EXCHANGE RATE MOVEMENT AND PERFORMANCE OF THE MANUFACTURING SECTOR IN NIGERIA

EXCHANGE RATE MOVEMENT AND PERFORMANCE OF THE MANUFACTURING SECTOR IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND TO THE STUDY

The exchange rate of a country is a term, usually, used to imply the value of a country’s currency in relation to that of another country (Arthur & Sheffrin (2003)). Thus, we can have the value of a Nigerian Naira in terms of US Dollars. This exchange rate is, however, affected by many factors some of which range from interest rates, output levels, inflation rate, trade balance, politics, internal harmony, degree of transparency in the conduct of leaders and administrators, general state of economy, and to the quality of governance in a country. All these factors become harmonized to either make the exchange rate volatile or non-volatile. In the past, currency crises have contributed to exchange rate volatility (Carrera & Vuletin, 2003). In Nigeria, Englama et al (2012) established that demand for foreign exchange and international oil price volatility affect the volatility of the exchange rate.

Financial economists have long sought to understand and characterize foreign exchange volatility, because it helps to understand how it affects asset prices, policymakers are interested in measuring asset price volatility to learn about market expectations and uncertainty about policy (Erdemlioglu, Laurent & Neely (2012)). Volatility, as it suggests, implies frequent, unstable and unpredictable changes in the value of any economic aggregate (Arthur & Sheffrin (2003)). This volatility provides huge basis for economic planning and decisions. The exchange rate is believed to be the most volatile price in the economy if it is floated (Erich & Robert (2012)) closely trailed by stock prices and crude oil prices. This has mostly been the case in Nigeria particularly after the adoption of a floating exchange rate regime (Sanusi, 2004).

Industrial production has been used in wide applications. It is a measure of output of the industrial sector of the economy. In Nigeria, this sector comprise of Crude Petroleum and Natural Gas, Solid minerals, and Manufacturing. In the 4th quarter of 2012, the sector contributed about 20.01% to the Nigerian Gross Domestic Product with the Crude Petroleum and Natural Gas accounting for the a larger percentage of the output from this sector. In this same period, the Manufacturing sector which is of more importance to this study accounted for only 7.12% of the total Gross Domestic Product (CBN, 2012). It is certain from this that this sector accounts for a relatively minute portion of the Nigerian output. However, it is important to note that this sector has been at the frontiers of development in many emerging economies such as Brazil, Russia, India, China, Mexico etc. In contrast to the Nigerian manufacturing sector situation, China, in 2012, had 43.5% contribution to output from the industrial sector (CIA World Fact Book). Also, Mexico had 34.2% of total output coming from the sector (Wikipedia, 2013). The importance of this sector to National development is probably why it is so important in the economy of any Nation. The industrial production of any Nation is affected by several factors such as investment, labour productivity, raw materials, market size, economic system, and political environment. Perhaps, the identification of the core role this sector plays in development was responsible for the various industrialization policies adopted by different regimes in Nigeria.

Core to the discussion in this work is the role exchange rate volatility plays in industrial production. A particular emphasis is laid on the manufacturing sector because it has the most potential for landing any country on the path of sustainable growth.

Mostly, exchange rate volatility affects industrial production from the angle of pricing. Pricing can be in terms of input prices such as assets and machinery pricing if machines are imported, pricing of imported raw materials etc. It can also be in terms of export prices, i.e. the price a good is sold in other countries. When a firm expects that exchange rate will be stable, then, adequate decisions can be taken concerning investment in inputs and output levels. But with volatility, taking such decisions becomes problematic especially if firms are risk averse.

Exchange rates, across the world, have generally fluctuated especially after the end of the Bretton Woods system of fixed exchange rates in 1972 in USA, United Kingdom, Germany, Japan etc. which gave way for the prominence of floating exchange rate. However, the effect of an uncertain exchange rate on output growth, especially industrial output, is generally not certain. While some argue that volatility generates uncertainty thereby increasing the level of riskiness of trading activities and eventually depress trade (Bleany 1996, Cottani 1990, Clark 1973). In their support, Azid, Jamil and Kausar (2005) also argued that real exchange rate uncertainty can have negative effects on both domestic and foreign investment decisions. This is because it causes reallocation of resources among sectors and countries, imports and exports and also leads to uncertainties about investment decisions.

