Home Project-material THE EFFECT OF EXCHANGE RATE FUNCTIONS ON THE NIGERIA MANUFACTURING SECTOR: A CASE STUDY OF BUTTERFIELD BAKERY

THE EFFECT OF EXCHANGE RATE FUNCTIONS ON THE NIGERIA MANUFACTURING SECTOR: A CASE STUDY OF BUTTERFIELD BAKERY

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Abstract

The title of this research study is the effect of exchange rate functions on the Nigeria manufacturing sector in which Butterfields bakery was used as case study. From current research, the issue of deciding on effective way to stabilize exchange rate of goods and services in manufacturing sector in Nigeria is one of the key elements of a firm’s financial strategy. Therefore, proper care and attention need to be given while such decision is taken. Exchange rate of a country plays a key role in international economic transactions because no nation can remain in autarky due to varying factor endowment. The purpose of this study was to examine the effect of exchange rate fluctuations on the manufacturing sector in Nigeria. The study employed four (4) variables such as manufacturing gross domestic product (MGDP), manufacturing foreign private investment (MFPI), manufacturing employment rate (MER) and Exchange rate (ER). The ex-post facto research design was used for this study. Man

CHAPTER ONE

INTRODUCTION

Effects of exchange rate functions in developing countries like Nigeria has received considerable attention and generated much debate. The debate focuses on the degree of functions in the exchange rate had generated internal and external shock in Nigerian Economy. Exchange rate of a country plays a key role in international economic transactions because no nation can remain self-sufficient due to varying factor endowments.

Oladipupo & Onotaniyohuwo (2011) states that movements in the exchange rate have ripple effects on other economic variables such as interest rate, inflation rate, unemployment, money supply, etc. These facts underscore the importance of exchange rate to the economic well-being of every country that opens its doors to international trade in goods and services. The importance of exchange rate derives from the fact that it connects the price systems of two different countries making it possible for international trade to make direct comparison of traded goods. In other words, it links domestic prices with international prices. Opaluwa, et al (2010) opines that following the functions 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 functioning exchange rate. Exchange rate policies in developing countries are often sensitive and controversial, mainly because of the kind of structural transformation required, such as reducing imports or expanding non-oil exports, invariably imply a depreciation of the nominal exchange rate. Such domestic adjustments, due to their short-run impact on prices and demand, are perceived as damaging to the economy. Ironically, the distortions inherent in an overvalued exchange rate regime are hardly a subject of debate in developing economics that are dependent on imports for production and consumption (Dada & Oyeranti, 2012). 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).

Despite various efforts by the government of Nigeria to maintain a stable exchange rate, the naira has continue to depreciate from N4.54 in 1988 to N17.30 in 1993, N21.89 in 1997, all against the one US dollar. The policy of guided or managed deregulation pegged the naira at N99 in 2001, N128.50 in 2006 and N158.76 in 2011. Thereafter, the exchange rate appreciated to N157.58 in 2012 and later N232.40 in 2015. Towards the end of the year, the naira depreciated to N415.36 in 2016 and current in 2nd August, 2017 the exchange rate of one US dollar to naira is N362.21. Against this backdrop, this research study seeks to examine effects of exchange rate functions on manufacturing sector in Nigeria over a period of 25 years (1993 – 2017).1.2 BACKGROUND OF THE STUDY

Following the function 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, 2005). 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, 2004), the sector has become increasingly dependent on the external sector for import of non- labour input (Okigbo, 2003). In the ability to import therefore; can impact negatively on manufacturing production

Oyejide (2005) posited that the breakdown of the Brelton woods system induce variability in the rate of exchange worldwide; Nigeria inclusive. Umubanwer (2005) 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, 2005). The impact of fluctuation in exchange rate on manufacturing output had not receives adequate attention. This paper attempts to give attention to the issue.1.3 STATEMENT OF THE PROBLEM

Functions in the exchange rate movements since the beginning of the floating exchange rate regime have raised concerns particularly on the impact of such movements on trade flows. Exchange rate is a major constraint on development of an economy, making planning more problematic and investment more risky. For instance, if potential foreign investors to Nigeria are risk averse (or even risk neutral), larger exchange rate fluctuations may reduce the overall foreign direct investment inflows since it increases uncertainty over the returns in a given investment. Potential investors will invest in a foreign location only if the expected returns are high enough to cover for the currency risk (Gerardo, et al: 2012).

Most developing economies are net debtors and in consequence, changes in the trading partners‟ exchange rates may affect the real cost of servicing their debts. A strong appreciation of the dollar, for example, implies a higher cost of servicing an external debt that is mainly denominated. Furthermore, for a developing country like Nigeria that is highly dependent on trade, the exchange rate, which is the price of foreign exchange, has implications for balance of payments viability and the level of external debt. For instance, if the exchange rate is overvalued, then it would result to unsustainable balance of payments deficit, encourage capital flight and escalate external debt stock, which in turn will lead to declining level of investment. On the other hand, a real depreciation raises the cost of imported capital goods, and since a large chunk of investment goods in developing countries is imported, domestic investment would be expected to fall with a real depreciation (Iyoha, 2008). All these show that the impact of exchange rate variability on economies especially developing ones is not only in one direction.

Therefore, understanding the behaviour of the exchange rate is very important for many reasons. First, the relationship between a country’s exchange rate and economic growth via trade is a crucial issue from both the descriptive and policy prescription perspectives. As Edwards (2014) asserts: “It is not an overstatement to say that the issue of real exchange rate behaviour now occupies a central role in policy evaluation and design”. A country’s exchange rate behaviour is an important determinant of the growth of its cross-border trading and it serves as a measure of its international competitiveness (Bah and Amusa: 2003). It also plays a crucial role in guiding the broad allocation of production and spending between foreign and domestic goods. In addition, researches have shown that exchange rate stability influences importantly export growth, consumption, resource allocation, employment and private investments (Takaendesa, et al: 2005, Aron et al, 1999). The behaviour of exchange rate is a useful indicator of economic performance of an economy that needs to be understood. In other words, assessing the link between exchange rate fluctuations and Nigeria’s trade flows would have policy implication. Also, variability of the naira value in recent years calls for understanding of the factors that actually cause exchange rate to fluctuate. For example, knowledge of these would help to facilitate policies that would aid the attainment of exchange rate stability and economic growth through trade flows in the long run.

Furthermore, along the lines of the existing literature, a related question very few researchers have investigated is whether changes in exchange rate regimes or policies which can be associated with a shift in the amplitude of fluctuations cause export flows to decrease. Few others, for reasons known to them, ascertained the impact of these fluctuations on either the oil sector, excluding the non-oil sector or vice versa. Nevertheless, we know that in a country like Nigeria that is so much over-dependent on oil, assessing the effect of exchange rate fluctuations on either oil or non-oil sector trade exclusively may not really give a value judgement and the conclusion thereof. However, to bridge this gap and also avoid the effect of Dutch disease associated with some previous findings, the current study attempts to examine the possible effect and link between exchange rate fluctuations and Nigeria’s trade flows for both the oil and the non-oil sectors. Hence, our results are therefore likely to be more reliable for policy purposes.1.4 OBJECTIVES OF THE STUDY

In a highly import dependent economy like Nigeria, the 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 effects of exchange rate functions on manufacturing sector in Nigeria.

These specific objectives are as follows:

1. To investigate empirically, the effects of exchange rate functions on Nigerian importation of input and capital goods.

2. To determine if the continuous functions of exchange rate of naira have any effect on the quality and quantity of output of manufacturing firms.

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3. To examine the effects of exchange rate functions on Nigerian exportation of input and capital goods.

4. To discover if the introduction of counter trade by the government is alleviating the problems created by the delay of international trade and to make appropriate recommendations.

5. To seek and determine as far as possible methods by which the risk associated with exchange rate fluctuations can be minimized.1.5 RESEARCH QUESTIONS

In view of the above problems, the following research questions are raised:

1. Does fluctuation in real exchange rate in Nigeria has any significant impact on economic growth?

2. What are the effects of different macroeconomic policies on exchange rate in Nigeria?

3. What are the determinants (determining factors) of real exchange rate in Nigeria?

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

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

6. To what extent does exchange rate fluctuation affect the exportation of made in Nigeria goods?1.6 STATEMENT OF THE HYPOTHESIS

The hypotheses for this research work are formulated after thorough in-depth analysis of primary data collected and the assessment of the result of the pilot survey conducted. The hypotheses are tentative statements that are yet to be proved; the hypothesis for the research takes its bearing from the statement of problem and it is as follows:H01: The purchasing powers of the consumer of the goods are not affected by the unstable exchange rate.

H02: Exchange rate fluctuation adversely affects the marketing of the commodities.

H03: The fluctuating exchange rate has no impact on the balance of trade.1.7 SIGNIFICANCE OF THE STUDY

The unique role of people and commercial banks in enhancing exchange rate cannot be over emphasized. A sound business idea remains a mere dream until someone is able to organize the finances necessary to translate the idea into a business reality, and more often than not, this finance comes in the form bank credit.

The significance of this study, the recommendations made at the end of the study and their implementation make the research immensely beneficial to the following:

1. Importers who are always trading and in dire need of finances.

2. Policy makers of the Central Bank of Nigeria who issue guideline to govern Nigeria trade practices.

3. Banker’s especially commercial Bank guidelines.

4. Students of accounting and other related fields that might take a clue from this study to further research into the field of exchange rate function on the Nigeria manufacturing sector.

5. The general public who can contribute and still be informed of the activities of our banking institutions.1.8 SCOPE OF THE STUDY

The scope of this study 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.1.9 DEFINITION OF TERMS

1. Exchange Rate: This is the price one country’s currency expressed in another country’s currency.

2. Balance of Payment: This means that a foreign exchange rate must be at its equilibrium level with other countries.

3. International Trade: It is exchange of goods and services between two countries, it brings increase in the economy.

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.

5. Dutch auction System (DAS): This is a method of exchange rate determination through auctions where the bidders pay according to their bid rates.

6. 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.