Empirical Study of the Determinants of Foreign Exchange Reserve Adequacy in Nigeria

Foreign exchange reserves buffer external shocks and maintain currency stability, and empirically examining their determinants in Nigeria provides evidence for reserve management policy in a commodity-dependent economy vulnerable to oil price volatility. This study empirically examined the determinants of foreign exchange reserve adequacy in Nigeria using quarterly data from 2005 to 2022. Reserve adequacy was measured using the IMF Assessing Reserve Adequacy metric and the Guidotti-Greenspan rule. Determinants examined included oil price levels, oil production volume, current account balance, capital flows, CBN monetary policy rate, and import coverage ratio requirements. Dynamic OLS and Generalised Method of Moments were applied to address potential endogeneity. Results showed that oil price was the dominant determinant of reserve accumulation, with a USD 10 increase in per barrel crude price associated with a USD 1.8 billion increase in reserve levels. Capital inflows significantly supplemented reserves but were highly volatile. Import coverage deteriorated significantly during domestic production crises and exchange rate stress events. The CBN's monetary policy rate showed a significant positive association with portfolio capital inflows contributing to reserves. By the ARA metric, Nigeria's reserves were adequate in only 6 of 17 years assessed. The study fills an empirical gap on Nigerian reserve adequacy determinants and recommends a reserve target of 6 months of imports as the minimum policy anchor, with automatic sterilisation rules for oil revenue windfall above the moving average oil price benchmark.

Keywords: foreign exchange reserves, reserve adequacy, Nigeria, oil price, CBN monetary policy