Asymmetric Responses of Manufacturing Sector to Changes in Exchange Rates, and Bank Credits: Developing Country Evidence

Abstract

This paper analyses the asymmetric responses of manufacturing output to changes in exchange rates and bank credit in Nigeria. The results reveal significant countercyclical effects of exchange rate changes on manufacturing output. Bank credit to the private sector was the only predictor with procyclical effects on Nigeria’s manufacturing output. As these responses are often impacted by behavioural patterns, shifts in policy and economic fluctuations, the study employed the non-linear ARDL method alongside the Wald test, Quandt-Andrews and Zivot-Andrews tests. The results of the phase shift analysis show that in Nigeria, only private sector credit leads the manufacturing output cycle, while changes in the exchange rate, inflation and lending rates lag behind. Regardless of the timeframe, manufacturing output was adversely affected by positive and negative changes or variations in the exchange rate. Shifts in bank credit, whether positive or negative, had a positive and considerable effect on manufacturing production. The Wald test confirms the presence of asymmetry in the effects of the exchange rate and private credit on output. The Quandt-Andrews F-statistics for both the maximum likelihood ratio (LR) and Wald statistics, as well as the Zivot-Andrews intercept and trend test results, show that there were breakpoints in bank credit and exchange rate variations in different years, particularly in 2016 and 2020, which marked periods of economic recession, health pandemics, policy shifts, external shocks and macroeconomic instability, as measured by rising petrol pump prices. Neither model, with or without structural breaks, supports the conventional economic theory that devaluation leads to an expansion in output. This is attributed to the contractionary effect of naira depreciation in the context of significant foreign currency-denominated external debt. The negative output effect of naira devaluation in Nigeria was also explained by the low level of competition among domestic firms. In the short term, the results further account for the inflation-output trade-off in Nigeria’s manufacturing industry, while in the long term, the neutrality principle does not fully apply to Nigeria, whose financial market is still emerging, hampered by structural imbalances in the economy. To minimize arbitrage, the Nigerian government should implement financial policies capable of closing the gap between devaluation and appreciation of the naira exchange rates. Specifically, the monetary authorities should set credible inflation targets, and the rate of interest adjustment should align with these targets. This can be achieved by creating an autonomous central bank responsible for maintaining price stability. The research findings will be valuable to manufacturers, the financial sector and small and medium-sized enterprise (SME) owners, both in and outside Nigeria. SMEs and manufacturing industries can benefit from government funding, aid, or investment tax breaks. Such initiatives may take the form of reinvestment allowances, amortization allowances or cash-based grants.