EXCHANGE RATE RISKS AND PROFITABILITY OF AUTO PARTS DEALERS IN GHANA

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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Item Type: Ghanaian Project Material  |  Attribute: 69 pages  |  Chapters: 1-5
Format: MS Word  |  Price: GH110 ($20)  |  Delivery: Within 30Mins.
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