Impact of Exchange Rate Deregulation on Manufacturing Sector Performance in Nigeria

The study examined the impact of exchange rate deregulation on manufacturing output performance in Nigeria over the period 1980 to 2016. The normalized co-integration technique was used to test for long-run relationship between exchange rate and manufacturing output while the granger causality test was used to ascertain the direction of causality between them. Also, the error correction mechanism (ECM) was used to calculate the speed of adjustment of the model to short-run disequilibrium condition. The empirical findings revealed that exchange rate has non-significant positive long-run effect on manufacturing industry output. However, unidirectional causal impact of exchange rate on manufacturing output was established using the pairwise granger causality test. Based on the above result, it is recommended that in discharging the mandate of exchange rate management, the monetary authorities should aim at stabilizing exchange rate through the use of appropriate monetary policy tools as well as support export diversification programmes in order to enhance foreign exchange inflow.


INTRODUCTION
In modern economies, the manufacturing sector is generally regarded as capable of accelerating the growth and development process. One major reason for this is the nature of activities in the sector which is believed to involve significant linkages across other sectors in terms of contribution to and from these sectors (Okigbo, 1993;Opaluwa, Umeh, and Ameh, 2010). However, the manufacturing sector in Nigeria is still under-developed, with very low level of capacity utilization and contribution to aggregate output in spite of the fact that it is considered the fastest growing sector in Nigeria since 1973/1974 (Ojo, 1990;Obadan, 1994). Low level of development in the sector has often been attributed to increasingly dependence on the external sector for import of essential manufacturing inputs (Okigbo, 1993). Inability to source foreign exchange at affordable rates can impair the capacity to import, thereby impacting negatively on manufacturing performance. The structural adjustment programme (SAP) which was adopted in 1986 to restructure the Nigerian economy led to an increase in agricultural output but also had negative effect on the manufacturing sector (International Labour Organization, 1996). SAP entailed the deregulation of prices (including exchange rate) which led to unstable and rising trends in the general price level. This unintended consequence of SAP led to de-industrialization and rising unemployment in the economy. It should be noted that after 28 years of exchange rate deregulation as entrenched in SAP, the industrialization process in Nigeria is still very slow while unemployment is on the increase. Iyoha (2003) noted that the decline in manufacturing contribution to GNP showed that SAP, indeed, impacted adversely on the operations of the manufacturing sector in Nigeria. The relative share of industrial output in GDP achieved a high level of 45.57 percent in 1980 and a low level of 26 percent in 1986. With the adoption of SAP, the manufacturing sector's relative share of national output declined even further, reaching a low level of 5. For an open economy that depends on importation to support domestic production, exchange rate plays a critical role in its ability to attain optimal production capacity. Thus, exchange rate fluctuations/uncertainty which attended the introduction of exchange rate deregulation had serious implications for the macroeconomic stability of the country. For example, an over-valued exchange rate hurts the performance of export industries thereby reducing foreign exchange inflow, leading to unsustainable balance-of-payments deficits. On the other hand, excessive devaluation of the domestic currency or depreciation of the exchange rate increases the cost of imported production inputs thereby fuelling inflationary pressures. The Nigerian manufacturing sector imports most of its industrial inputs thereby raising the cost of production. This discourages investment in the sector and in the process retards manufacturing sector output growth. Based on the above background, this study examined the performance of the manufacturing sector in the post exchange rate deregulation period in order to ascertain the extent to which deregulation has affected the contribution of the manufacturing sector to the economy. Estimation techniques of the Johansen normalized co-integration and Granger causality were employed in the study. The error correction mechanism (ECM) was used to determine the speed of adjustment of the model in the case of a disequilibrium in the system.

