Effect of Exchange rate fluctuation on the Nigeria manufacturing sector
Exchange rate fluctuations can significantly impact the Nigerian manufacturing sector. A depreciating local currency relative to major foreign currencies can increase the cost of imported raw materials and machinery for manufacturers, leading to higher production costs. This, in turn, reduces the competitiveness of domestically produced goods in the international market. Moreover, it may also result in inflationary pressures, affecting both input costs and consumer prices. Conversely, an appreciating local currency may make imports cheaper but could negatively impact export-oriented industries by reducing the competitiveness of their products abroad. The Nigeria manufacturing sector, therefore, faces challenges in maintaining cost-effectiveness and global competitiveness amidst volatile exchange rates, necessitating effective risk management strategies to mitigate the adverse effects of currency fluctuations.
This paper examines the effect of exchange rate fluctuations on the Nigerian manufacturing sector during a twenty five (25) years period (1986 – 2010). 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 was used for the analysis. The population target of this study is the total number of 25 years from (1986 – 2010) (25) annual time series as data relating to other years after 2010 are not available. The used in this study is the secondary source of data. The data to be utilized in this study we be sourced through library research, publications of the Central Bank of Nigerian (CBN) i.e. statistic bulletin, National Bureau of Statistic(NBS), on line information and economic journals. Based on the findings, the researcher found out that exchange rate has no significant effect on economic growth of Nigeria also that there is no significant effect of fluctuation on exchange rate on the manufacturing sector. Some recommendations for policy were made based on the findings. Amongst others is the need to strengthen the link between agriculture and manufacturing‟s sector through local sourcing of raw materials thereby reducing reliance of the sector on import of input to a reasonable level
Approval page i
Dedication ii
Acknowledgement iii
Abstract iv
Chapter One
Introduction
1.1 Background of the Study 1
1.2 Statement of the Problem 3
1.3 Objectives of the Study 5
1.4 Research Questions 6
1.5 Formulation of Hypothesis 6
1.6 Significant Of the Study 7
1.7 Scope and Limitations Of The Study 8
1.8 Definition of Terms 9
Chapter Two
Introduction
2.1 Review of Related Literature 10
2.2 Theoretical Concept Of Exchange Rate 18
2.3 Theoretical Frame Work for Exchange Rate Fluctuation and Manufacturing Output 18
2.4 The Objectives of Exchange Rate Policy in Nigeria 20
2.5 Types of Exchange Rate 23
2.6 Factors Affecting Rate Of Exchange 25
2.7 Fluctuation in The Exchange Rate Of The Naira 26
2.8 Factors Influencing The Determination Of Exchange Rates 27
2.9 Factors That Can Affect The Manufacturing Process 29
2.10 Factors That Causes The Currency Fluctuation 33
2.11 Manufacturing Sector 36
2.12 Overview of Manufacturing 49
Chapter Three
Introduction
3.1 Research Methodology 64
3.2 Research Design 65
3.3 Source of data 65
3.4 Research Instrument 66
3.5 Reliability And Validity Of Research Instrument 66
3.6 Population Of The Study 66
3.7 Sample And Sampling Procedure 67
3.8 Method Of Data Analysis 67
3.9 Decision Criterion For Validation Of Hypothesis 70
Chapter Four
Introduction
4.0 Presentation and Analysis of Data 71
4.1 Presentation of Results 72
4.2 Results 73
Chapter Five
Summary of the Findings, Conclusion and Recommendations
5.1 Summary of the Findings 77
5.2 Conclusion 78
5.3 Recommendation 79
BIBLIOGRAPHY 81
APPENDIX
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Following the fluctuation of the naira in 1986, a policy induced by the
structural adjustment programme (SAP), the subject of exchange rate
fluctuation has become a topical issue in Nigeria. This is because it is the
goal of every economy to have a stable rate of exchange with its trading
partners. In Nigeria, this goal was not reached in spite of the fact that
the country embarked on devaluation to promote export and stabilize
the rate of exchange. The failure to realize this goal subjected the
Nigerian manufacturing sector to the challenge of a constantly
fluctuating exchange rate. This was not necessitated by the devaluation
of the naira but the weak and narrow productive base of the sector and
the rising import bills also strengthening it. In order to stem this
development and ensure a stable exchange rate, the monetary authority
put in place a number of exchange rate policies.
However, very little achievement was made in stabilizing the rate of
exchange. As a consequence, the problems of exchange rate fluctuation
persisted in macro-economic management, exchange rate policy as an
important tool derives from the fact that changes in the rate of
exchange have significant implications, for a country‟s balance of
payment position and even its income distribution and growth. It is not
surprising since its behaviour is said to determine the behaviour of
several other macro-economic variable (Oyejide, 1985). It is even more
so for Nigeria which had embarked on a course of rapid economic
growth with attendant high import dependency.
The manufacturing sector plays a catalytic role in a modern economic
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 a quest for increasing productivity
in relation to import substitution and export expansion, creating foreign
exchange earnings capacity, raising employment, promoting the growth
of investments of 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-industrializes and
its capacity utilization is also low. This is in spite of the fact that
manufacturing is the fastest growing sector since 1973/74 (Obaden,
1994). The sector has become increasingly dependent on the external
sector for import of non-labour input (Okigbo, 1973). In the ability to
import therefor; can impact negatively on manufacturing production
Oyejide (1985) posited that the breakdown of the Brelton woods system
induce variability in the rate of exchange worldwide; Nigeria inclusive.
Umubanwer (1995) has noted that three 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, 1990). The impact of fluctuation in exchange rate on
manufacturing output had not receives adequate attention. This paper
attempts to give attention to the issue.
1.2 STATEMENT OF THE PROBLEM
This research work is meant to emphasize on the issue of fluctuating
exchange rate on the Nigeria manufacturing sector. Some of the
problems which cause the fluctuation of exchange rate on the Nigeria
manufacturing can be seen below.
The exchange rate of the naira was relatively stable between 1975 and
1979 during the oil boom or (regulatory require). This was also the
situation prior to 1990 when agricultural products accounted for more
than 70% of the nation‟s gross domestic product (GDP) (Ewa, 2011:78),
however, as a result of the development in the petroleum oil sector in
1970, the share of agriculture in total export declined significantly while
that of oil increased.
Furthermore, more manufacturing companies are faced with the
problem, not recognising the fact that fluctuation in exchange rate
adversely affect output of the manufacturing sector, this because Nigeria
manufacturing sector is highly dependent on import of input and capital
goods, this is in spite of the fact that manufacturing sector is the fastest
growing sector since 1973 (Obadan, 1994), this sector has become
increasingly dependent on the external sector for import of non-labour
input. The impact of fluctuation in exchange rate on manufacturing
output has not received adequate attention.
Instabilities of foreign exchange rate is also a problem to manufacturing
sector; however, instability to import therefore can impact negatively on
manufacturing production; furthermore, Jhingen (1997), emphasized
that exchange rate fluctuation cause uncertainty and impede on
international trade.
Thus uncertainty in trade transaction post a lot of problems such as
inflation, which determine the internet balance of a country, it has also
tended to undermine the international competitiveness of non-oil export
and make planning and projection difficult at both micro and macro
levels of the economy, some small and medium scale enterprise have
been strangled out as a result of low dollar naira exchange rate.
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 this topic has had a lot of impact on the
Nigerian manufacturing sector. It is therefore, the objective of this study
to evaluate the effect of exchange rate fluctuation on the Nigerian
manufacturing sector.
To investigate empirically, the effect of exchange rate fluctuation on
Nigerian import or export and capital goods.
To determine if the continuous fluctuation of exchange rate of naira
have an impact on the quality and quantity of output of manufacturing
firms.
1.4 RESEARCH QUESTIONS
To what extent does exchange rate fluctuation affect the importation of
input and capital goods?
Does exchange rate fluctuation have effect on the quality and quantity
at goods manufactured by Nigeria firms?
To what extent does exchange rate fluctuation affect the exportation of
made in Nigeria goods?
