THE EFFECT OF EXCHANGE RATE FLUCTUATIONS ON THE NIGERIA MANUFACTURING SECTOR (1986 – 2015)
ABSTRACT
This paper examines the effect of exchange rate fluctuations on the Nigerian manufacturing sector during a twenty nine (29) year period (1986 – 2015). The argument is that fluctuation in exchange rate adversely affects output of manufacturing sector. This is because Nigerian manufacturing is highly dependent on import of input and capital goods. The methodology adopted for this study is empirical. The econometric tool of regression (OLS) was used for the analysis. The data used in this study is the secondary source of data. Based on the findings, the researcher found out that exchange rate fluctuation has a negative effect on the Nigeria manufacturing sector. At the end some recommendations for policy were made on improving the manufacturing sector in Nigeria.
TABLE OF CONTENTS
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
1.2 Statement of Problem
1.3 Objectives of the Study
1.4 Research Questions
1.6 Significance of the Study
1.7 Scope and Limitations of the Study
1.8 DEFINITION OF TERMS
CHAPTER TWO
INTRODUCTION
2.1 Theoretical Concept of Exchange Rate.
2.2 Theories of Exchange Rate Determination.
2.3 Types of Exchange Rate
2.4 Exchange Rate System
2.5 Factors that Affects Exchange Rate
2.6 Exchange Rate Policies in Nigeria.
2.7 Exchange Rate Effect on the Manufacturing Sector
2.8 Empirical Literature
CHAPTER THREE
THEORETICAL FRAME WORK, MODEL SPECIFICATION AND METHODOLOGY.
3.1 THEORETICAL FRAMEWORK
3.2 MODEL SPECIFICATION
3.3 RESEARCH METHODOLOGY
3.3.1 SOURCES OF DATA
3.3.2 METHOD OF DATA ANALYSIS
CHAPTER FOUR
ANALYSIS AND INTERPRETATION OF RESULT
CHAPTER FIVE
SUMMARY OF FINDINGS, RECOMMENDATION AND CONCLUSION
5.1 SUMMARY OF FINDINGS
5.2 POLICY RECOMMENDATION
5.3 CONCLUSION
BIBLIOGRAPHY
APPENDIX
REGRESSION RESULT
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Apart from factors like inflation and interest rates, exchange rate plays one of the most important role in determining a country’s relative economic growth. It plays a very vital role in a country’s level of trade which is important to almost every laissez faire economy in the world. This is why exchange rates are among the most studied, analyzed and governmentally manipulated economic measures. Whether fixed or floating exchange rate effect macro-economic variables such as import, export, output, interest rate, inflation etc. Exchange rate fluctuations have great influence on domestic prices through their effect on aggregate supply and demand and as such, it has a great effect on the manufacturing sector and the economy at large. In general, when a currency depreciates, it will result 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 an exchange rate depreciation increases marginal costs and leads to higher price of domestically produces goods kandil, (2004).
Prior to 1986, the fixed exchange rate system was practiced in Nigeria. At that time, Naira was very strong in relation to dollar. The exchange rate was N1 = $1. The increasing demand for foreign exchange and the inability of the exchange control system to device a suitable mechanism for the allocation of foreign exchange in consonance with the goal of internal balance made the system of fixed exchange rate to be discarded in September, 26. 1986 when the Structural Adjustment Programme (SAP) came in. As we all know, it is the goal of every economy to maintain a stable rate of exchange with her trading partners. As a result, the subject of exchange rate became a topical issue in Nigeria as the SAP induced a policy on exchange rate following the fluctuations of the Naira in 1986. Much achievement was not achieved in revising the goal of stable exchange rate even with the country embarking on devaluation to increase export and stabilize the rate of exchange. The failure to realize this goal, subjected the Nigeria manufacturing sector to the challenge of a constantly fluctuating exchange rate. Although, number of exchange rate policies have been put in place by the monetary authority to enhance development in the productive base of the sector and also ensure a stable rate of exchange.
The manufacturing sector is an important sector in the Nigeria economy. The manufacturing sector makes significant contribution to economic development through its incomes and employment linkage with other sector of the economy. The manufacturing sector produce a range of goods that include milled grain, vegetable oil, meat products, diary product, sugar, refined soft drinks, beer, cigarettes, textiles, footwater, wood, paper products, soap, paint, tubes, plastic etc. Since a peak of 7.33% in 1982, the contribution of this sector to the Nigeria economy has generally been on a decline. Many factor have contributed to the variation in sector share through time. Many of which show both the variability of manufacturing to global economic pressures as well as the impacts that policy changes can have in reshaping the sector.