II.
INSIGHTS FROM LITERATURE. Preservation of the value of the domestic currency, maintenance of favourable external reserve position and attainment of both internal and external balance, among others, are major objectives of exchange rate management in Nigeria. Exchange rate policy is an essential component of macroeconomic management in Nigeria because the dynamics of exchange rate have significant implications for a country's balance of payment position, income distribution and growth (Oyejide and Ogun, 1985). It is often argued that the behaviour of exchange rate determines the behaviour of several other macroeconomic variables (Oaikhenan and Edo, 2002). Exchange rate movements, for instance, affect other indicators of a nation's economic health like interest rate, inflation rate, unemployment rate, term of trade (Douglas and Jike,2005). Hence, exchange rate which is a measure of the strength of a currency relative to another currency or a group of currencies is both an instrument of macroeconomic management and an indicator of macroeconomic performance. Abdullahi (1981) and Ammani (2011) observed that after many years of independence, Nigeria could nether produce sufficient consumer goods for its rapidly increasing population nor provide for the raw material needs of agrobased industries like oil mills, textile and paper mills, the furniture industry etc. let alone producing for export. Indeed, many of the agro-based industries are either closing shop or are operating at sub-optimal levels due to inability to import part or all of the raw materials required to support their operations. In addition, other performance assessment indicators suggest that the country was in need of a structural reform and it was against this background that the structural adjustment programme (SAP) was introduced in 1986to address perceived structural imbalance arising from overdependence on both consumer and industrial goods imports. Ahmed and Lipton (1997) opined that structural adjustment refers to a set of measures designed to fast-track or accelerate the process of economic development through correction of structural imbalance in an economy. The World Bank and IMF often emphasize such measures as conditions for financial support. These reforms aim at eliminating distortions such as currency overvaluation, high fiscal deficits, trade restrictions and inefficiencies in public service delivery which impair efficiency in allocation of economic resources. The structural adjustment programme (SAP) derived from the Washington consensus or agreement was adopted in the mid-1980s to restructure and redirect the Nigerian economy, eliminate price distortions and diversify its productive base. This was a follow-up to earlier failed attempts to lift the country out of the adverse macroeconomic condition that confronted it in the early part of that decade. Exchange rate deregulation was a major policy instrument of the structural adjustment programme. However, exchange rate deregulation had unintended consequences on the Nigerian economy thereby bringing to question whether it was indeed a suitable option for Nigeria at the time it was introduced (Ude, 1996).The consequences, according to Osisioma (2004), include a general hike in prices of most finished goods, low aggregate demand for manufactured goods, accumulation of inventories of unsold finished products, and production cut-backs. Uche (2000) attributed the failure of the deregulated regime the promote economic stability and jump-start the growth process of nonoil sectors, like manufacturing, largely, to lack of fiscal discipline and deficit budgeting. Also, Oyejide (1985) and Umubanmwen (1993) emphasized the adverse consequences of the Bretton Woods system which induces variability in the exchange rate and which also reduces the ability to import on the country that adopts Washington Consensus. Drawing from the above scenario, Anyanwu, Oyefusi, Oaikhenan, and Dimowo (1997) argued that currency devaluation, occasioned by exchange rate deregulation has not significantly affected economic performance positively in Nigeria. An assessment of the competitiveness of the real exchange rate constitutes a major component of a country's macroeconomic performance. Some developing nations are believed to have adopted currency devaluation as a policy option for boosting domestic export (Haddad and Pacavo, 2010). According to Sanger and Wines (2010), China effectively used this strategy to drive domestic production and enhance its export competitiveness. Over the years scholars have examined the link between exchange rate and economic performance in both developed and developing economies but not many have focused on sectoral impact of exchange rate, particularly in a developing economy like Nigeria. Also, evidence from some of these studies have not been consistent. For instance, while studies by Enekwe, Ordu and Nwoha (2013) (2012) offer greater insight for a deeper understanding of the nexus between exchange rate and manufacturingoutput. These studies specifically showed the exchange rate depreciation is an impediment to manufacturing sector performance. A similar study by Ehinomen and Oladipo (2012) aligned with the outcome of the above studies. It showed that exchange rate appreciation supports manufacturing output growth. This result however contradicts Branson and Love (1988) which reported negative impact of exchange rate appreciation on manufacturing performance. In terms of causality, Okoye and Nwakoby (2015) established causal link from manufacturing capacity utilization to exchange rate, an indication that manufacturing operations in Nigeria affect exchange rate movements.

