Effect of Exchange-Rate Volatility on Nigeria’s Sovereign Borrowing Costs

Abstract

The study examined the effect of exchange-rate volatility on Nigeria’s sovereign borrowing costs, focusing on both short-run and long-run dynamics. Using a Vector Error Correction Model (VECM) on quarterly data, the study investigates the relationships among government debt, exchange-rate volatility, nominal and real exchange rates, and foreign-exchange market interventions over a 40-quarter period. Unit root and co-integration tests confirm a stable long-run equilibrium among the variables, justifying the use of VECM to capture both immediate and persistent interactions. The results indicate that lagged exchange-rate volatility positively influences government debt, suggesting that periods of high volatility lead to increased borrowing to meet fiscal obligations. The error correction coefficient for government debt is negative, demonstrating gradual adjustment toward long-run equilibrium, though the pace of correction is moderate. Nominal exchange rate changes have mixed effects, with some lags increasing debt while others reduce it, indicating that short-term fluctuations do not consistently drive borrowing decisions. The real exchange rate exhibits a weak and varied effect on debt levels, reflecting the limited immediate influence of structural currency movements. Foreign-exchange market interventions show a small negative effect, suggesting temporary easing of borrowing pressures but insufficient mitigation against volatility. The study concludes that exchange-rate volatility is a critical determinant of Nigeria’s sovereign borrowing costs, elevating debt levels and fiscal vulnerability while slowing the adjustment of debt toward long-run equilibrium. The findings highlight the need for policy measures to stabilize the currency, reduce borrowing costs, and strengthen fiscal resilience. The main recommendation is to implement comprehensive exchange-rate risk management strategies, including currency stabilization and prudent debt composition planning, to ensure sustainable sovereign borrowing and protect macroeconomic stability.