1.5 FORMULATION OF HYPOTHESES
The hypothesis of the study includes the null hypothesis denoted as „H0‟
and alternative hypothesis as „H‟.
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.
H0: Exchange rate fluctuation has no significant effect on the quality and
quantity of goods manufactured by Nigerian firms.
H1: Exchange rate fluctuation has a significant effect on the quality and
quantity of goods manufactured by Nigerian firms.
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 SIGNIFICANT OF THE STUDY
The study would identify the strengths and weakness of exchange rate
policy and management, identify those parts that are mostly affected by
instability in exchange rate 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 ascertain the
extent of the variation of exchange rate affect the quality 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 their 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
This research work is designed to cover a very long period that is (1986
2010). The scope consists of the regulatory deregulatory exchange rate
period i.e. the fixed exchange rate and floating rate period. The study is
structured to evaluate Nigerian exchange rate as the pilot of economic
growth and development. Thus, this study is therefore limited to the
effect of exchange rate fluctuation in the Nigerian manufacturing sector.
1.8 DEFINITION OF TERMS
1. Exchange rate: This is the price of one country‟s 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 settling international
transactions.
3. Dutch auction System (DAS): This is a method of exchange rate
determination through auctions where the bidders pay 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.
Effect of Exchange rate fluctuation on the Nigeria manufacturing sector:
Fluctuations in exchange rates can have significant effects on the manufacturing sector of Nigeria, or any country for that matter. Nigeria, like many other countries, relies on imports and exports for its manufacturing processes, and changes in exchange rates can impact various aspects of the sector. Here are some of the potential effects:
- Input Costs: Many manufacturing industries rely on imported raw materials, components, and machinery. When the local currency (in this case, the Nigerian Naira) weakens against other currencies, the cost of importing these inputs increases. This can lead to higher production costs for manufacturers, potentially reducing their profit margins.
- Export Competitiveness: A weaker local currency can make domestically produced goods cheaper for foreign buyers. This can boost the competitiveness of Nigerian exports in international markets, potentially leading to increased demand for locally manufactured goods. However, this effect depends on the extent to which the manufacturing sector is export-oriented.
- Imported Machinery and Technology: The manufacturing sector often requires advanced machinery and technology for efficient production. Fluctuations in exchange rates can impact the cost of importing these items, potentially affecting the sector’s overall productivity and technological advancement.
- Inflation: Significant exchange rate fluctuations can lead to imported inflation. As the cost of imported goods and raw materials rises due to currency depreciation, manufacturers might pass on these higher costs to consumers in the form of higher prices. This can contribute to overall inflation in the economy.
- Investment and Capital Flows: Exchange rate instability can deter foreign direct investment (FDI) in the manufacturing sector. Investors may be hesitant to commit capital when there is a high risk of currency depreciation, as it can erode the value of their investments over time.
- Profitability and Financial Stability: Exchange rate fluctuations can impact the financial stability of manufacturing companies, especially if they have taken on foreign currency-denominated debt. Sudden currency depreciation could lead to increased debt burdens and financial stress for these companies.
- Supply Chain Disruptions: Exchange rate volatility can disrupt supply chains. Manufacturers relying on imported inputs may face delays and uncertainties in sourcing materials due to fluctuating currency values, potentially leading to production interruptions.
- Policy Response: Governments may intervene in the foreign exchange market to stabilize their currency. Central bank interventions, such as selling foreign currency reserves, can influence exchange rates in the short term. However, the effectiveness of such interventions can vary.
- Economic Uncertainty: Frequent and large exchange rate fluctuations can create economic uncertainty. Manufacturers might find it challenging to plan for the future when currency values are highly unpredictable, leading to cautious decision-making and reduced investment.
In summary, exchange rate fluctuations can have a multifaceted impact on the Nigerian manufacturing sector, affecting input costs, export competitiveness, inflation, investment, financial stability, and overall economic uncertainty. The extent and nature of these effects depend on various factors, including the degree of reliance on imports and exports, the sector’s exposure to foreign exchange risk, and the policy responses of the government and central bank.