THE IMPACT OF EXCHANGE RATE VOLATILITY ON THE MANUFACTURING SECTOR OUTPUTS IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

The study of dynamic relation between savings and macroeconomic shocks has received considerable attention in recent years especially in emerging economies like India. However, it is a well recognized fact that the dynamic response of savings to macroeconomic shocks can bevery significant in developing countries and Nigeria in particular. Agenor, McDermott, and Prasad (2000) argued that terms of trade disturbances are highly correlated with output fluctuations and can be a major source of aggregate economic volatility. Such disturbances tend also to have a large impact on savings (both private and public), because of their large income effects. Moreover, terms of trade shocks can also entail an asymmetric response in savings, as a result, of the existence of borrowing constraints on world financial markets. World Bank (1999) argued that the experience of the past few years suggests that households (and governments) from poor countries may be able to deposit their windfall savings on the international capital market in good times, but that they may be unable to borrow as much as they would like in bad times because of collateral problems or a (perceived) high risk of default. Deaton (1992) suggested that this asymmetry can create an incentive for precautionary savings, because in the case of a negative shock, consumption can be smoothed only by running down previously accumulated assets.

There exists some disagreement about what counts as savings. For example, the part of a person’s income that is spent on mortgage loan repayments is not spent on present consumption hence; this is savings, even though people do not always think of repaying a loan as savings. Savings is closely related to investment. By not using income to buy consumer goods and services, it is possible for resources to instead be invested by being used to produce fixed capital, such as factories and machinery. Savings can therefore be vital to increase the amount of fixed capital available, which contributes to economic growth (Bower, 2011).

Pertinent to note here is that on one side, countries that save more tend to grow faster provided that the financial system is deep while on the other hand, some analysts fear that a rising savings rate could hamper economic recovery if consumer expenditures form a large component of aggregate demand. More so, low savings rate has been cited by some studies as one of the most serious constraint to sustainable economic growth, one of those studies is that of World Bank (1989) which concludes that on the average, third world countries with higher growth rates incidentally are those with higher savings rates. United Nation also maintained that increasing savings and ensuring that they are directed to productive investment are central to accelerating economic growth (UN Department of Economics and Social Affairs 2005). This makes savings as a macroeconomic variable a subject of critical consideration while Nigeria strives to attain economic growth and development.

The rate at which savings fluctuate remains a source of challenge to policy-makers world over, and Nigeria in particular. Consequently, the critical importance of savings for the maintenance of strong and sustainable growth in the world economy and particularly Nigeria cannot be over emphasized. Hence, savings rates have doubled in East Asia and stagnated in Sub-Saharan Africa, Latin America and the Caribbean for more than three decades (Loayza, Schmidt-Hebbel and Serven, 2000).

In Nigeria, savings rate has not been stable. It is worthy of note here that nothing stops countries that are faced with different preferences, income streams and demographic characteristics from choosing different savings rates theoretically. In practice, the intertemporal choices that underlie savings for instance, in Nigeria, depend on an array of market failures, externalities and policy-induced distortions that are likely to drive savings away from socially desirable levels (Heijdra and Ligthart, 2004).

Savings accumulation helps countries in promoting economic growth which in turn, leads to economic development. Generations differ in their savings propensities and possibly creativity; consequently, innovations may come more frequently at certain stages in life. Thus, both investment opportunities and the supply of available savings may depend on the age distribution of the population thereby generating Macroeconomic shocks. However, when a bad shock hits the economy, the responsiveness of savings to macroeconomic shocks depends on a lag response of real interest rate to change in national or private savings as well as to output growth, and other macroeconomic variables (Uremadu, 2007).

Olusoji (2003) maintained that when applied to capital investment, savings increase output. More so, institutions in the financial sector like deposit money banks (DMBs) or commercial banks mobilize savings deposit on which they pay certain interest. To effectively mobilize savings in an economy, the deposit rate must be relatively high and inflation rate stabilized to ensure a high positive real interest rate, which motivates investors to save from their disposable income. In Nigeria, the problem of mobilizing savings and deposits has always been the bane of economic growth and development.

However, in Nigeria, savings rates have been fluctuating overtime. The ratio of total savings to Gross domestic product (GDP) in Nigeria fluctuated between 7.8 percent and 8.5 percent in the 1970 to 1975. Thereafter, in the year 1976 to 1980, it fluctuated but, increased from 8.5 percent to about 11.6 percent. Furthermore, it remained on the increase from about 13.8 percent to 18.4 percent between the periods 1981 to 1985.

During the period 1986 to 1989, Nigeria’s savings GDP ratio averaged 16.4 percent. However, with the distress in the financial sector of the 1990s, the rate of aggregate savings to GDP ratio declined significantly. The distress syndrome resulted in a significant fall in Nigeria’s domestic savings in the period 1990 to 1994, with the savings to GDP ratio dropping to 11.6 percent on the average. Between the periods 1995 to 2000, it dropped further to about 6.9 percent on the average. Between the periods 2001 to 2005, the figure increased to about 8.4 percent on the average. More so, from 2006 to 2011, the ratio of aggregate savings to GDP increased on the average, to about 16.6 percent.