III. SCOPE AND METHODOLOGY
The study covered the period 1980-2016. Quantitative technique of data analysis was adopted in investigating the relationship between the dependent variable (manufacturing output) and the independent variables (exchange rate, inflation rate, monetary policy rate, broad money supply, foreign direct investment, and market capitalization). Data for the study were obtained from secondary sources, specifically from CBN statistical bulletins (2016) and World Bank (2018).

3.1: Model Specification
The model for the is specified in the implicit form as follows: The above model can be re-specified explicitly as: The above model indicates thatmanufacturing industry output is a function of exchange rate, inflation rate, monetary policy rate, foreign direct investment (net inflows percentage of GDP), financial deepening and market capitalization. Inflation rate and monetary policy rate (interest rate) are exponential due to an intention to take the double log of the model for linearization purpose of which inflation and monetary policy are already smoothened.The variables are logged to ensure comparability of the variables on the same scale. This, taking the log of the variables in order to ensure linearity in the equation, we have: LINDt= α0 + α1LEXRTt +α2INFLt+ α3MPRt +α4LFDIt+ α5LM2t+ α6LMCAPt + ut………….
(iii) All the variables are as previously defined above. From theory, the apriori expectation of the relationship between the independent variables and industrial output are as follows: exchange rate, inflation rate, and monetary policy rate are expected to have a negative and statistically significant relationship with industrial output such that an increase in exchange rate, inflation rate and monetary policy rate, will lead to a reduction in manufacturing industry output; market capitalisation, foreign direct investment and financial deepening are expected to have a positive and statistically significant relationship with manufacturing output.

3.2: Technique of Estimation.
The Augmented Dickey Fuller (ADF) unit root test was conducted to test for stationary trend in the series because research has shown that time series data are often nonstationary and could produce spurious estimates (Granger, et al, 2017).The Johansen co-integration technique was used to establish evidence of long-run relationship among the variables. Evidence of co-integrating relationship is established if the trace statistic and or the Max Eigen-value statistic is equal to or greater than the critical value at 5 per cent. The error correction (ECM) mechanism was used to ascertain short-run adjustment dynamics of the model. The ECM coefficient shows how quickly variables respond to short-run disequilibrium, should there be a disturbance to the model. The error correction technique corrects for short-run disequilibrium by restoring or tying the value of the dependent variable to its long-run equilibrium. The Johansen normalized co-integration was conducted to determine the long-run effect of exchange rate on manufacturing output.

IV. RESULTS AND DISCUSSION
The results of the various tests are presented and discussed in this section as follows:

4.1: Results of ADF unit root test
The result of the unit root test is shown in table 1 below: Based on the ADF unit root test statistics, it was found that all the variables are non-stationary at level. However, stationary trend was achieved after taking the first difference at 5 per cent significance level. Given the stationary trend of all variables at their first difference (I(1)), investigation of the long run relationship using the Johansen co-integration method was conducted. The results of the Johansen co-integration trace and max eigen value results are shown in tables2 and 3 below:

4.2: Co-integration Test
The result of the co-integration test is presented below:   Table 3 complements the result shown in table 2. Here, the Max-Eigen statistic (56.69) is greater than 5% critical value (47.07) for the first co-integrating equation. Though the other equations show the absence of or no co-integration, this is sufficient evidence of co-integration. Hence, a rejection of the null hypothesis of no co-integrating equations and acceptance of the alternate hypothesis of presence of co-integration.

