The impact of monetary policy on the manufacturing sector of the economy: a case study of Nigeria

CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND TO THE STUDY

One of the major traditional functions of the Central Bank is to manage the nation’s money and economy through the issue of various monetary policy circular (MPCS).

We can view monetary policy circulars according to Patric I. Osiegbu (2006) as measures designed to regulate and control volume, cost and direction of money and credit in the economy to achieve some specified macro-economic policy objectives which can change from time to time depending on the economic position of a particular country. The monetary policy circulars are often issued after meetings between the Central bank officials, Federal Ministry of Finance and Managing Directors of various banks or their representatives. When the rate of increase or decrease in various sectors of the economy must have been discussed and agreed, they are sent to the Presidency through the Minister of Finance to be incorporated into the national budget.

The primary objective of monetary policy is the achievement of price and exchange rate stability. According to Nnanna (2001), the importance of price stability derives from the harmful effects of price totality, which determine the ability of policy makers to achieve other laudable macro-economic objectives. There is indeed a general consensus that domestic price fluctuations undermines the role of money as a store of value and frustrates efficient manufacturing sector of the economy.

The manufacturing sector ended in the year 2007 with little or no significant growth, even as the fate of the sector hangs in the balance in the new year 2008 with anxieties over an anticipated increase in Value Added Tax (VAT), from 5 percent to 15 percent amongst other persisted harsh operating environment that have continued to bedevil the sector over the years. This is evident in the continued low-level capacity utilization recorded in 2007, which went up slightly by 1.14% from 44.06% in 2006 to 45.2% in 2007. (CBN 2007) According to Manufacturers Association of Nigeria (MAN)’s survey (2008) this performance led to the near collapse of the manufacturing sector. Reports indicated that 30% of industries were classified as closed down, 60% of industries classified as oiling, and 10% of industries classified as operating at sustainable level.

The reasons adduced to the poor performance of the sector were as follows: poor power supply to industries by Power Holding Companies of Nigeria (PHCN), inaccessibility to long term funds and high cost of funds and multiple taxes and levies from the three tiers of government despite Decree Act 21 of 1998 which clearly stimulated the list of approved taxes.

Prudent monetary policy forced inflation down to 11.5% 2009, (est.value) from 11.6% in the third quarter of 2008 (est. value). However, food inflation remained in double digits for most of the year as increasing transportation costs and other overheads prices of basic commodities escalate astronomically.

Generally, Central Bankers and economist are less divided in their perceptions of the objectives of monetary policy than in their views about what role the central bank should play in accomplishing these objectives. Consistent with its legal mandates, the objectives of the monetary policy of the CBN since its inception have been the following:-

• Achievement of domestic price and exchange rate stability
• Maintenance of a healthy balance of payments position
• Development of a sound financial system.
• Promotion of rapid and sustainable rate of economic growth and development

1.2    STATEMENT OF PROBLEM

It is believed that structure of the economy of the developed and underdeveloped countries are inevitable proofs of such problems as unstable economics growth unemployment etc. Due to the economic problems, government in various parts of the world usually distributes resources and channels their efforts towards developing the appropriate policy to ensure economic stability. The impact depends on the nature of the Nigeria economy, the effectiveness of monetary policy in regulating micro economy has been quite unrealistic, therefore, a research of this type would aim at finding out the effectiveness or otherwise of the monetary policy and it instruments like open market operation, reserve ratio, liquidity ratio, bank ratio and interest rate in regulating inflation in Nigeria.

1.3    OBJECTIVES OF THE STUDY

The aim of the study is to examine the impact of monetary policy on the manufacturing sector of the economy.

i.        The study will also examine the effects of interest rate and legal reserve requirement on the manufacturing sector of the economy.

ii.       The study seeks to analyse how the monetary policy instruments have influenced the manufacturing industry.

1.4    SIGNIFICANCE OF THE STUDY

The study is significant to stakeholders and participants in the economy as it seeks to measure the impact of monetary policy on capacity utilization and how government makes use of it to control economy activities.

