THE IMPACT OF EXCHANGE RATE VOLATILITY ON THE MANUFACTURING SECTOR OUTPUTS IN NIGERIA

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CHAPTER ONE

INTRODUCTION

  • BACKGROUND OF THE STUDY

Manufacturing activities have significant impacts on the economy of nations as their contributions, which account for substantial proportion of total economic activities of nations, play crucial roles in the development process of any economy. In 2008, Nigeria manufacturing accounted for 4.13% of the Gross Domestic Product (GDP). The figure is an indication of downward movement, from 11.05% in 1980. Before independence, Nigeria, with its large population notwithstanding, had very little industrial development; a few tanneries, and oil crushing mills, which processed raw materials for export. During the 1950’s and 1960’s, a few factories, including the first textile mills and food-processing plants, opened to serve Nigerians. During the 1970’s, and early 1980’s, industrial production increased rapidly, principally in Lagos, Kaduna, Kano and Port Harcourt. Factories also appeared in smaller, peripheral cities such as Calabar, Bauchi, Katsina, Akure and Jebba, due largely to government policies encouraging decentralization.

 

Most of the manufacturing outputs in Nigeria are food and beverages, cigarettes, textiles and clothing, soaps and detergents, footwear, wood products, motor vehicles, chemical products and metals. Smaller-scale manufacturing businesses engage in wearing, leather-making, pottery-making and word-carving.

The smaller industries are often organized in craft guilds involving particular families who pass skills from generation to generation. In an attempt to broaden Nigeria’s industrial base, the government invested heavily in joint ventures with private companies, since the early 1980’s. The largest of such project is the integrated steel complex at Ajaokuta, built in 1983 at a cost of $4 billion. The government has also invested heavily in petroleum refining, petrochemicals, fertilizers and equipments for assembling of automobiles and farm equipment. In terms of the manufactured goods used within Nigeria, it is of interest to examine the level of indigenous production as opposed to the imported manufactured goods (out-puts) as this shows the level of exchange rate volatility in Nigeria. In Nigeria, from independence to date, importation has been on the increase. The level of exportation has never since independence, caught-up with the level for importation. For some years, in the past, Nigeria has always aspired to attain equilibrium in trade balance by designing different forms of trade and exchange rate policies.

 

These polices remain very important because exchange rate, whether fixed or floating, affects macroeconomic performance such as import, export, national price level, output, interest rate, and so on. It also affects economic units such as individuals’ purchasing power, firms’ performance, and so on. Chong and Tan’s (2008) empirical analysis revealed that exchange rate volatility is responsible for changes in macroeconomic fundamentals for developing economies. The volatility and unpredictability of exchange rate is due to the confluence of the factors that affect it (Anoruo et al, 2006; Benita and Lauterbach, 2007; Hanias and Curtis, 2008). As such, the issue of exchange rate sensitivity and determinacy is controversial and has been a subject of much debate. A large number of studies have tried to address the issue both theoretically and empirically, and found different results, which have fueled the debate further. The traditional view is that fluctuations in exchange rates affect relative domestic and foreign prices, causing expenditures to shift between domestic and foreign goods (Khan et al, 2010; Benita and Lauterbach, 2007; Betts and Kehoe, 2005). The new view is that relative prices are not much affected by exchange rate fluctuations in the short-run (Cheong, 2004). Besides, exchange rate fluctuations influence domestic prices through their effects on aggregate supply and demand. In general, when a currency depreciates, it results in higher import prices if the country is an international price taker; while lower import prices result from appreciation. The potentially higher cost of imported inputs associated with exchange rate depreciation increases marginal costs and leads to higher price of domestically produced goods (Kandil, 2004). Further, import-competing firms might increase prices in response to foreign competitor price increases to improve profit margins. The extent of such price adjustment depends on a variety of factors such as market structure, the relative number of domestic and foreign firms in the market, the nature of government exchange rate policy, and product substitutability (Fouquin et al, 2001; Sekkat and Mansour, 2000).