4.3: Long-run Estimation
Evidence of long-run response of manufacturing to changes in the explanatory variables is presented in table 4' The long-run model estimation based on Johansen normalized co-integration test (table 4) shows non-significant positive effect of exchange rate (t=1.2930) on manufacturing output at 5 percent level of significance. Exchange rate coefficient of 0.115737 implies that 1 percent increase in exchange rate will induce a less than proportionate increase in manufacturing output. Though this result is not consistent with apriori expectation, it explains the extent to which the nation's manufacturing sector depends on foreign imports for the sustenance and expansion if its operations. The t-statistic for inflation rate (11.5923) and the coefficient (0.012056) indicate statistically significant positive effect of inflation rate on manufacturing output. Specifically, 1 percent increase in capital will induce a less than proportionate percent increase in manufacturing output. This result also does not apriori expectation but it is an indication low productive capacity of the sector. The estimates for market capitalization (t=7.7102 and α=0.522986) show significant positive effect on manufacturing output, an indication that an increase in market capitalization enhances the capacity of the market to support manufacturing operations thereby raising the output of the sector. This is in agreement with a priori theoretical expectation. For foreign direct investment, the t-statistic (6.8332) and α coefficient (-0.670851) indicate significant negative effect of foreign direct investment on manufacturing output. This outcome implies the foreign direct investment inflow leads to reduction in the output of the manufacturing sector. It is however not in agreement with theory.
The result further shows that monetary policy rate (proxied as interest rate) has significant negative effect on the output of the manufacturing sector such that if interest rate is raised by 1 per cent, there is a decline in manufacturing output by about 0.05 per cent. This outcome indicates that manufacturers react to high interest rates by borrowing less, thereby not being able to produce more or even maintain existing production level.
Finally, the result financial deepening (proxied as M2) shows statistically negative effect of broad money supply on manufacturing output performance. The coefficient of -0.035878 indicates that 1 per cent increase in money supply reduces manufacturing output by about 0.04 per cent. This does not agree with a priori expectation but it suggests diversion of monetary aggregates away from manufacturing, possibly to sectors that offer high and fast returns.

4.4: Granger Causality Test
The granger causality was conducted to determine how changes in one variable affect the behaviour of the other variable. The results are presented in tables 5 and 6. To ensure consistency in the result, the causal relationship between exchange rate and manufacturing output was examined using the pairwise granger causality method. The results of the analysis at lag one and two show that a significant unidirectional relationship exists between exchange rate and manufacturing output in Nigeria with causality running from exchange rate to manufacturing output. This implies that exchange rate significantly affects manufacturing sector output at 5 percent significance level.
Based on the result, the alternative hypothesis is accepted for the two results since the p-value of the f-statistics at lag 1 and lag 2 show (0.0008 and 0.013 respectively) are significant at 5% level of significance (> 0.05).

4.5: Error Correction Mechanism
To check for the ability of the model to adjust to short-run disequilibrium, the error correction mechanism model (ECM) was employed and the result is as presented in table7.   period. The coefficient of adjustment of the ECM is correctly signed i.e. negative. It lies between the theoretical expectations (from -1 to 0). The negative sign indicates convergence in the long-run. Thus, the model will rightly act to correct any deviation of the dependent variable from its long-run equilibrium value.

V. CONCLUSION AND RECOMMENDATIONS
The study examined the impact of exchange rate deregulation effects on manufacturing industry output in Nigeria. The unit root test revealed that all the variables attained stationary trend at first difference. The normalized Johansen cointegration technique was used to ascertain evidence of longrun relationship between the explanatory variables and manufacturing industry output. The empirical findings revealed that exchange rate has non-significant positive longrun effect on manufacturing industry output. However, unidirectional causal impact of exchange rate on manufacturing output was established using the pairwise granger causality test. Based on the above findings, the study concludes that exchange rate deregulation policy has significant effect on the performance of the Nigerian manufacturing sector. Given that exchange rate has a significant relationship with manufacturing industry output, it is recommended that in discharging the mandate of exchange rate management, the monetary authorities should aim at stabilizing exchange rate through the use of appropriate monetary policy tools as well as support export diversification programmes in order to enhance foreign exchange inflow.