EXCHANGE RATE VOLATILITY AND FIRM-LEVEL ECONOMIC ACTIVITIES IN NIGERIA

Abstract

Exchange rate volatility (the risk associated with unexpected movements in exchange rate) adversely affects economic activities, both at the micro and macro levels, because it increases uncertainty. Between 1990 and 2012, Nigeria’s exchange rate volatility ranged from 0.1% to 38.8%, while the average annual growth of exports of manufacturing firms declined from 12.7% to -27.4%. Previous studies generally focused on the effects of exchange rate volatility on macroeconomic variables with little attention on firm-level activities. This study, therefore, examined the impact of exchange rate volatility on firm-level investment, output and export in Nigeria.

Three semi-log equations (investment, output and export), based on the theory of the firm, were estimated. Data were collected on 50 manufacturing firms and were classified into oil and gas, food products, beverages, conglomerates, healthcare, agricultural, household durables, industrial goods, printing and publishing, automobile and tyres sub-sectors. The criteria for sample selection were based on data availability and representativeness of the various sub-sectors. Firm-level data were obtained from the firms’ Annual Reports and Financial Statements and macroeconomic data were collected from International Monetary Fund’s International Financial Statistics Year Book. Exchange rate volatility was computed using the Generalized Autoregressive Conditional Heterosckedacity (GARCH) model. The one-step system Generalized Method of Moments (GMM) estimator was used to determine the effects of exchange rate volatility on firm-level investment, output and export, while the Hansen, Sargan and Breusch-Godfrey diagnostic tests were carried out to establish the robustness of the parameter estimates. Statistical significance was determined at the 5% level.

Exchange rate volatility had a negative impact on firm-level investment, output and export, with disparities across sub-sectors. A percentage increase in exchange rate volatility reduced firms’ investment by 0.4% and 0.7% in the agricultural and household durable sub-sectors, respectively. The relatively low reduction of investment in agriculture was attributed to limited imported inputs. On output, a percentage increase in exchange rate volatility reduced firms’ output in the food products, beverages, healthcare, and automobile and tyres sub-sectors by 0.4%, 0.1%, 0.8% and 0.01%, respectively. The effect of exchange rate volatility was lower on firms’ output in the automobile and tyres sub-sector as the firms in the sub-sector earned foreign exchange and were able to hedge against the risk of exchange rate volatility. A percentage increase in exchange rate volatility reduced firms’ export in the food products, beverages and healthcare sub-sectors by 1.1%, 3.1% and 4.0%, in that order. These relatively high percentages suggested that exports by firms in the sub-sectors would decline significantly in the event of exchange rate volatility. All these results showed that the sampled firms were heavily dependent on external trade which was influenced by exchange rate volatility.

Exchange rate volatility led to a decline in firm-level investment, output and export in Nigeria. Effective management of exchange rate by the monetary authority is desirable in order to moderate the adverse effect of exchange rate volatility on firm-level economic activities. Keywords: Exchange rate volatility, Firm-level economic activities, Generalized Method of Moments model Word count: 478