As evidenced from the Nigerian data, Central Bank of Nigeria (CBN, 2011), the ratio of savings to GDP is dynamic as the year increases but, between 2005 and 2008, it increased significantly. However, the periods between 2009 and 2011 show that the dynamism in the savings/GDP ratio is on the decrease. However, the transformation of these fluctuations in savings/GDP ratio into a sustained output expansion remains a source of challenge to policy makers and government. It is certain that without a significant increase in the level of savings (public and private), no meaningful growth in output would be achieved. Hence, this will make the stability of savings difficult.

From the foregoing discussions, it is clear that an understanding of the nature of aggregate national savings behaviour is critical in designing policies to promote savings, investment and growth (Umoh, 2003). Accordingly, for an effective mobilization of savings, it is vital to understand how savings responds to its core and leading determinants in Nigeria since this has not been sufficiently established by policymakers and researchers.

1.2       Statement of the Problem

The savings rate plays a very important role in economic growth process especially when it is stable and increasing. But fluctuations in savings can make it difficult for the financial market to function.

Savings stabilization can offer Nigeria substantial economic benefits by enhancing investment level. Since Nigerian savings fluctuate may be, because of temporary changes in global economic and political conditions that affect the increased savings sustainability and stability, then the case for strengthening and stabilizing savings makes economic sense.

In Nigeria, the level of funds mobilization by banks is quite low due to a number of reasons, ranging from low savings deposit rates to the poor banking habit or culture of the people (Nnanna, Englama and Odoko; 2004). According to them, another disincentive to funds mobilization is the attitude of banks to small savers. Most banks target corporate customers and government deposits and pay little or no attention to the small savers. Admittedly, the services rendered to the small savers are more tasking on the banks, but there is need to encourage them to save. As a matter of fact, the funds from household savings are relatively cheaper and more stable than government deposits that are very volatile and expensive.

However, in mobilizing savings in Nigeria, the behaviour of savings and real rate of interest has to be examined. Reduction in inflation rate and proper sensitization of savers on the vital role which real interest rate plays on savings mobilization, may make investors give due attention to real rate, while trying to save or invest in deposit accounts (Chete, 1999). Further, people consider some other reasons for financial savings other than the spread on savings and/or its yields (Chete, 1999).

More so, government expenditure, intervention and/or regulation could cause savings distortions in the economy but, financial liberalization would indeed foster economic growth (McKinnon, 1973 and Shaw, 1973). In Nigeria, the savings response to government expenditure needs to be examined since distortions in savings could occur as a result of government expenditure, and this in turn, affects the whole economy.

General Price level also remains a central issue to policy makers and analysts since its importance is premised on the distortions which its high rate can exert on domestic macroeconomic conditions, especially on savings, with the potential to derail the economy from the path of sustainable growth and development (Central Bank of Nigeria, CBN, 2007). Inflationary trend and/or the trend of general price level in Nigeria have been cyclical. Between 1970 and 1979, the index of price in Nigeria averaged 0.43 percent but, between 1980 and 1989, it increased to 2.21 percent.  More so, there existed a rise in the average index of price in Nigeria from 1990 to 1999. The index of price in Nigeria between 1990 and 1999 averaged 35.0 percent. However, from 2000 to 2010, the index of price in Nigeria averaged 143.87 percent.

Furthermore, CBN (2009) posited that historically, from 2006 to 2012, Nigerian price rate averaged 10.58 percent, whereby February 2010 recorded its peak at 15.6 percent and July 2006 has its lowest value of 3 percent. Furthermore, the rate of price in Nigeria was recorded at 12.90 percent in June of 2012. As a result, price in Nigeria has not been stable. Hence, for a country like Nigeria, characterized by significant structural imbalances and uncertainties, an insight into the way savings respond to price is very necessary.

More so, oil price in Nigeria has not been stable. The price of oil declines and increases over time may be as a result of increased sale of oil and gas production in the US.  This comes soon after other reports show that the US is reducing its imports of African crude oil including that from Nigeria and will fully halt importation from Africa next year. Therefore, the tragedy of Nigerian participation in international trade derives from our inability to influence the prices at which these commodities (in this case oil and its associated products) are sold. Nigeria therefore, accepts the prices offered it irrespective of the huge internal transaction costs (dilapidated infrastructure, inflation, inappropriate policy-orchestrated uncertainties and so on) that feed into Nigerian prices (Oluba, 2010). Poignantly, Nigeria is at the mercy of the industrialized world even when it participates in trade on its own commodities. Nigeria has suffered several oil price shocks in the past four decades. The most recent was the global economic crisis of 2008 which saw the price of crude oil nosedive considerably and consequently threatening macroeconomic stability. Therefore, in Nigeria, the price of oil between 1970 and 1979 averaged ₦140.5281. Also, the average oil price in Nigeria between 1980 and 1989 is ₦100.688. Furthermore, from 1990 to 1999, price of oil in Nigeria averaged ₦72.80933. Finally, between the year 2000 and 2011, the price of oil in Nigeria averaged ₦228.8139.

Moreover, evidence from the Nigerian data show that while government expenditure, the growth rate of GDP, and total savings fluctuates on a high rate (level), price, oil price, population and interest rate fluctuates on the low rate (level) but, are relatively stable.

The literatures reviewed so far seem to have taken for granted the dynamic response of savings to some selected macroeconomic variables in Nigeria’s case. Although a vast empirical literature has shed light on various aspects of savings behaviour (for instance, to investment), this study will include many macroeconomic indicators (e.g. output, general price level, oil price, government expenditure, population and interest rate) while examining the dynamic response of savings to selected macroeconomic variables in Nigeria. However, the questions that shall be addressed here are: