EXCHANGE RATE AND MANUFACTURING OUTPUT IN NIGERIA (A CASE STUDY OF SELECTED MANUFACTURING FIRMS IN LAGOS STATE)

CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY

The manufacturing sector is not the primary driver of the economy of developed nations although it is important. The service sector has gained ascendancy (Szirmai and Verspagen, 2011). The Verdoorn's (2008) and Kaldor's (2014) laws however attest to the primal significance of the manufacturing sector to the economy in the developing countries. This position has been confirmed by Onakoya (2014), and Arnold, Javorcik & Mattoo (2011). In manufacturing sector the basic inference is that increased labour productivity leads to rise in the growth of manufacturing output because of the effect of increased economies of larger production and technical progress. This position has also been reinforced by (Thirlwall, 2013) who postulated that the productivity-enhancing innovations technologies deployed in manufacturing sector engender economies of scale in greater proportion than the spill-over effects of in both of the service and agricultural sectors. In Nigeria, the contributions of the manufacturing sector to GDP have fluctuated widely over the years. From a paltry 4.8% at independence in 1960, it grew fifteen years later to 7.4% in 1975. By the end of 1975, its contribution tumbled to 5.4% only to surge to its peak of 10.7%, five years later in 1980. Since then, the manufacturing portion of GDP had declined: 2012 (7.9%), 2016 (6.3%). The lowest ebb ever was 3.4% recorded in 2001, beyond which some traction of 4.21% was gained in 2009 (Central Bank of Nigeria, 2012). These contributions further moved up to 6.67% and 6.83% respectively in 2012 and 2013 (National Bureau of Statistics, 2014). The recent economic recession also affected the manufacturing sector. Indeed, there was 8.7% reduction in industrial production in the fourth quarter of 2016 over the same quarter in 2015. The average production growth was 1.35 % from 2007 until 2016 with a peak of 20.10% in the first quarter of 2011 and the lowest record of - 10.10% in the quarter 1 of 2016. The role of exchange rate in any economy is very significant as it directly and indirectly affects domestic price level, profitability of traded goods and services, allocation of resources and investment decisions. Exchange rate movement and exchange rate uncertainty is an important factor which investors take into consideration in their decision to invest abroad (Unugbro, 2007). Foreign capital inflows are generally perceived as something desirable to the industrialized and developing countries. It can eliminate foreign exchange shortages, improve standard of living, deepen and broaden the financial markets. Capital inflows have also helped individual countries to absorb shocks either internal such as harvest failures to external such as fluctuations in commodity prices or recessions in industrial economies (Unugbro, 2007). Considering the major determinants of foreign investment, exchange rate risk is possibly seen as the most important determinant of foreign investment flows (Aranyarat, 2010). Fluctuation in exchange rate often times tends to increase the risk and the uncertainty of transactions (internal and external) and predisposes a country to exchange rate related risks. In theory, it is generally agreed that exchange rate fluctuation affects output negatively or positively. It is believed that the negative impact of exchange rate fluctuation may come directly through uncertainty and adjustment costs, and indirectly through its effect on allocation of resources and government policies (Aliyu, Yakub, Sanni, and Duke, 2013). In Nigeria and indeed many developing countries, the price of foreign exchange plays a critical role in the ability of the economy to attain optimal levels in production activities. In the wake of policy change, occasioned by the introduction of structural adjustment programs (SAP) in July, 1986, which led to the emergence of the flexible exchange rate as oppose to fixed exchange rate as a regime that was in place before the policy change. During the fixed exchange rate regime, the supply of foreign exchange was highly subsidized through the overvaluation of domestic currency. The essence of the policy was to maintain a relatively cheaper cost of importation of industrial raw-material and equipment, so as to sustain the policy of import substitution industrialization strategy. In exchange rate the fluctuation is an important factor that affects economic performance, due to its impact on macroeconomic variables like imports, export prices, interest rate, inflation rate and outputs (Adeniran et al, 2014). The Nigeria government has embarked on several strategies aimed at improving industrial production and capacity utilization in recent times, despite this fact the sector is still experiencing a decline in output. The unimpressive performance of the sector in Nigeria is mainly due to massive importation of finished goods with severe implication on exchange rate and inadequate financial support for industrial activities, which ultimately has contributed to the reduction in capacity utilization in the country (Obamuyi, Edun and Kayode, 2013). The persistent depreciation in the exchange rate has led to a shortage of foreign exchange for the importation of the essential inputs for the industrial sector which has led to high costs of production in the country.

STATEMENT OF PROBLEM

The manufacturing sector plays catalytic role in a modern economy and has many dynamic benefits that are crucial for economic transformation. In an advanced country, the manufacturing sector is a leading sector in many respects. It is an avenue for increasing productivity in relation to import substitution and export expansion, creating foreign exchange earning capacity, raising employment, promoting the growth of investment at a faster rate than any other sector of the economy, as well as wider and more efficient linkage among different sectors (Fakiyesi, 2005). But the Nigerian economy is under-industrialized and its capacity utilization is also low. This is in spite of the fact that manufacturing is the fastest growing sector since 1973/74 (Obadan, 2012). The sector has become increasingly dependent on the external sector for import of non-labor input (Okigbo, 2008). Inability to import therefore, can impact negatively on manufacturing production. Oyejide (2010) posited that the breakdown of the Bretton woods System induced variability in the rate of exchange worldwide; Nigeria inclusive. Umubanmwen (2015) has noted the adverse consequence of this on ability to import. Devaluation which further aggravates the situation has not significantly affected economic performance in the positive direction in Nigeria (Ojo, 2013). Other problems of the economy include excessive dependence on imports for consumption and capital goods, unprecedented fall in capacity utilization rate in industry and neglect of the agricultural sector. These have resulted in fallen incomes and devalued standards of living amongst Nigerians (Okunola, 2006). The question here is that in spite of the success of other countries in the implementation of these deregulation policies, the Nigerian manufacturing sector hasn’t experienced such success, why is that?

AIMS OF THE STUDY

The major purpose of this study is to examine exchange rate and manufacturing output in Nigeria. Other general objectives of the study are:

1. To examine the performance of the manufacturing sector in the Post Exchange rate deregulation period.

2. To examine the effect of exchange rate fluctuation on Nigeria import or export and capital goods in Nigeria.

3. To examine the impact of exchange rates on manufacturing output in Nigeria

4. To examine if the continuous fluctuations of exchange rate of Naira have impact on the quality and quantity of output in the manufacturing firms.

5. To examine the relationship between exchange rates and manufacturing outputs in Nigeria.

6. To recommend ways of ensuring adequate management of exchange rate in the manufacturing sector.

RESEARCH QUESTIONS    

1. How is the performance of the manufacturing sector in the Post Exchange rate deregulation period?

2. To what extent does exchange rate fluctuation affect the importation of input and capital goods?

3. What are the impacts of exchange rates on manufacturing output in Nigeria?

4. Does exchange rate fluctuation have effect on the quality and quantity at goods manufactured by Nigeria firms?

5. What is the relationship between exchange rates and manufacturing outputs in Nigeria?

6. What are the recommended ways of ensuring adequate management of exchange rate in the manufacturing sector?

RESEARCH HYPOTHESES

Hypothesis 1

1. Exchange rate does not have impact on manufacturing output in Nigeria
2. : Exchange rate has a significant impact on manufacturing output in Nigeria

Hypothesis 2

1. There is no significant relationship between exchange rates and manufacturing outputs in Nigeria.
2. : There is a significant relationship between exchange rates and manufacturing outputs in Nigeria.

SIGNIFICANCE OF THE STUDY

The significance of this research work lies in the fact that if the cause of the unstable exchange rate of the naira is identified and corrected, the economy will rapidly grow and develop into an advance one. This is so because if the unstable exchange rate of naira is proved to be affecting the macro-economy major variables badly, including Real exchange rate, Real interest rate, inflation rate, manufacturing output, gross domestic product and trade openness of the country, attempts should be made to stabilize the exchange rate. This is because these variables are gauge for the measurement of growth and development of any economy. Importantly, this study would help the government and the central bank of Nigeria (CBN) to identify the strength and weakness of each foreign exchange system and hence adopt the policy that suits the economy best. This will definitely enhance growth and development of the economy, the study will also serve as a guide to future researchers on this subject.

SCOPE OF THE STUDY 

The study is based on the exchange rate and manufacturing output in Nigeria, case study of selected manufacturing firms in Lagos State.

LIMITATION OF STUDY

Financial constraint- Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint- The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

DEFINITION OF TERMS

Exchange Rate: This is the price of one country's currency in terms of another.

Foreign Exchange: Foreign exchange is the exchange of one currency for another or the conversion of one currency into another currency. Foreign exchange also refers to the global market where currencies are traded virtually around the clock. Foreign exchange is a means of payment for international transaction; it is made up of currencies of other countries that are freely acceptable in settling international transactions.
Dutch auction System (DAS): This is a method of exchange rate determination through auctions where the bidders pay according to their bid rates.

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.

Depreciation of currency: Depreciation is also said to mean a lowering in value of a currency. According to Yakubu (2007) appreciation and depreciation depict a situation where the market force of demand and supply determine the exchange rates. It is often associated with a freely floating exchange rate system. The monetary authorities may however, determine the exchange rate decree or executive flats based on their perceptions of macro-economic condition in the country.