ABSTRACT
Exchange rate volatility has a direct impact on import and
export trade. The adoption of a flexible exchange rate regime after the demise
of the Bretton Woods system of exchange has become a major source of risk to
trade and therefore, negatively affects imports which are critical to the
development and growth of third world countries. This study therefore, examined
the impact of exchange rate risks on the profitability of auto parts dealers
(importers) in Ghana who have carried on their businesses from 2000-2015. The
study used qualitative methodology hence descriptive statistics which reveals
that the exposure of auto parts importers to exchange rate risks are caused by
domestic currency depreciation, excessive demand for foreign exchange, type of
foreign exchange market, source of supply, credit sales, credit period, default
payment and type of vehicular parts. Auto parts importers in Ghana are thus
exposed to exchange rate risks and exchange rate volatility impacts on firms`
cash flows, profitability and therefore market value. It is thus recommended
that the financial markets should be well developed to accommodate and support
the operations of auto parts importers considering the economic importance of
the road sector to Ghana`s economy. Also, policy makers should work to control
inflation and stabilize the value of the cedi.
CHAPTER ONE
INTRODUCTION
Thirty years under the Bretton-Woods system of exchange rate
saw a relatively stable nominal and real exchange rates. However, exchange
rates volatility increased from the early 1970s after the collapse of the
Bretton-Woods system as the world adopted a flexible exchange rate regime which
has been a major source of concern to developing countries such as Ghana.
Exchange rates influence trade in many diverse ways. Real exchange rates which
reflect relative prices of tradable to non-tradable products have a potentially
strong influence on the incentive to allocate resources such capital and labour
between the productive sectors. The critical issue is that, exchange rates
volatility is very profound under a flexible regime and this constitutes a huge
source of risk to trade and therefore can impact negatively on imports which
are economically critical to the very survival and growth of developing
countries.
Background to the study
Trade in the 21st century is beset with new risks and impacts
that threaten the very survival of every organization including the micro and
small firms in every country. Since the breakdown of the Bretton Woods system
of fixed exchange rates, both real and nominal exchange rates have fluctuated
widely from the early 1970`s. This volatility has been cited by the proponents
of managed or fixed exchange rates as detrimental, since exchange rate
uncertainty would adversely affect the valuation of multinational firms. Models
developed by Shapiro (1974) and Dumas (1978) predict that changes in exchange
rates negatively impact a multinational cash flows, its profitability, and
therefore its market value.
Several African countries in a bid to transform and develop
their economies in the 1980s, adopted various economic reforms (such as SAP,
PAMSCAD and ERP) with the liberalization of the foreign exchange market as a
key consideration. Consequently, Africa has experienced highly volatile exchange rates since then.
Akpokodje and Umojimite (2009) posit that the perceived link between exchange
rate volatility and imports raises some pertinent questions as to whether there
is any connection between exchange rate volatility and imports and if there is,
the degree of effect of exchange rate volatility on imports and the magnitude
of this effect. For instance, Warjiyo (2013) posits that the advent of the
global financial crunch in 2008 brought in its wake volatile capital flows and
increasing risk appetite of international investors. These developments
triggered significant exchange rate volatility beyond its fundamental
equilibrium path in most small open economies, including Ghana.
Statement of the problem
The role played by firms currently in the economy of all
countries is undoubtedly of great importance. However, firms with foreign
subsidiaries as well as those that trade internationally are susceptible to
global currency fluctuations and therefore movements in foreign exchange rates
can wipe out profits or increase gains of private investments. The world has become
a smaller market place due to rapid advances and sophistication in
communication technology. Technology has therefore helped in reducing
international trade barriers thus playing a crucial role in boosting
international trade. The elimination of restrictive international trade
barriers, capital controls, fixed foreign exchange regimes among many others
have contributed to the promotion of free trade across distances and political
boundaries. Though international business opens up new and profitable opportunities,
it simultaneously brings into play several challenges which include foreign
exchange risk management.
A major argument put forward against flexible exchange rates
regime has been that exchange rate movements could have negative impact on international
trade and investment. In speculating exchange rate movements, if the exchange
rate movements are not fully anticipated, an increase in the exchange rate
movements which directly increases risk, will result in risk-averse firm agents
reducing their import or export activities and redirecting resources towards domestic markets. With growing involvement
and participation of Africa in international trade, market participants which
include exporters, importers, producers, traders and investors have become
increasingly exposed to exchange rate fluctuations. Basically, volatility of
exchange rates is influenced by factors such as weak economic fundamentals
(such as Inflation rate, GDP growth rate and unemployment rate), excessive
speculative activity and macroeconomic shocks.
Firms engaged in foreign trade, transact business in foreign
currency, thus exposing them to the risk associated with adverse movements in
foreign exchange rates. Excessive volatility of foreign exchange rates will
increase uncertainty regarding returns and therefore makes it difficult to
manage current cash flows, project business growth and investments. In the
current global competitive market environment, managing foreign currency
exposure has become an inevitable but important feature in international trade
and investment. With increasing flow of global investment and trade towards
Africa in anticipation of higher returns, the associated unpredictability of
exchange rate movements is impacting negatively on stakeholders. Hence, there
is a need to evaluate and understand the foreign exchange risk facing various
stakeholders doing business in Africa and ways to minimize the impact.
The importation of new auto spare parts and accessories as
well as used ones is a major industry in Ghana which employs millions of
Ghanaians across the length and breadth of the country. Used motor vehicle
parts and accessories are heavily patronized by many Ghanaians as well as
people from French speaking countries within the West African sub-region.