The study will add to the existing body of knowledge in this area. of research, it will shed light on the instrument of monetary policy and how it is used to attain its aim and objectives.

1.5   STATEMENT OF RESEARCH QUESTION

In other to give a direction and guide towards the actualization of the study, the following questions will be introduced to assist the researcher during the course of the study. Among such questions includes the following:-

i.        Does monetary policy have any impact on the performance of the manufacturing sector of the economy?

ii.       What effect do Reserve Ratio, Liquidity Ratio and Interest Rate have on manufacturing sector?

iii.      To what extent does exchange rate affect the performance of the manufacturing sector?

1.6   STATEMENT OF HYPOTHESIS

Hypothesis is conjectural statements about the relationship that exist between two or more variables. In the light of the objectives stated above, we therefore hypothesized that:

1.       H0: Monetary Policy has no effect on manufacturing sector performance.

H1: Monetary Policy has an effect on manufacturing sector performance.

2.       H0: Monetary policy has no effects on the level of inflation.

H1: Monetary policy has effects on the level of inflation.

1.7    METHODOLOGY OF THE STUDY

The study made use of secondary data which are sourced from the Central Bank of Nigeria bulletin (2008), National Bureau of Statistics bulletin and analyzed through the use of multiple regression analysis, (i.e. the Ordinary Least Square method) vide the SPSS programme.

1.8   MODEL SPECIFICATION

For the purpose of this research Work the following model is specified:

Model 1

CU =a0 + a1RR + a2 INTRATE + µ

Where:

CU              =       Capacity utilization (dependent variable)

RR              =         Reserve Ratio

INTRATE   =         Interest Rate

µ                 =        Error Terms

a0                =       Constant

Model 2

INF =a0 + a1 MS + a2 INTRATE + a3 EXCRATE + µ

Where:

INF             =        Inflation (dependent variable)

MS              =        Money Supply

INTRATE   =        Interest Rate

EXCRATE =        Exchange Rate

µ                 =        Error Terms

a0                =        Constant

1.9    SCOPE OF STUDY

The study is aimed at evaluating the role of monetary policy on capacity utilization in the Nigerian economy. The scope of this study is between 1979 to 2008.

1.10 LIMITATIONS OF THE STUDY

In the course of the study, there are some limiting factors experienced by the researcher and they include:

Time constraint: The time available for the research to carry out and complete the research is relatively short, considering the vast and demanding nature of the topic. Also finance, considering the financial status of the researcher getting the required amount of money to conveniently conduct the research was a bit difficult and this form part of the limiting factor of the study. And finally the epileptic power supply in the nation that has disrupt the compilation of various findings obtained, as the researcher had to improvise for other source of power.

1.11 ORGANISATION OF STUDY

The research work is divided into five (5) chapters.

Chapter One covers the introduction, the aim and objectives as well as the methodology of the study chapter two reviews literature on monetary policy in general. The views and related studies of scholars on the research topic are considered and examined. Chapter three focus on the methodology used in analysing data and determine relationship between concepts in the study. Chapter four presents the data analysis, interpretation of results and test of validity. Chapter five dwells on the summary of findings, conclusion and recommendations.

1.12 DEFINITION OF TERMS

Monetary Policy: This is a deliberate and continuous management of the money supply of a country to promote selected socio-economic objective.

Treasury Bill: These are debt instrument used by government to raise fund within a short period of time.

Reserve Ratio: This is a monetary policy instrument that obliges bank to hold a specified proportion of their deposit liabilities as cash deposit with the Central Bank.

Liquidity Ratio: This is the rate or percentage of money that banks have has reserves in form of security that can be easily turn to cash.

Interest Rate: The rate is directly managed by the monetary authorities through such management is based on expert advice in the absence of a well-developed financial market. It is the expected returns form or premium, which must be offered to induce people to hold the wealth in some form other than money.