IMPACT OF EXCHANGE RATE ON DOMESTIC CREDIT: EVIDENCE FROM NIGERIA

Abstract

This study investigates the relationship between exchange rate fluctuations and domestic credit dynamics in Nigeria. Employing non-linear autoregressive distributed lag (NARDL) and linear autoregressive distributed lag (ARDL) models, this research explores the effects of Real Effective Exchange Rate (RER) on Domestic Credit (DOD) over a significant period. The findings of the non-linear ARDL analysis reveal a notable positive short-run effect of RER on DOD. Specifically, the depreciation of the naira appears to discourage market participants from assuming higher risks, resulting in a decrease in credit volumes. Conversely, an appreciation of the naira encourages market participants to take greater risks, leading toan improvement in credit volumes. However, the linear ARDL analysis demonstrates a contrasting negative effect of RER on DOD. In the context of the linear ARDL results, the appreciation of the naira seemingly discourages market participants from taking increased risks, consequently causing a deterioration in credit volumes. Based on the findings, a key policy recommendation emerges. Policymakers are advised to consider devaluing the naira to dissuade market participants from assuming higher risks, thereby potentially reducing credit volumes in the short run. This recommendation aims to address the observed dynamics between exchange rate movements and credit volumes, offering a strategic approach to influence market behaviors and credit outcomes in Nigeria's economic landscape.