THE MODERATING ROLE OF FISCAL POLICY ON THE RELATIONSHIP BETWEEN RESOURCE ENDOWMENT AND REAL EXCHANGE RATE VOLATILITY

Abstract

Nigeria's real exchange rate has remained persistently volatile, posing significant challenges to macroeconomic stability, trade competitiveness, and fiscal management, and this instability, compounded by the country's heavy reliance on natural resource wealth, motivated the present investigation into whether fiscal policy moderates the relationship between resource endowment and real exchange rate volatilityover the period 1990–2024.The study employed the Autoregressive Conditional Heteroskedasticity (ARCH) model and the Smooth Threshold Regression (STR) model. The ARCH results revealed that natural resource rents significantly depreciate the real exchange rate, contrary to the conventional resource curse expectation of appreciation, and that this effect is reinforced when resource revenue is channeled into government expenditure but reversed when financed through fiscal deficits, while an asymmetric volatility term confirmed that positive and negative shocks affect exchange rate volatility differently. The STR results further showed that the resource endowment-volatility relationship is regime-dependent, with a statistically significant threshold at a government expenditure value of 0.725962: below this point, higher spending and resource rents heighten volatility, while beyond it, the relationship inverts and further spending dampens volatility. The study concludes that fiscal policy is not a passive factor but an active mechanism that determines both the direction and intensity of the resource-exchange rate relationship, with a definite tipping point separating destabilizing from stabilizing fiscal regimes. It is recommended that fiscal authorities deliberately scale government expenditure beyond the identified threshold, prioritize productive expenditure over deficit financing, and design countercyclical buffers that account for the asymmetric nature of resource-driven exchange rate shocks.