Friday, April 22, 2016 6:27PM / FDC
The current exchange rate crisis facing Nigeria stems from the country’s high import content. Almost everything in Nigeria is imported from toothpicks to refined petroleum products. The reliance on imported items has led to a huge demand for foreign exchange and a depreciation of the naira through the years.
The country’s external reserves, which have been used to defend the naira from spiraling out of control, have been on a free fall in recent years. Though some argue that the gross mismanagement of the country’s external reserves is what brought it to its present low level, it is instead the intense pressure from Nigerians’ utilization of imported products that has led to a dearth in external reserves as and a low import cover of less than five months.
This dire economic position has been further complicated by the significant drop in export revenues from crude oil, resulting in external reserves being depleted without being refilled.
Besides negatively impacting the country’s exchange rate and external reserves level, excessive importation has led to a near decimation of the country’s manufacturing industry. The comatose state of manufacturing is reflected in the country’s high unemployment and underemployment numbers.
In order to curtail Nigeria’s reliance on imports as well as reduce the deleterious effects of excessive importation, the government has developed an import substitution strategy that on one hand, limits access to forex (which then makes it difficult to import) and on the other hand, supports the country’s manufacturing sector.
The intent is noble. Import substitution has many benefits including improved employment and forex preservation. However, there are many factors that relevant authorities must consider to ensure that import substitution is effective, and that it does not lead to unnecessary economic woes for Nigerian businesses.
For example, many businesses, especially those that require key imported raw materials, are still counting losses incurred due to the CBN’s forex restriction. Additionally, the broad based import substitution that is being implemented in Nigeria lacks the focus necessary to develop a comparative trade advantage. As a result, any advancement in the manufacturing sector as a result of the program will not be self-sustaining. Thus, it is imperative that the government has a clearly pragmatic approach towards import substitution and that it learns from countries that failed at successfully implementing import substitution.
Impact of Import Substitution on a Country
Import substitution is a strategy to reduce a county’s dependence on foreign markets through the local production of goods, especially basic necessities. Even though it may seem like a viable economic step towards tackling import dependency and conserving foreign exchange, it does not always result in a positive out-come.
In general, countries that practice import substitution are usually characterized by trade protection and overvalued ex-change rates, which increase domestic prices and make exports less competitive. As a result, import substitution countries are of-ten unable to export enough to purchase required imports.
Thus, government authorities restrict imports to certain essential goods while the currency is devalued to make imports more expensive and exports attractive. The economy faces budget deficits due to government spending on industrial investments outpacing its revenue. More money is printed to cover the budget deficit, thereby stoking inflation, making domestic goods more expensive and reducing exports further.1
One example is India’s import substitution strategy between the 1950s and 1980s. The Indian authorities were pessimistic of the country’s ability to boost its export earnings and decided to embark on an import substitution policy.2 It implemented a range of import bans, quotas, high customs duties (sometimes as high as 200%), and harsh foreign exchange restrictions.
These protectionist policies led to a decline in India’s share of world export markets from 2% in the early 1950s to 0.53% 40 years later due to loss of export opportunities. India also faced balance of payment problems due to the growth of its import substituting industries, which required large quantities of imported raw materials, machinery and capital goods. Another consequence of import substitution was the creation of inefficient and obsolete products that could not compete in the international market.
There were also instances when import substitution worked well in a country. Sri Lanka’s agricultural sector recorded increased production due to import substitution policies. Protectionist policies led to the increase in production of rice and several food crops . However, it is important to note that import substitution sup-ported by input subsidies, effective marketing plans, guaranteed prices and research.
Though countries usually undertake import substitution in order to enhance domestic production and reduce foreign dependence, import substitution may actually create economic problems pressures that were not envisaged. These policies become viable if it is complemented with government support and adequate infra-structural investments.
Import Substitution in Nigeria
Import substitution is not new in Nigeria as several past administrations have attempted various import substitution strategies. Some of these include the 1972 Indigenization Decree, which led to the development of the petrochemical plants, the iron, steel, textile, breweries, agriculture and cottage industries, and the establishment of assembly plants that used imported processed materials in the automobile and cement industries.
Though these at-tempts met some degree of success, it is mainly the cement industry that has been able to fully actualize the benefits of import substitution. Nigerian cement companies not only meet local demand for cement, they also export cement to neighbouring African countries.
In 2012, the Jonathan Administration introduced the Nigeria Industrial Revolution Plan (NIRP) in order to enhance local production of goods that were imported as well as chart a comprehensive course for turning Nigeria from a country that only exports raw materials (crude oil) to one that has a solid manufacturing base.
The current Buhari Administration has repeatedly stated its intention to revolutionize agriculture, manufacturing and overall infrastructure. The decision by the current administration to implement this highly comprehensive and strategic NIRP, developed by the past administration, should help reposition the country’s manufacturing industry in the medium term.
The case for import substitution is strong given data from the National Bureau of Statistics (NBS). In 2015, Nigeria spent approximately N1.6 trillion on importing “boiler, machinery, appliances”, N1.3 trillion on “mineral products” and over N600 billion on “vehicles, aircrafts and associated parts”. Spending such huge amounts to import has led to a dearth in local manufacturing and a steep decline in the foreign exchange earnings conserved.
Though import substitution has the benefit of increasing domestic employment, enhancing resilience against global shocks, conserving foreign exchange and protecting domestic infant industries, it is not without its drawbacks.
Nigeria’s protectionist and import substitution strategy of import bans, quotas, and the restriction of foreign exchange allocation to the importation of select items are reminiscent of India’s import substitution blueprint.
The blanket policy approach of banning or restricting the importation of a wide range of intermediate goods and finished products without ascertaining the feasibility of producing such items has led to increased production costs and rising inflation.
The Lagos Chamber of Commerce and Industry (LCCI) recently released a document highlighting the impact of the CBN’s tightened foreign exchange policy on businesses and the economy. The sectors that have been heavily affected include: financial ser-vices, manufacturing (food and household products), the tire and rubber industry, pharmaceuticals, oil and gas, and furniture and foam manufacturingsectors.
Generally, the impacts of the CBN’s extremely restrictive foreign exchange policy include:
• a significant reduction in manufacturing output given that many of the products on the list of the 41 items with forex allocation restrictions are intermediate goods, which are critical inputs to several manufactured products;
• lower profitability and higher production and operating costs;
• higher credit defaults with foreign suppliers due to the lack of forex to settle obligations;
• increased inflationary pressures;
• higher unemployment due to the closure of several manufacturing companies; and
• Negative perceptions of the country as an investment destination.
Hence, there is a need for a critical examination of the import substitution policy.
Given the need for Nigeria to reduce its over reliance on imports and improve its global trade competitiveness, it is imperative for the country to have a feasible plan to lower its import content and develop its export potential. Despite the merits of import substitution and protectionism of local industries, choosing such an economic approach underscores a lack of clear economic vision.
The current import substitution strategy in Nigeria seems to be borne out of fear and capricious thinking rather than clear economic rationalization. For instance, the CBN’s shutting official access to forex for the importation of selected items uses import substitution as a smokescreen for the real exchange rate issue of currency misalignment and forex scarcity facing the country.
In addition, rather than have a blanket policy towards import substitution and trade controls, a case by case approach that limits the importation of goods based on a comparative advantage analysis should be used. In essence, a temporary import substitution for select commodities in which Nigeria has potential comparative advantage should be pursued.
The country should also have an export-oriented economic vision to spur growth and development while also reducing dependence on imports. Countries such as Japan, South Korea and China that have used an export promotion approach attained a fast rate of economic growth despite beginning from a state of underdevelopment. This outward-looking strategy to development has led to growth not just in primary products and raw materials segment, but also in manufacturing.
Additionally, incentives and governmental support are required for successful reduction in import content and export development. The success in the development of the cement industry to its cur-rent state, where it is dominated by local cement manufacturers that also export, can be replicated in other sectors.
This is especially necessary in agriculture where government can provide subsidized financing, inputs and machinery. There could also be incentives to attract foreign investors as they respond positively to favourable trade and forex policies. It is critical to make the business environment attractive to foreign investors so that they can bring their capital, technology, managerial and technical experience to the country.
A combination of temporary selective protectionist restrictions, innovation, governmental support, human capital development and an effective export-driven master plan is required to catalyze Nigeria’s economic and industrial development. This will save Nigeria from the claws of import dependency.
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