The Effect Of Exchange Rate Policies On The Nigerian Manufacturing Sector An Empirical Analysis

Project and Seminar Material for Economics

Abstract

The main objective of this study is to examine empirically the effect of exchange rate policies on Nigerian Manufacturing Sector, because most policies put in place by Nigerian Government from time to time focus on the margin between official rates and parallel market rate (Unofficial rates).

In July 1987, a merger of the erstwhile first and second-tier exchange rates in the early phases of the structural adjustment programme took place but this did not solve any problem.

The constructed model was estimated using the simple regression analysis to test the relationship between the variable considered to the dynamic behaviour and interaction of all other variables.

The result findings implied that a unit change in exchange rate will lead to 42 percent decrease in average capacity utilization of the Nigerian Manufacturing Sector while all other estimated variable co-efficient included in the model gave the expected negative signs.

Finally, it was recommended that the internal strength of the economy should be built up through agricultural and industrial transformation which with the big potential of the Nigerian Economy should result in its less dependence on external trade and short run crisis management of limited foreign exchange resources.

Chapter One

1.0 Introduction

1.1 Background of the Study

The survival of any economy depends on the composition of the manufacturing sector that operates in the country. This is however affected by different macro-economic variables ranging from induced investment multiplier, stock exchange performance indices, interest charged on loanable funds, exchange rate and exchange rate policies.

Foreign exchange earnings from international trade transactions and external aid are vital for the economic transformation of Less Developed Countries (LDCs). All other things being equal, foreign exchange resources so earned can induce increased factor supplies and promote the development of manufacturing sector, technical skills and knowledge all of which should enhance domestic capital formation and exchange has traditionally been a critical element in the development planning process of Less Developed Countries (LDCs). Whatever maybe the foreign exchange position of a Less Developed Countries (LDCs) , effective management of available resource is crucial for efficient and effective performance of manufacturing sector.

Nigeria went through varying development experiences which required prudent management of available foreign exchange resources after independent. Inadequate foreign exchange was a major constraint in the execution of the First National Development Plan, 1962-1968, a situation that was accentuated by the prosecution of the civil war which ended in January 1970. The period 1970-1980 witnessed a dramatic improvement in Nigeria’s foreign position following the substantial increase in crude oil prices in 1973/74 and 1979. however, foreign exchange management appeared too short term in nature with the result that it did not consider possible long-term developments in the world economy. Following the collapse of the world oil market in the early 1980’s, Nigeria once more entered a very high foreign exchange position especially in the context of previous commitments. Resource management and exchange policy in place, initially continued with the short term approach, but became more dynamic since 1986 when it was evident that the problems of the economy were more fundamental than was previously conceived. Despite the fact that foreign exchange management, since 1986, has responded adequately to the needs of the economy it has revealed several issues which the design future national development strategies must take into account.

In the context of the efforts to improve the efficiency of foreign exchange management in Nigeria, the aim of this paper is to review and assess the foreign exchange policies (management strategies) and its impact on the Nigerian Manufacturing Sector.

1.2 Statement of the Problem

The exchange rate has a direct bearing on many economic variables, it effects; the stability of price, economic growth, employment and balance of payment. The dependence of the Nigerian economy on imports for raw materials capital equipment as well as technical expertise for the manufacturing sector is such that any drastic fluctuation in the Naira exchange rate is going to affect economic growth. A drastic change in cost of raw materials thereby increasing cost of production thus resulting in price instability in the local market and affect economic growth and development.

Most policies put in place by Nigeria government from time to time, focuses in the margin between official rates and parallel market rate (unofficial rates), but the question is, has these policies been able to merge the two exchange rates in the economy. In view of the significant role of exchange rate that is non-inflationary and capable of promoting non oil exports and capital inflows and discouraging imports and capital overflows. Merger parse should not be the desired goal. In July 1987, a merger of the erstwhile first and second – tier exchange rates in the early phases of the structural adjustment programme took place. But this did not solve any problem. Distortions soon resurfaced in the foreign exchange market and the desired objectives of exchange rate policy were not accomplished.

In order to strengthen the production sector in Nigeria, her government has adopted policies like Second Tier Foreign Exchange Market (SFEM), Autonomous Foreign Exchange Market (AFEM), Inter Bank Settlement (IBS), Wholesales Dutch Auction System (WDAS) and Retail Dutch Auction System (RDAS), which was adopted recently because of the Fluctuation in exchange rate of Naira due to the economic meltdown in the world. But the questions still linger in the mind, that:

To what extent has the exchange rate policies adopted by Nigerian government improve the performance of manufacturing sector?
What are the possible implications of interest rate policies on Nigerian Manufacturing Sector?
What happen to firm’s profit, turn over and investment in the face of fluctuation or unfavourable exchange rate?

These issues are to be addressed in this research as a way of assessing the impact of exchange rate policies on manufacturing sector in Nigeria economy.

1.3 Objective of the Study

The main objective of the study is to examine empirically the effect of exchange rate policies in Nigeria manufacturing sector.

The specific objectives of this study are:

To trace the relationship between exchange rate fluctuation and performance of manufacturing sector in Nigeria.
To examine the direct effect of exchange rate policies on Nigerian Manufacturing Sector.
To draw policy conclusion at enhancing and synchronizing the probable benefits of exchange rate policies while limiting its side effects.