Fluctuations in the rate of exchange can affect the ability to import and therefore manufacturing output. As we know, importation can impact negatively on manufacturing production. Oyejide (1985) posited that the breakdown of the Bretton woods system induce variability in the exchange rate worldwide; Nigeria inclusive. Fluctuation in exchange rate has been the major reason for various problems which the Nigeria economy experiences. The impact of exchange rate fluctuation on manufacturing output had not received adequate attention. This work attempts to give attention to the issue.
1.2 Statement of Problem
Since September 1986, when the market determine exchange rate system was introduced via the second tier foreign exchange market, the naira exchange has exhibited the features of continous depreciation and instability. Investment in the manufacturing sector is expected to give the economy a lift towards development, but unfortunately to the present GDP has been very poor due to the changing policies of exchange and thus the acquisition of raw materials Oladeji S. I., (1990). In Nigeria, the financial markets are still underdeveloped and the economy still highly open in nature, allowing currency to float could produce fluctuations in exchange rate, thus resulting a large difference between other market clearing rate in the long run. The Nigeria manufacturing sector has become increasingly dependent on the external sector for import of non-labour input and even at this, the effect of exchange rate fluctuations on the Nigeria manufacturing sector has not received much attention. The flustering rate of exchange which came as a result of the changing foreign exchange policy practiced by the government has led to inefficiency in the productivity of the manufacturing sector.
Instabilities of exchange rate has posed a serious problem to manufacturing sector, however, instability to import therefore can impact negatively on manufacturing production; furthermore, Jhigan (1997) emphasized that fluctuation cause uncertainty and impede growth in international trade. Some small and medium scale enterprise have been strangled out as a result of low dollar naira exchange rate. Based on the problem posed by exchange rate fluctuation, this work seeks to specifically examine the effect of exchange rate fluctuation on the Nigeria manufacturing sector.
1.3 Objectives of the Study
In a highly import dependent economy like Nigeria, the naira exchange rate has become one of the most widely discussed topic in the country today. This is not surprising as the topic has had a lot of impact on the Nigeria manufacturing sector.
The objectives of this study include the following:
1.) To evaluate the effect of exchange rate fluctuation on the Nigerian manufacturing sector.
2.) To investigate empirically, the effect of exchange rate fluctuation on Nigeria import or export and capital good.
3.) To determine if the continous fluctuation of exchange rate of Naira have an impact on the quality and quantity of output of manufacturing firms.
1.4 Research Questions
1.) To what extent does exchange rate fluctuation affect the importation of input and capital goods?
2.) Does exchange rate fluctuation have effect on the quality and quantity of goods manufactured by Nigeria firms?
3.) To what extent does exchange rate fluctuation affect the exportation of made in Nigeria goods?
1.5 Formulation of Hypothesis
The hypothesis of the study includes the null hypothesis denoted as H0 and alternative hypothesis denoted as H1.
1.) H0: Exchange rate fluctuations have no effect on the importation of input
and capital goods.
H1: Exchange rate fluctuations have effect on the importation of input and
capital goods.
2.) H0: Exchange rate fluctuations has no significant effect on the quality and
quantity of goods manufactured by Nigeria firms.
H1: Exchange rate fluctuations has a significant effect on the quality and
quantity of goods manufactured by Nigeria firms.
3.) H0: Exchange rate fluctuations do not affect the exportation of made in
Nigeria goods.
H1: Exchange rate fluctuations affect the exportation of made in Nigeria
goods.
1.6 Significance of the Study
This study would identify the strengths and weakness of exchange rate policy and management, identify those parts that are mostly affected instability in exchange rate and provide the general public with adequate information on the foreign exchange transaction and its impact on the manufacturing sector. In general, the study benefits the following:
1. The government will benefit as it will enable them investigate the degree of volatility of exchange rate on the effect of quantity of input and capital goods imported into Nigeria by manufacturing firms, the government can make policies that will help Nigerian manufacturers prosper in the business.
2. The manufacturers will be much aware of the impact of the exchange rate fluctuations on the firms.
3. To the students, it will be a work base for further research.
4. To the public, it will be a thorough understanding of the exchange rate fluctuation and having taken appropriate measure will lead to a stable economy.
1.7 Scope and Limitations of the Study
The research work is designed to cover a very long period of time (1986-2015). The scope consists of both the fixed exchange rate and floating exchange rate period. The study is patterned to evaluate Nigeria exchange rate as the plot of economic growth and development. Thus, this study is limited to the effect of exchange rate fluctuation on the Nigeria manufacturing sector.
1.8 DEFINITION OF TERMS
1. Exchange rate: this is the price of one country “currency in terms of another.
2. Foreign exchange: foreign exchange is a means of payment for international transaction; it is made up of currencies of other countries that are freely acceptable in setting international transactions.
3. Dutch Auction System (DAS): this is a method of exchange rate determination through auctions where the bidders pay through according to their bid rates.
4. Exchange control: this is a foreign exchange arrangement in which the government purchase all coming foreign exchange and is the only source from which foreign exchange can be purchased legally.