DeGrauwe (1988), on the other hand argued that uncertainties present opportunities for profit if firms are risk seeking thus increasing investment and ultimately economic growth.

This greater investment will be manifested in industries in the form of procurement of new machineries and equipment, training and skills building for workers, research and development etc. It had also been argued that exchange rate volatility may not have any significant effect on macro variables especially when such shocks can easily be hedged away.

Developing countries, and, indeed, Nigeria, have not escaped the debate. Many African countries witnessed regimes of volatile exchange rates typified by consistent depreciation and appreciation of their exchange rate (Olayungbo, 2008). In Nigeria, the adoption of a flexible exchange rate mechanism as part of the Structural Adjustment Program of the

1.2       STATEMENT OF THE PROBLEM

It is no news that excessive instability and misplacement of foreign exchange prices constitutes one of the major modern day economic problem which all governments try to solve. This was particularly as a result of the IMF promoted liberalization policy of world economies, poor policy coordination and poor competitiveness of industrial outputs in Third World Countries; these have resultant effects on the rate of growth in these countries. Empirical analysis for the Euro area generally suggest that such pronounced exchange rate changes may strongly impact both inflation and economic activity (Anderton (2003), Hahn (2003), Faruqee (2004) and Angeloni, Kashyap, Mojon and Terlizzese (2003)).

It is important to realize that the degree of exchange rate variability a country is exposed to is not necessarily closely related to the type of exchange rate regime it has adopted. A country may peg its currency to an anchor currency, but it will float against all other currencies if the anchor does as well. Also, while it is possible that a pegged exchange rate be stable, it is not to say that it cannot be volatile. Pegging can reduce nominal exchange rate volatility vis-à-vis one trading partner, but it can by no means eliminate overall exchange rate variability. In fact, pegging a country‟s currency leaves it prone to fluctuation against other currencies (Sanusi, 2004). Also, a wrongly placed peg can generate foreign exchange pressure and large discrete changes in currency value, hence, volatility results. Further, the switch of most developing economies to market-oriented economies often requires major adjustments in the international values of these currencies.

The literature, however, consists of conflicting facts on the effect of foreign exchange rate volatility on output. While some argue to its positive side, there are some others who believe that it has negative effects (see Dada and Oyeranti (2012), Jamil, Streissler, Kunst (2012), Rasaq (2013)). In their study, Dada and Oyeranti examined the effect of exchange rate volatility on economic aggregates such as government revenue, government expenditure, inflation rate, output etc. but failed to adequately consider its effect on industrial production by singling it from the National output. Also, they employed the growth rate of Nominal GDP when data for Real GDP are widely available. Etah et al (2011) went too micro by considering the effect of exchange rate volatility on agricultural production in Nigeria. Also on the micro scale is the work of Olayungbo (2008) who focused on the effect of exchange rate volatility on the primary and manufacturing sectors only of Sub-Saharan countries leaving out other components of industrial production.

Given these defects in previous works in this area, it would be wrong to directly infer that volatility in exchange rate positively or negatively affects industrial production in Nigeria. However, the knowledge of exchange rate volatility is something of great worth in economics that needs to be dealt with especially as it concerns industrial production in Nigeria. Hence, this study raises the following important questions:

a.    What has been the trend in industrial production in Nigeria between the periods of 1986 – 2012?

b.    What has been the trend in exchange rate in Nigeria from the SAP period, 1986, till 2012?

c.    What nexus exists between exchange rate volatility and industrial production in Nigeria?

d.    Has the volatility affected the industrial sector  more, relative  to the Nigerian agricultural sector?

This study attempts to provide answers to these questions.

TOPIC: EXCHANGE RATE MOVEMENT AND PERFORMANCE OF THE MANUFACTURING SECTOR IN NIGERIA

Format: MS Word

Chapters: 1 - 5
Delivery: Email

Number of Pages: 65

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