1.4 Research Hypotheses

Hypotheses one

Ho: There is no relationship between exchange rate fluctuation and performance of manufacturing sector.
Hi: There is a relationship between exchange rate fluctuation and performance of manufacturing sector.

Hypotheses Two

Ho: Exchange rate policies do not affect the manufacturing sector.
Hi: Exchange rate policies affect the manufacturing sector.

1.5 Significance of the Study

Nigeria economy is impact oriented and monoculture in nature, almost 85% of her revenue are generated from proceed of oil, the epileptic nature of other sector aids importation of finished and unfinished goods into the country. The case is so worst to the extent that drinkable water and toothpick are imported into the country. In view of this quick attention must be given towards the fluctuating nature of Naira and the review of the existence exchange rate policies must be of paramount issue, if the economy will move forward mostly in the face of world economy recession.

Many studies have been carried out on the effect of exchange rate policies on manufacturing sector mostly in growth and development, but much effort must be laid in the manufacturing sector of sector of any economy because of the vital roles in plays in the quest for growth and development which will be the central theme of this research work.

Also, this research will be of great significant because of its recency, for it will take into consideration the performance of the manufacturing sector and try to ascertain the impact of the recent fluctuation in Naira and the introduction of Retail Dutch Auction System (RDAS) by Central Bank of Nigeria (CBN) level of production and capital investment in Nigeria.

Relevant research in this topic stopped at 2005 and the most recent stopped at 2006 because of unavailable data, this research work will take the pain and update the trend to 2008.

1.6 Scope and Limitation of the Study

This study is primarily concerned with the effect of exchange rate policies on the Nigerian manufacturing sector. This study covers the period of 1970-2007 in the area of data analysis but extends its framework to the first quarter of 2009 in discussion and empirical analysis. The researcher encountered some constraints, which limited the scope of the study. These constraints include but are not limited to the following.

a) Availability of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

1.7 Definition of Terms

Exchange Rate:

In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.

Policy:

A policy is a set of ideas or plans that is used as a basis for making decisions, especially in politics, economics, or business. An official organization’s policy on a particular issue or towards a country is their attitude and actions regarding that issue or country.

Manufacturing Sector:

Manufacturing industries are those that engage in the transformation of goods, materials or substances into new products. The transformational process can be physical, chemical or mechanical. Machines and equipment are typically used in the process of manufacturing

1.8 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows

Chapter one is concerned with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
Chapter three deals on the research design and methodology adopted in the study.
Chapter four concentrate on the data collection and analysis and presentation of finding.
Chapter five gives summary, conclusion, and recommendations made of the study

Chapter Five

Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to have a critical analysis of the effect of exchange rate policies on the Nigerian manufacturing sector.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations are made, which in the opinion of the researcher will be of benefit in addressing the challenges of exchange rate fluctuations.

5.2 Summary

This study aimed at having a critical analysis of the effect of exchange rate policies on the manufacturing sector. Three objectives were raised to guide this study. These objectives include: To trace the relationship between exchange rate fluctuation and performance of manufacturing sector in Nigeria, to examine the direct effect of exchange rate policies on Nigerian Manufacturing Sector, to draw policy conclusion at enhancing and synchronizing the probable benefits of exchange rate policies while limiting its side effects.

5.3 Conclusion

Based on the above findings pertaining to the objectives of the study the following conclusions are drawn.

The study empirically verified the effect of exchange rate fluctuations on the manufacturing sector. This is against the backdrop of the fact that exchange rate is a crucial variable and the manufacturing sector is expected to be the moving force in the drive towards industrialization. It is observed that the fact that Nigeria is highly dependent on the external sector for import of inputs has made the effect of exchange rate devaluation worse especially in manufacturing because capacity to import was constrained by the depreciating currency leading to a corresponding decline in output. It is pertinent to note that the devaluation of exchange rate in association with factors such as technology and human skills are necessary for a country to be established in the export market which are lacking in the case of Nigeria.

5.4 Recommendation

In order to address the problem of exchange rate fluctuations in the manufacturing sector, and for the sector to meet expectations and contribute significantly to economic growth and development, the following recommendations will be useful: The need for local sourcing of raw materials and input through agriculture should be intensified. A technological policy aimed at developing a local engineering industry is advocated. By so doing, the link between agriculture and the manufacturing sector will be established, leading to expansion of export base which would attract more foreign exchange into the country. This could culminate into high external reserves build –up and reduce adverse pressure on balance of payment. Manufacturing activities should be encouraged by government by giving incentives and subsidies to local manufacturers and improving the technological and infrastructure development so as to increase the sector’s contribution to Gross Domestic product and employment within the country. Change in exchange rate management strategy should be allowed to run a reasonable course of time. Jettisoning strategies at will and on frequent basis has implication for exchange rate and obvious consequence for a sector that depends on foreign inputs. The monetary authority (the Central Bank of Nigeria) should monitor the unethical practices of some commercial bank which have resulted in much fluctuation in the rate of exchange. More stringent punitive measures have to be taken against the culprit banks.

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