Why control of forex volatility and inflation is key for Nigeria’s industrial output growth
The overlapping period of upward exchange rate volatility, high inflation, and decline in industrial sector contribution to aggregate GDP data establishes inter-relationship of the economic indicators.
Successful industrialisation of the Nigerian economy will expand national output, reduce income inequality, increase foreign exchange earnings, and stablise the value of the national currency. Over the last four decades, however, the country's industrial sector has experienced significant relative decline in productivity and contribution to national output.
The industrial downturn has been attributed to upward volatility of the exchange rate and rising inflation, amongst other causes. The aggregate economy expanded on average at a rate of 3.35 percent from 1985 to 2010, and at 2.5 percent from 2011 to 2021, according to the Central Bank of Nigeria (CBN) Statistical Bulletin, 2021. But in these periods, the industrial sector recorded an average growth of 0.30 percent and 0.55 percent.
For a developing economy like Nigeria, which has made several policy efforts towards industrialisation, the aggregate economic output and output growth are expected to be driven by greater percentage contributions of the industrial sector. Unfortunately, empirical has not backed such a supposition.
To unravel the dilemma, it is important to explore the nexus of the country’s exchange rate regimes, inflation, and industrial output. Incidentally, choosing an appropriate type of exchange rate (fixed or floating) that guarantees the stability of the value of the local currency has been a key objective of the country’s exchange rate policy. Accordingly, Nigeria's exchange rate regime has transitioned from a fixed regime in the 1960s to a pegged system between the 1970s and the mid-1980s, before transitioning to various variants of a floating regime starting in 1986, following the introduction of market ‘deregulation’ and the adoption of the Structural Adjustment Programme (SAP).
A major mechanism of SAP was the auction method used to determine the naira exchange rate in the ‘free market.’ However, this sparked off precipitous fluctuations in the naira exchange rate. In what was a managed floating exchange rate regime, inflation became elevated and there was no strong commitment to defending any specific price threshold.
It is important to note that instability and uncertainty have accompanied the various exchange rate regimes. The uncertainties were fostered by policy reforms that either promoted systematic movement of the exchange rate or induced exchange rate volatility.
Exchange rate volatility impacts economic performance through a variety of channels including interest rate, credit penetration, and rising prices of other assets. Fluctuations in the exchange rate can significantly affect economic output and prices by impacting demand and supply of goods and services. On the supply side, a country acts as a global price taker when its domestic currency depreciates or is devalued. This directly affects domestic production and price level. The prices of capital goods imported by manufacturers as inputs for domestic manufacturing also tend to increase on account of naira depreciation or devaluation.
According to data obtained from the CBN Statistical Bulletin (2021), between 1985 and 2010 the average share of industrial output to the gross domestic product (GDP) was 44.12 percent; but between 2011 and 2021, it decreased to an average of 23.25 percent. The data further shows that in 1981, Nigeria's average industrial capacity utilisation was 73.25 percent. By 2010, the value had fallen to 56.22 percent.
Furthermore, between 1981 and 2021, the industrial sector contracted 16 times. CBN adduced the pattern of exchange rate volatility – resulting from currency devaluation and external shocks – as a causative factor for the output decline. The year with the highest positive growth in industrial production during the period under review was 1990, with a growth rate of 15.30 percent year-on-year. But the overall average growth rate from 1981 to 2021 is only a negligible 0.37 percent.
Evidently, Nigeria's manufacturing sector has performed poorly over the last 40 years, with diminishing contributions to the country's GDP. This period coincided with decades of high inflation and exchange rate instability in the country. Inflation soared from 11.29 percent in 1987 to more than 50 percent between 1988 and 1989. In 1990, it dropped to around 7.36 percent but subsequently increased to 44.59 percent in 1992 and 57.17 percent a year later. Nigeria’s inflation grew to its peak of 72.84 percent in 1995.
World Bank data shows the nation’s historical inflation as staggering. The average annual inflation rate from 1960 to 2021 was a double digit of 16.1 percent. However, the overall increase in price for the period was 566,912.02 percent. Indeed, whereas Nigeria’s inflation rate for 2021 was 17.0 percent, the world’s average was 3.5 percent.
The overlapping period of upward exchange rate volatility, high inflation, and decline in industrial sector contribution to aggregate GDP data establishes inter-relationship of the economic indicators. Exchange rate volatility and high inflation have co-acted to hamper industrial sector’s contributions to the Nigerian national output, with grave implications for the welfare of Nigerians.
To address ‘imported inflation’ of capital goods sourced from overseas, the government needs to invest in local technology alternatives. High and rising prices of domestic manufactured products also discourages local demand. To address this situation, concerted efforts should be made by the monetary and fiscal authorities to reverse the high and upward trajectory of inflation. So far, fiscal and monetary policies have been at cross purposes, with the latter counteracting the expansionary budgets and deficit spending of the former – including the excessive ways and means financing provided the federal government by the CBN.
To improve the value of the naira and stymie the negative impact of high foreign exchange rate on inflation and investment in the real sector economy, the government must introduce reforms that would attract foreign investors to invest in Nigeria. The government should also provide a favourable environment for trade, successfully counter insecurity, and invest in physical and social infrastructures while also encouraging private sector investment in them.
If adequate policy and investment steps are taken, the Nigerian industrial sector can grow in leaps and bounds and make higher contributes to output growth. Overtime, the sector can become dominant in the economy. Exportation of locally produced or processed goods will bolster the value of the naira. The ongoing de-emphasis of the oil sector should see a rise in the emphasis placed on the industrial sector and its value chain – including education, research and development (R&D), and trade.
Olabusuyi Rufus Falayi, PhD, is a Senior Lecturer, Department of Economics, KolaDaisi University, Ibadan, Oyo State, Nigeria.
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