Impact of Exchange rate on Agriculture and Manufacturing Sector in Nigeria

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The research aim is to determine the impact of Exchange rate on Agriculture and Manufacturing Sector in Nigeria within the period of 1981-2016. You can download the full research work from chapter one to five.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The response of agricultural sector and manufacturing output to exchange rate fluctuation has been the subject of long and vigorous discussion, going back to Nerlove’s classic treatment of the long-run supply elasticity for corn, cotton and wheat in the United States (Waziri, 2017). Estimates of supply elasticity (short-run and long-run) based on the Nerlove model vary widely by crop and region, leading some to argue that the Nerlovian model is inadequate for deriving the long-run response. In view of the poor performance of the agricultural sector in recent years and the impact of most of the economic reform programmes on agricultural supply in Nigeria, especially on the impact of adjustment on agriculture output points to the fact that the reforms are showing the desired outcomes, but others think otherwise (Noko, 2017). Exchange rate reform is a necessary but insufficient condition for increased agricultural and manufacturing sector output (Kwaghe, 2015). While supply response for food or export crops can be significant, aggregate supply response may be comparatively low, suggesting that at least some increased output might have occurred through switching of resources between them, with changing price incentives.

The theoretical case that price reforms will lead to supply response is weak, especially in relation to food production, where policy biases are limited. Food prices may fall in relative terms.  Price variability affects supply response, but in no standard direction. For the past two decades, while population grew at a rate between 2.5% and 3% per annum, food production grew at a rate of about 2.5% per annum (CBN 2015; Noko, 2017). The pressure on domestic price levels persisted as the consumer prices, which reached very high levels at the end of 1993 increased further in 2011 and 2016. Data from the Nigeria Bureau of statistics (NBS, 2018) showed that the average all-items composite consumer price Index (CPI) for the first half of 2011 stood at N405.10 This represents an increase of 21.5% and25.3% over the levels in the corresponding periods of 2009 and 2010 respectively (CBN, 2015).

Growth in agriculture is essential to provide food for a growing nonagricultural labour force, raw materials for industrial production, savings and tax revenue to support development of the rest of the economy, to earn more foreign exchange (or save foreign exchange when primary products are imported) and provide a growing market for domestic manufactures (Noko, 2017).  Nigeria is endowed with large agricultural potentialities with abundant land, rivers, streams, lakes, forests and grasslands, as well as a large active population that can sustain a productive and cultivable agricultural sector. In spite of these endowments, the sector has continuously produced below expectations (Noula Armand Gilbert, 2013; Ojo, Olufemi, 2014).  

Prior to independence in 1960 up to early 1960s, the economy was characterized by the dominance of exports (mostly agriculture) and commercial activities. In spite of the fluctuations in world commodity prices, agriculture contributed about 65 per cent to GDP and represented almost 70 per cent of total exports. Agriculture provided the foreign exchange that was utilized in importing raw materials and capital goods as the peasant farmers produced enough to feed the entire population, the various Marketing Boards generated much revenue, the surplus of which was used by government to develop the basic infrastructure needed for long term development (Tule, 2015). Since the emergence of the oil industry in the late 1960s, the role of agriculture in the economy has been on the downward trend especially its contribution to GDP, where its share to GDP fell from 48.23 per cent in 1971 to almost 21 per cent in 1977 to 34 per cent in 2015 (Daramola, Ehui, Ukeje, Mcintire, 2005; Akpaden, Enin, State, Ibom; 2010; Victor, 2015). However, according to Mbutor and Al-Hassan (2013) agricultural sector contribution to growth in GDP grew only at 6.9 per cent in 2003. On average, the sector grew at 7.2 per cent between 2005 and 2007. From 2008 to 2011, growth of the agricultural sector began to decline. It grew by 6.3 per cent, 5.9 per cent, 5.8 per cent and 5.7 per cent in 2008, 2009, 2010 and 2014, respectively. By 2015, the growth in the agricultural sector declined to 3.9 per cent. In 2013 agricultural production grew by 4.5 per cent, favorable weather conditions and sustained implementations of the initiatives under the Agricultural Programme (ATAP) were largely responsible for the growth in the sector (CBN, 2016).

