Substitutability of Currency in Nigeria: A non-linear approach

Abstract

The persistent rise in foreign currency demand, especially in recent years, exerts pressure on Nigeria's exchange market. This trend is often heightened by economic agents’ perceived loss of purchasing power and confidence in the domestic currency, which makes them recourse to holding foreign currency that have a relatively stable value, such as the United States dollar (USD). To determine the presence of currency substitution and its effects on money demand in Nigeria, quarterly data from 1994 to 2017 was used. The non-linear Autoregressive Distributed Lag (ARDL) Model was employed in order to account for potential existence asymmetries informed by economic induced shocks overtime. The result affirms the existence of asymmetric cointegration for the variables, which implies the existence of a long run nonlinear relationship. In addition, crude oil price showed a significant effect of foreign currency demand from the stand view of domestic economic agents. The study suggests the closing of the exchange rate gap in the existing market to reduce the asymmetry expected from depreciation in domestic currency and further create buffers to manage the effect of oil price volatility, so as to check the substitutability rate of domestic currency in Nigeria.