CHAPTER ONE
2.0 LITERATURE REVIEW
2.1 INTRODUCTION
Foreign exchange is defined by Samuelson and Mordhaus (1983) “as a currency or other financial institution that allows are country to settle amounts owed to another country” According to lisped ((1982) “the term foreign exchange refers to what is traded actual foreign currency or various claims on it.” These different definition of foreign exchange all mean or refer to the effecting payment for international transaction foreign exchange can be acquired by a country through the export of goods and service direct investment inflow draw down on external loans aids and grants and it can be extended to settle international obligations when foreign exchange expenditure is lower than foreign exchange receipt the surplus is added to external reserves. These external reserves which are also saving from foreign exchange transactions are held by the authorities to finance short falls in foreign exchange receipts and to safe guard the international value of the domestic currency A country’s external reserves are the financial assets available to the monetary authorities to meet temporary imbalance in the external payments position and to purpose other policy objectives.
External reserve management is the technique of optimizing a nations external resources to meet its economic needs. As the nations apex financial institution the central bank of Nigeria (CBN) has the sole responsibility for the management of external reserves comprising monetary fund (IMT) holding of special drawing right (SDRS) and foreign exchange (CBN) 1995. The bank started exercising this power in 1962 prior to this date the country’s external reserves were held by the federal and regional governments as well as their parastatals. This arrangement made is difficult to manage the external resaves with adverse imputations for the conduct of monetary policy in order to redress the problem the foreign exchange component of the external reeves was consolidated with the CBN in January 1962 leaving only working balance with other holders (CBN 1995). Nigeria as a member of internal community has bilateral and multilateral relations with other countries and organization which necessitate the exchange of goods and services.
External reserves are kept and carefully managed to facilitate such business and diplomatic transactions. More importantly the management of the reserves effect the conduct of monetary policy and ultimately the performance of the nations economy. T his is because the exchange in net foreign assets. Influence the total money supply. External reserve management by the CBN involves the constant review of the country’s exchange position so that external financial obligation are met according One of the major objective of external reserve management is to maintain adequate level of reserves to facilitate international transaction from one asset to another incurs minimums cost in addition reserves are managed to yield income measure of adequacy of reserves used by the bank is the reserves importation. It is desired that external reserves be available to pay for at least four months of imports at the current rate of monthly import demand. In practice the standard is a guide. Another measure as adequately used by the CBN to monitor the reserves in the reserve is total demand liabilities ration. Under the exchange control act of 1962 the CBN was required to maintain external reserves equivalent to 60 percent of total demand liabilities (CBN 1995) like the other adequacy criterion the external reserves total demand liabilities ratio is implement by the bank according to the realities of the country’s foreign exchange earnings.