 

Most Nigerian manufacturing companies depend on imported inputs in the form of equipment, plant, machinery, and other materials. Given the fact that the bulk of the country’s foreign earnings is from oil, which accounts for over 80.0 per cent of the foreign exchange earnings (CBN, 2008a), thus revealing the extent of the vulnerability of these companies to swing in the exchange rate which is greatly affected by fluctuations in the oil price in the international market. Mohammad (2010) noted that the risks associated with volatile exchange rates are major impediments for countries such as Nigeria that attempt to develop through export expansion strategies and financial liberalization. Besides, Chong and Tan (2008) posit that the impact of exchange rate volatility on economic fundamentals is substantially great if an economy does not provide possible tools in hedging currency risk in its market place which unfortunately, is the case in Nigeria. Furthermore, Chong and Tan (2008) argued that exchange rate volatility has a catalytic effect to various parties’ importers, manufacturers and consumers.

One of the most dramatic events in Nigeria over the past two decades was the devaluation of the Nigerian Naira with the adoption of the Structural Adjustment Programme (SAP) in 1986. A cardinal objective of the SAP was the restructuring of the production base of the economy with a positive bias for the production of agricultural exports. The foreign exchange reforms that facilitated a cumulative depreciation of the effective exchange rate were expected to increase the domestic prices of agricultural exports and therefore boost domestic production. Significantly, this depreciation resulted in changes in the structure and volume of Nigeria’s exports and imports. However, the volatility, frequency, and instability of the exchange rate movements since the beginning of the floating exchange rate, raise a concern about the impact of such movements on Nigerian manufacturing companies.

 

Nigerian manufacturing sector seems to remain underdeveloped and is not showing any significant growth, despite the implementation of the Structural Adjustment Programme (SAP). According to Delude (1999), apart from objectives not realized, exchange rate policy and management under Structural Adjustment Programme (SAP) have left some issues unresolved and/or created some distortions in the economy, one of which is deindustrialization. A close look at the relative contribution of manufacturing production to Gross Domestic Product (GDP) before and after SAP shows that SAP, indeed, triggered a shrinking of the manufacturing sector in Nigeria. In 1980, manufacturing accounted for 10.4% of the Gross Domestic Product (GDP). This relative share rose to 10.44% in 1983, and decreased to 9.53% in 1986 (CBN, 2011). But, with the adoption of SAP, the manufacturing sector’s relative share in GDP began to fall and reached a low of 5.75% in 1989, and fell further to 5.14% in 1997 (CBN, 2011). Since the enthronement of democracy in 1999, the contributions of the sector to the GDP has continued to decrease to 2.52% (in 2007) and fell to 1.85% (in 2011) (CBN, 2011). Apart from structural rigidity, poor quality of labour force, high interest rate, corruption, and so on, are responsible for the poor performance of the sector. Also, exchange rate volatility is a major factor that affects its performance (Delude, 1999).

Below is the diagram of exchange rate volatility and percentage change in Nigeria manufacturing output to GDP computed from CBN statistical bulletin from 1980 to 2011.

where,

EXR = Exchange rate,

%NMAO to GDP = Change in Nigeria manufacturing sector output to GDP.

 

The diagram above shows that since 1998, exchange rate has been on increase from 21.886 per dollar to 132.888 in 2004. However, as exchange rate was depreciating over the years, the percentage change in Nigeria manufacturing output to GDP declined from 5.22% to 3.1%. In 2005, exchange rate reduced to 131.2743 and to 118.546 in 2008. These show the appreciation in naira. The percentage change in Nigeria manufacturing output to GDP decreased from 2.83% to 2.41%. Between 2009, 2010 and 2011, the exchange rate increased from 148.9017 to 150.298 and to 154.6994 respectively. The depreciation in naira show that percentage change in Nigeria manufacturing output increased from the past year to 2.47% in 2009, and declined to 1.89% and 1.85% respectively, in 2010 and 2011. One of the questions that demand attention is this: “Do the depreciations in Naira affect the decline in Nigeria’s manufacturing output?”

 

  • Statement of the Problem.

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