Activities of firms, enterprises as well as individuals in this industry, are
concentrated in the regional capitals which include Kumasi “magazine” in the
Ashante region, Takoradi “kokompe” in the Western region and Abossey Okine in
the Greater Accra region. These are well-known trade centres that control a
majority interest in the industry. The location of Abossey Okine spare parts
market in the capital city of Ghana, makes it the nerve centre of both new and used motor vehicle spare parts trade in Ghana.
The Abossey Okine spare parts market have been in existence for over forty
years and has membership which cuts across West African countries with Ghanaians
dominating.
Even though this is an industry that employs millions of
Ghanaians (males and females), there is virtually no known research work
conducted to assess the economic value of this industry, its` contribution to
Ghana`s gross domestic product (GDP), how dealers could finance their import
trade with foreign exchange and how revenues of these dealers are adversely
affected by exchange rate volatility.
Purpose of the Study
The adoption of a market economy and thus a floating exchange
rate regime predisposes developing economies such as Ghana`s to high levels of
exchange rate risks, thereby making both export and import trade very risky.
Several studies conducted in Ghana have investigated the effect of exchange
rate volatility on trade in general but have not considered the automobile
sector with particular focus on the auto spare parts industry. Most of these
research works used secondary data in examining the effect of exchange rate
volatility on trade and also on profitability of firms. This study therefore
adopts a descriptive research approach and uses primary data from respondents
sampled. This will allow for in-depth knowledge about how exchange rate
volatility affects import of auto spare parts into Ghana in order to
effectively design and implement policies that will help the industry develop,
grow and expand.
Research objectives
The main objective of the study is to examine and explain the
reasons why importers of auto spare parts in Ghana are exposed to exchange rate
risk which makes it very difficult for them to maximize profits and expand. The
study also seeks to assess how other circumstances affect the profit maximization objectives of dealers in auto
spare parts operating in Ghana among other factors. Specifically the study
seeks to achieve the following objectives:
To examine the determinants of exchange rate risks facing
auto parts dealers in Ghana.
To assess the impact of exchange rate volatility on the
profitability of auto parts importers in Ghana.
Research questions
This study focuses on the following questions to find answers
in order to achieve the objectives stated above:
What are the determinants of exchange rate risk among auto
parts dealers in Ghana?.
Does exchange rate volatility affect the profitability of
dealers in auto spare parts in Ghana?.
Significance of the study
Even though there have been several studies on effects of
exchange rate volatility on the profitability of firms especially banks and
insurance companies, there is very scanty literature on exchange rate risk
exposure of businesses in the informal sector particularly those in the import
sector and the impact it has on their profitability. In a country where almost
every item is imported ranging from used clothes to tooth pick, it is almost
impossible for any business entity to thrive without being exposed to exchange
rate risk. It is then quite pertinent to note that an industry that employs
millions of people has still not received any special attention from
government, financial institutions as well as academia to harness the full
potential of the industry. As noted by the Association of Youth Auto Spare
Parts Dealers (AYAPD) at Abossey Okine (2009), the fast depreciation of the
cedi, import duties and other port charges are the main challenges facing their
trade with foreign exchange risk having the greatest impact on their overall
earnings.
Delimitations
With the exception of only three working papers on
determinants of profitability of auto parts business in countries in Africa
which include Ghana, all the other theories presented under the theoretical
review are on American, European and Asian countries which may not directly
relate to Ghana in terms of macroeconomic indicators and industry structures.
The study looks at the import business of auto parts dealers in Ghana in
general, but with particular attention focused on dealers at the Abossey Okine
spare parts market in Accra who have existed for not less than ten years. Other
auto parts centres dotted across the length and breadth of Ghana are not
covered by the study. The study used exchange rates between the Ghanaian cedi
and the three main trading currencies namely; the US dollar ($), British pound
sterling (₤) and the Euro (є) to analyse the effect of their movements on the
profitability of auto parts importers.
Limitations of the study
The study adopts a qualitative research approach using descriptive
research design due to the data type and data source which also inform the
choice of sampling procedure. This approach helps to describe variables rather
than to test a predicted relationship between identified variables. Qualitative
methodology is dialectic and interpretive. During the interaction between the
researcher and the research participant, the informant’s world is discovered
and interpreted by means of qualitative methods (De Vos, 1998). However,
qualitative research method has a number of weaknesses which affect results
findings and include:
Data collection often involves large amounts of handwritten
notes, which must be sorted out and organized into meaningful and data.
To generate the findings, the researcher needs to examine all
the notes and tabulations and to organize them in some way that “makes sense”.
There are no fixed steps that should be followed and the
study cannot be exactly replicated (Brink &Wood, 1998).
Organization of the study
This study is organised into five chapters which are
carefully arranged in the following way: Chapter one, presents an overview of
the whole study. It further explains the justification for the study and how
its objectives will be achieved. Chapter two presents a review of both
theoretical and empirical literature on the concept of exchange rate risk,
measures of exchange rate risk and the effect of exchange rate risk on
profitability of auto spare parts dealers. Conceptual and theoretical framework
are also explained. Chapter three looks at the methodology adopted by the study
which includes sections such as the research design, sampling and sampling
procedure, data and data collection procedure, instrumentation and method of
data processing and analysis. Chapter four contains the analysis and
interpretations of the data and findings. Chapter five provides the summary,
conclusions of the content of the entire study and draws out recommendations
for policy direction.
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