. Performance of successive government’s budget in Nigeria has based its budgetary preparations mostly on earnings from oil; hence the performance of the economy often becomes sensitive to the variations in crude oil production and its prices to provide the needed foreign currencies needed to support imports. In recent years, oil prices have not been stable thus having adverse effects on budgetary planning in Nigeria with serious consequences on the overall economy (Asaolu & Ilo, 2012). The over reliance of the economy on importation of virtually all goods including refined oil despite being the 5th largest exporter of crude oil in the world, has made the Nigerian economy more vulnerable to exchange rate volatility, despite the expectations that depreciating exchange rate is expected to boost exports (Dornbusch & Fischer, 1980). However, there is need to study the implications of depreciating exchange rate on stock prices in an imports dependent country like Nigeria.

Exchange rate and oil price are two strong prices and their volatility can transmit either negative or positive effects on stock market prices in Nigeria (Adaramola, 2012). Their volatilities threaten smooth operation of business and the economy and as such can affect the expected future cash flow of companies listed on the stock exchange market and this will reduce the value of the firm and hence the share price of the listed company (Asaolu and Ilo 2012). International Crude oil price fluctuations are observed to be accompanied by some variations in the general stock market performance, measured by the All Shares Index (ASI). In January 1986, crude oil price was as low as 25.62 dollar per barrel (dpb) while stock price (ASI) was 111.3. Over the years ASI has increased significantly with upward fluctuations in oil price. In November 2000 ASI has increased to 7, 164.4 while the oil price has increased to 34.26 and by December 2000 oil price has declined to 28.4 dpb while the ASI rises to 8,111.0. The year 2007 and especially 2008 experienced significant boom with high ASI stock market values. The February 2008 recorded the highest stock index 65,652.4 with a corresponding Oil price of 95.35 dpb. June 2008 has the highest oil price 134. 02 dpb considering from years between 1983-2016, with corresponding ASI of 55, 949.0 and after this price oil price began to fluctuate downward with its last highest value of 105 dpb in June 2014 the oil price depreciation is persistent and the lowest oil price 30.62 recorded in February 2016 while the ASI falls significantly to 24, 570.73. As at august 2016, oil price has risen to 44.8 dpb and ASI 27, 599.03 (CBN, 2010).

From the foregoing there seems to be to be inconsistent relationship between oil price and stock price, in Nigeria is mixed. The data shows periods where crude oil price increases are accompanied by increases in stock prices, implying a positive relationship while at some other period a negative relationship is observed and this observation corresponds to the mixed findings of Adaramola, (2012); Adebiyi et. al, (2014) Akinlo, (2014); Akomafe, Jonathan & Danladi, (2014); Abdulrasheed, (2014); Asaolu & Ilo, (2012); Augustine, (2015) and Osuala & Ebieri, (2015). Thus, the essence of this study is to carry out further empirical investigation because of the to mix findings that exist regarding the effect of crude oil price, exchange rate and sectoral stock prices in Nigeria.

 

 

  • Objective of the Study

The main objective of this study is to empirically determine the effect of crude oil price shocks on sector stock prices in Nigeria. The specific objectives are to:

  1. determine the effect of oil price shocks on sectoral stock price indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria;
  2. determine the presence of long-run co-integration relationship among oil price, exchange rate and sectoral stock price indices ((NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria;
  3. determine the presence of asymmetry in crude oil price and their effects on sectoral stock prices indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria; and
  4. determine the effect of exchange rate on sectoral stock price indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria;

 

  • Research Questions

This study answered the following research questions:

  1. What is the effect of oil price shocks on sectoral stock price indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria?
  2. Is there long-run co-integration relationship among oil price, exchange rate and sectoral stock price indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria?
  3. Is there asymmetry between crude oil price and sectoral stock price indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria?
  4. What is the effect of exchange rate on sectoral stock price (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria?

 

  • Hypotheses

Based on the objectives, the following hypotheses were germane:

Ho1:      Crude oil price has no statistical impact on sectoral stock price indices (NSE Banking

Sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in

Nigeria.

Ho2:     There is no long-run co-integration relationship among crude oil price, exchange rate and sectoral stock indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria

Ho3:      There is no Asymmetry between oil price shocks and sectoral stock indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria

Ho4:     Exchange rate has no statistical impact on sectoral stock price indices (NSE Banking sector index; NSE Consumer goods sector index and NSE Oil & Gas sector index) in Nigeria.

The null hypotheses were tested at 5% level of significance.

 

  • Scope of the Study

This study examined the effect of exchange rate volatility and crude oil price shocks on sectoral stock price in Nigeria Stock Exchange using quarterly data from 2009.Q1 –2016.Q4. Three sectoral indices out of seven (7) stock indices of the Nigeria stock exchange. Exchange rate quarterly data is based on the average.

The three sectoral indices included in the study are banking, consumer goods, oil & gas Sectoral index from the Nigeria Stock Exchange Index. The All share index, NSE 30 Index, Lotus Islamic banking index and NSE Industrial goods were excluded from the study because the NSE 30 and ASI are aggregated stock prices of the stock market however; this study was primarily interested in disaggregated stock price and not aggregated stock prices in Nigeria. The lotus Islamic banking index is also not included because Islamic banking is a recent development in Nigeria and as such data for this variable is not available. NSE Industrial goods are also excluded from the analysis because the data is not available from 2009 which is period shorter than the other variables available. NSE Industrial goods is only available from 2012-2016 which implies lesser observation than the other 2 sectors.

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