Viewing the other major variables in the study i.e. exchange markets, the Nigerian foreign exchange market is of recent origin. In fact, prior to 1962, there was no formal foreign exchange market in the country. Linked with a long tie with former colonial master, Britain, the Nigerian pound was tied to the British Pound Sterling with easy convertibility. This scenario contributed largely to late development of an active foreign exchange market in Nigeria. During this period, foreign exchange earned by the private sector (mainly from agriculture) was held in balances abroad by commercial banks which acted as agents for local exporters. Sequel to the establishment of the Central Bank of Nigeria (CBN) in 1958, and the subsequent centralization of foreign exchange market became imperative. This ultimately led to the enactment of the first exchange control law in Nigeria- the Exchange Control Act 1962 (Okororie, 2008).

Owing to the strong link between exchange rate, manufacturing export and agricultural export especially during flexible exchange rate regime, a period of decrease in agricultural exports volume where increase in earnings has been experienced. According to Essien (1999) cocoa products of 116.2 million kg earned ₦239.1 million in 1985 but in 1987 cocoa products of 92.4 million kg earned ₦419.5 million and since then the receipt has continued to increase (apart from1984) despite lower export volume. The monetary value of agricultural exports which stood at an average of ₦725.8 million in 1981-1989 increased to ₦802.7 million in 1990-1999. On the other hand, the rate of agricultural exports to total exports ratio during the same period stand at 0.038, but declined to 0.014. Although the export baskets also expanded with non- traditional export commodities such as tubers, fruits and spices coming on board (Anyanwu, et al, 2010).

Similarly, the Central Bank of Nigeria (CBN) (CBN, 2016) in its annual reports (various editions) highlighted that during the 1960s and early 1970s, manufacturing activities were positively accelerated and value added per worker was at par with, if not higher than that in other African countries such as Botswana, Ghana and Kenya. During this period the share of manufacturing in GDP nearly doubled from less than 5 percent to 8 percent and on that trend many people believed that the country was on a path to industrialization. It was observed, however, that as from the 1980s till present manufacturing firms in Nigeria experienced relative stagnation as the sectors value added per capital lagged behind that of many comparator countries. Presently, the manufacturing sector is experiencing collapse with an average capacity utilization hovering around 40 percent and thus exchange rate management becomes imperative to drive the most important sector of Nigeria (Victor, 2015).

  • Statement of Problem

The main objectives of exchange rate policy in Nigeria are to preserve the value of the domestic currency, maintain a favorable external reserves position and ensure external balance without compromise the need for internal balance and the overall goal of macroeconomic stability. The use of the exchange rate as an instrument of control in the Nigerian economy has been rather limited. During the period of fixed exchange rate (1960-1986) the country pegged its currency with the Great Britain Pound (GBP) sterling until the devaluation of sterling pound in 1967. Thereafter, the country’s currency maintained parity with U.S dollar up to 1973 when the Nigerian pound was changed to Naira because the exchange rate policy of pegging the Naira to U.S dollar become a drag on its economy, thus depleting external reserve within the periods, the fixed exchange rates were established for both the pound sterling and the U.S dollar at £ 0.5833 and U.S $1.5200 to =₦=1.00 respectively (CBN, 2012; Noko, 2017).

During the period of fixed exchange rate, Nigerian currency was perceived to have been over-valued, in order to find a realistic value of the naira, a Second-tier Foreign Exchange Market (SFEM) emerged in September, 1986 under the Structural Adjustment Programme which marked the beginning of flexible or floating exchange rate regimes. Various related market-based exchange rate policies have been experienced and different downward exchange rates as; Dual exchange rate system (introduction of SFEM with the initial Firsttier Foreign Exchange Market) in September, 1986 the value of naira stands at 2.0206/$, Dutch Auction System (DAS) of bidding in April, 1987 naira depreciated to 4.0179/$, single enlarged Foreign Exchange Market with various pricing methods (Waziri et al, 2017). In July, 1987 naira depreciated to 4.2723/$, creation of Inter-Bank Foreign Exchange Market (IFEM) in January, 1989 naira depreciated to 12.9377/$, pegged exchange rate system in 1994 naira stands at 21.8861/$, Autonomous Foreign Exchange Market (AFEM) in 1995 naira remained unchanged at 21.8861/$, re-introduction of IFEM in October, 1999 naira continued depreciating to 108.000/$, Retail Dutch Auction System (rDAS) of foreign exchange management in July, 2002 naira depreciated to 130.8500/$, Wholesale Dutch Auction System (wDAS) in February, 2006 to October, 2013 naira depreciated to 141.7600 and again rDAS in 2013 to date (Waziri et al, 2017; Omotosho, 2015).

Despite the adopted of these policies at various stages to maintain a stable exchange rates which proved abortive, exchange rate fluctuates widely especially after the Structural Adjustment Programme (post-SAP era). Therefore, the downward trend of the country’s currency impacted greatly on agricultural and manufacturing sector export product (Daramola et al, 2005; Akpaden, 2010; Victor, 2015).  Consequently, exchange rate fluctuations discourage firms from undertaking investment, innovation and trade, it may also deter firms from entering into export markets, thereby weakening investors’ confidence in the sector, and also raises the price of imported inputs such as seeds, fertilizers, pesticides, and capital equipment thereby reducing the agricultural commodities and income of farmers, and exchange rate risk which leads to capital reversal considered unfavorable for the economy at this trying times.

1.3      Research Questions     

In the course of this research the following question will be addressed;

  • To what extent does exchange rate impacts on Nigeria’s agriculture output?
  • To what extent does exchange rate impacts on Nigeria’s manufacturing sector output?
  • Is there any long-run relationship between exchange rate and Nigeria’s agriculture and manufacturing sector output?

 1.4      Objectives of the Study                                      

The objectives of this study are to:

  • empirically investigate if exchange rate have significant impact on Nigeria’s agriculture output.
  • empirically investigate if exchange rate have significant impact on Nigeria’s manufacturing output.
  • evaluate the long-run relationship between exchange rate and Nigeria’s agriculture and manufacturing sector output.

1.5       Research Hypotheses

The hypotheses to be tested in the course of this research work are:

H0:   Exchange rate does not have significant effect on Nigeria’s agriculture output.

H0:   Exchange rate does not have significant effect on Nigeria’s manufacturing sector.

 

H0: Exchange rate does not have significant long-run relationship with Nigeria’s agriculture manufacturing sector output.

1.6       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, agricultural output, 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.

1.7 Scope of the study

.2 Description of Study Area.

This research work is designed to cover the period 1981-2016 a period of thirty-four years. The scope consist of the regulatory and deregulatory exchange rate period i.e. the fixed exchange rate and the floating exchange rate period. However, in the process of this research work, some constraints were encountered. Such as time constraints; that is handling academic works at the same time with the research work.

1.8 Operational Definition

Economic growth: This a quantitative increase in the monetary value of a country gross domestic product over time usually measured within the fiscal year.

Exchange rate:  Exchange rate is the rate of transformation of one currency to another. Nzotta (2004) defines exchange rates as the price of one currency in terms of another. An arbitrage in economics and finance is the practice of taking advantage of price difference between two or more markets, striking a combination of matching deals that capitalizes upon the imbalance, the profit being the difference between the market prices.

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.

Currency devaluation: Devaluation exists in any situation whereby the officially declared exchange rate is altered such that a unit of a country’s currency can buy fewer units of foreign currency. On the other hand when the monetary authorities alter the exchange rate such that the domestic currency can buy more units of foreign currency, we say that a case of revaluation exists.

Agriculture Sector Output: This is made up of the monetary value of all agricultural output produces within the fiscal year. The agriculture sector produces are combination of produce from crops, fishing, livestock, and forestry.

Exchange Rate (EXR): It is the price of a nation’s currency in terms of another currency. An exchange rate thus has two components, the domestic currency and a foreign currency, and can be quoted either directly or indirectly. In a direct quotation, the price of a unit of foreign currency is expressed in terms of the domestic currency. In an indirect quotation, the price of a unit of domestic currency is expressed in terms of the foreign currency. An exchange rate that does not have the domestic currency as one of the two currency components is known as a cross currency, or cross rate. In Iyioha (1998), for a developing country like Nigeria that is highly dependent on trade, exchange rate plays a significant role in the ability of the economy to attain its optimal productive capacity. Thus, it is the rate at which a unit of the currency of one country can be exchange for a unit of the currency of another country. These variables were chosen because of the role of exchange rate in the financial sector and especially on the demand for money.

Non-Oil Exports (NOX): A function of international trade whereby non-oil commodities produced in one country are shipped to another country for future sale or trade. The sale of non-oil commodities to another country adds to the producing nation’s gross output. Non-oil exports occur on a large scale between nations that have fewer restrictions on trade such as tariffs or subsidies.

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